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Creditor Proofing

Subject: Creditor Proofing Number: 09-04 Date: 2/20/2009

Equity may include inherent goodwill that is not reflected on the balance sheet

It is prudent for business owners to periodically protect the accumulated equity of a business from potential creditors. In most situations, payment of a dividend from the operating business to its holding company will be tax-free and will move equity out of the operating business.

Equity may include inherent goodwill that is not reflected on the balance sheet. As long as the appropriate "solvency test" is met, payment of a dividend that creates an accounting deficit may be permitted.

If the equity is required to finance ongoing operations, the dividend can be loaned back to the operating business on a secured basis. The impact of a dividend payment should be discussed with the company's bankers. Ratios, while not affected on a consolidated basis, will change in both Holdco and Opco.

If it is reasonable to expect that some of the equity will not be reinvested in the business, you should be careful to monitor eligibility for the capital gains exemption. If Holdco's non-operating assets or investments exceed 10% of the value of the Holdco, the capital gains exemption on the sale of Holdco will not be available. There are alternative structures for creditor proofing that can be used in such situations.

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