Holding company and operating company: which one borrows

Two-entity structures are everywhere: a property or asset-holding company on one side, the trading business on the other, the same owner behind both, and a lease between them. When it comes to borrowing, the structure creates one clean question — which entity signs — and one messy one — what the rent between them really is.

Which entity signs

Start from what the money is for.

Also note the size treatment: the regulation provides that "the Eligible Passive Company (with the exception of a trust) and the Operating Company each must be small under the appropriate size standards".

The rent, and why an analyst normalises it

Rent between related parties is a dial, not a fact. Owners set it for tax reasons, for basis reasons, or because someone picked a number in 2019 and nobody revisited it. An underwriter reading the operating company's profit and loss cannot take the rent line at face value, because you control both sides of it.

The operating company reports EBITDA of 196,000. Normalised to market rent, that becomes 196,000 + 30,000 = 226,000. On the strength of the trading business alone, you were understating cash flow by 30,000 a year, and if you had applied without explaining the rent you would have been underwritten on the lower figure.

Now do it the way a lender actually does it for a combined structure. Take the operating company's EBITDA before related-party rent: 196,000 + 96,000 = 292,000. The property carries annual debt service at the holding company of 71,400, and the operating company has 48,000 of its own annual debt service. Combined coverage is 292,000 ÷ (71,400 + 48,000) = 2.45.

That is the honest picture of the two entities as one economic unit, and it is far stronger than either set of statements read alone. Present it that way. If you do not, the analyst will build it themselves and may build it worse.

The reverse case is the dangerous one: rent set below market to make the operating company look profitable. Normalising it downwards reduces reported cash flow, and the holding company's loan then depends on rent that does not cover its own debt service. An analyst who spots this reads it as a structure that only works because the owner is subsidising one side.

The document walkthrough

• The lease. In writing, signed, dated, with a term at least as long as the loan you are asking for. A month-to-month arrangement between related parties is one of the most common reasons an SBA-structured deal stalls. If it does not exist, write it before you apply.
• Subordination. For an SBA-structured loan the lease has to be subordinate to the lender's security. Expect a subordination agreement and expect it to be non-negotiable.
• Financials for both entities, plus a combining schedule that eliminates the intercompany rent. Prepare this yourself.
• Evidence of market rent. A broker's opinion, a comparable lease, or an appraisal. Without it, the analyst picks a number.
• The ownership structure of both entities, with percentages, because the 20 percent guarantee rule reaches across both.
• Any management fees charged between the entities, which are normalised the same way rent is, and are harder to defend because there is rarely a market comparable.

Where the structure genuinely helps

• Asset protection between the sides. A judgment against the trading business does not automatically reach the property, subject to the guarantees you have signed, which is the usual caveat.
• Succession and sale. Selling the trading business while keeping the building is far cleaner when they were never the same entity.
• Different financing terms for different assets. Real property supports longer amortisation than working capital does. Splitting them lets each borrow on its own natural term instead of forcing everything onto one schedule.

Where it hurts

• Two sets of filings, two tax returns, two sets of books, and an ongoing obligation to keep the intercompany dealings documented.
• Guarantees that cross anyway, which removes much of the liability separation on financed debt.
• Cross-default risk. A default at the operating company can be an event of default at the holding company under the same lender's documents. Read the definitions section and find out.

What to do

Set the rent at a defensible market figure and document why. Write the lease for a term longer than any loan you intend to seek. Build a combining schedule now and keep it current. And before you apply, ask the lender two questions: which entity do you want as borrower, and which as guarantor, and does your cross-default definition reach the affiliate's obligations?

Refuse to leave the lease undocumented because "it is all the same money". To a lender, it is two companies, and the paperwork is the only evidence of which one owns what.