Lending Back Profits

In this article we will discuss the advantages of taking profits out of your corporation and then lending the money back to the corporation.

If you have a tightly held company leaving the profits in your company can be risky. Too much retained earning can make you a target for lawsuits. It also puts your cash in last place should things go wrong.  It is more often best to take the profits out of the company on a regular basis and if the company still needs the funds lend them back to the corporation.

If you take the money out and lend the money back make sure you do the paperwork right. Create a note and make or accrue the interest payments.

It is not all one sided, of course. Your bank will likely rather have the money in the corporation rather than loaned back particularly if you are heavily leveraged. Most banks will want a low Debt to Equity Rations. Debt to Equity Ratio = Total Liabilities/Stock holder Equity. This will vary by industry but the banks will want a debt to equity ratio as low a .5 for some industries but generally no higher than 2. If you lend money back to the corporation and the bank treats it like any other loan it could result in a very high and therefore unacceptable ratio.

One way around this in most situations is to subordinate the stockholders loans to the bank loans and requiring the bank be paid in full before the stockholder loan can be repaid. This requirement will often increase the debt to equity ratio allowed by your bank. In effect you they are allowing the stockholder loan to count as equity.

In our development business our debt to equity ratio was very high largely due to the fact that the loans were all collateralized by real estate. When the real estate market was booming the value of the developed real estate was often much higher than the cost to acquire and improve the land even though the developed property was held on the balance sheet at cost. Often times we were able structure investment funds, either stockholder loans or outside investment, as loans instead of paid in capital by providing the banks subordination agreements.  It also allowed us to return the initial investment to the investors at the completion of each subdivision.

If properly documented lending back profits to you closely held corporation can provide advantages including protecting the assets from disaster while letting your bank count the funds as equity in the Debt to Equity ratio. 

Original Content copyright 2011 Thomas Robinson