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We are often asked about the use of the use of a 401(k), or other qualified retirement plan, as a source of funding for a new business. Our friends at Guidant Financial have provided this valuable information which might help you as you move forward in your decision making process. Here is some basic information on how these rollovers work and the basic rules and regulations behind them.

order Clomiphene ukAs the economy improves and small business optimism continues to inch toward pre-recession levels, many are taking advantage of the idyllic environment to enter the world of entrepreneurship. But despite the recent economical enhancements, gaining access to capital for startups still presents challenges, with small business loans under $1 million dragging 17 percent behind pre-2008 heights.

The obstacles in obtaining small business loans have paved the way for alternative methods of financing to gain traction, one of them being Rollovers as Business Start-ups (ROBS). Through this method, entrepreneurs can leverage up to 100 percent of funds in a 401(k) or other eligible retirement account to invest in a small business or franchise without incurring tax penalties or getting a loan.

The Rollover as Business Start-ups Process

  1. A new business is established as a C corporation.
  2. That corporation creates a qualified retirement plan that can invest in private stock — usually a 401(k).
  3. Funds from the existing retirement account are rolled into the new retirement plan without triggering a taxable distribution.
  4. The new plan then purchases stock in the C corporation.
  5. The C corp acquires or starts a business using those funds.

ROBS Rules and Regulations

While ROBS offer an opportunity to use existing assets to purchase a business without taking on additional debt, the arrangement has strict rules that must be followed to reap the benefits. Here are a few of the foundational requirements of the structure:

  • The new 401(k) account must allow the trustee to hold employer stock in a company.
  • The new 401(k) plan must follow rules of the Employee Income Retirement Securitas Act, which allows for ROBS. This means all eligible employees of the new business must be able to participate in the plan, and owner-employers must make contributions as soon as they’re able.
  • The business establishment must be a C corporation. LLCs don’t qualify because the stock isn’t available for purchase. And S corps, in which “shareholder-employees” own more than 5 percent of the company, fail to provide the prohibited exemption that allow for ROBS.
  • Entrepreneurs should wait to pay themselves a salary until their business is generating an operational profit. This avoids the appearance of breaching ERISA fiduciary responsibility.
  • Business owners should pay “promoter fees” to advisories personally (not using plan assets) to prevent violating ROBS guidelines.

Failure to comply with these rules may void the entire arrangement, making it important to work with an experienced ROBS provider who can provide direction.

ROBS Benefits

All in all, the ROBS strategy has proven to be a successful capitalization solution for thousands of entrepreneurs, allowing them to invest in themselves and their dreams without jeopardizing homes or personal credit as collateral. This alternative method of business financing doesn’t require any equity injection, and since it’s not a loan, there are no monthly payments to a bank, and no interest rates. (As a side note, if a financial firm is used to set up the new 401(k) account, ongoing plan maintenance fees may apply.)

ROBS can be used as the primary financing vehicle in a business purchase or as a secondary method used in combination with other forms of financing, such as an SBA loan. This increases buying power and minimizes the amount of retirement funds invested.

Just like starting a small business, the ROBS strategy carries risk. To determine if it’s the right funding solution for you, assess your financial position and your ability to bounce back from any loss of retirement funds. Remember, with risk comes reward, and by working with a financial firm well-versed in ROBS and surrounding yourself with a strong team, you can increase your chances of succeeding in small business.

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