How do I use a holdco loan to an opco to finance a business purchase?

Buyers often set up a holding company, the holdco, to own the shares of the operating company, the opco, that carries on the business. That raises a practical question for the lender: if the loan goes to the holdco, how does the money reach the business? The answer depends on whether the deal is an asset purchase or a share purchase, and it shapes the security and guarantees the lender asks for.

Route one: the intercompany loan

In this route the holdco borrows from the lender and then re-lends some or all of the money to the opco under its own intercompany promissory note, and in many deals a separate security agreement between them. The opco then uses the funds directly, for example to pay part of the price for assets it is buying or to fund working capital. It leaves a clear paper trail showing the money reached the business.

Route two: shares plus opco security

In a share purchase the holdco often pays the seller directly for the opco’s shares, so the opco never receives the cash. The lender then looks to the opco’s business instead, asking for a guarantee from the opco and security over its assets, typically a general security agreement registered under the Personal Property Security Act in Ontario. The opco’s directors need to authorize that guarantee properly, because the opco is standing behind debt it did not receive.

What else to expect

Lenders usually want security over the opco’s assets, not just the holdco’s shares, and confirmation that dividends can move up to the holdco to service the loan. The Canada Small Business Financing Program guidelines say a holding corporation is not an eligible borrower because it does not operate a business, and that financing a share acquisition is not eligible, so neither route fits that program. Whether interest is deductible depends on how the borrowed money is used, so see interest deductibility and ask your accountant.