A financing option called a Rollover for Business Startups,ROBS, can provide you with financial resources to fund your business purchase or expansion. Here’s what you need to know about the process, including the pro’s and con’s.
How does a ROBS work?
Funds from eligible retirement accounts, including a 401(K), or a traditional individual retirement account, are rolled over into a business investment with the help of an attorney or a ROBS provider. The funds are invested in a new business, franchise or an existing business.
A C corporation is formed – a corporate structure that allows shareholders. A new 401(K) plan is then created for the business.
The owner’s existing retirement accounts are rolled into the new 401(k) plan. Most retirement accounts qualify for the rollover.
The rolled-over funds are used to purchase company stock in the C corporation. The proceeds from the sale of stock is the cash that is invested in the business.
ROBS is one financing option for your business
Lenders typically require strong personal credit, positive cash flow and collateral before approving a loan. A Rollover for Business Startups provides an option for an entrepreneur who has built up their retirement savings but who may otherwise have difficulty qualifying for a standard business loan.
You don’t take on debt
A ROBS isn’t a loan. You don’t have monthly payments with high interest fees or default concerns. You can reinvest more of your profits into your business. This is critical for most new and growing businesses.
You don’t pay penalties or taxes
Withdrawing funds directly from a 401(k) or IRA before turning 59½, create a 10% early withdrawal penalty and you will face a distribution tax. These are avoided with a ROBS.
Your retirement may be at risk
Despite the potential payoff, this is a downside. As a result of a business failing, your retirement nest egg may also disappear.
You’ll lose out on retirement-savings gains
Since you have committed your retirement nest egg to finance your business, you will lose the potential gains from a rising stock market, the tax-deferred savings of 401(k) and IRAs, and the power of compounding as investments grow over a long period time. Remember though, this is a potential gain.
You must operate as a C corporation
A C corporation is the most common business structure for larger companies. The tax implications differ from sole proprietorships and limited liability companies.
You may be faced with costly fees
Leading ROBS providers charge as much as $4,995, plus a monthly admin fee. Their services include assistance with filing the necessary IRS forms. These fees cannot be paid using the proceeds of the transaction.
The risk of an IRS audit may be greater
The IRS may look at you a little closer after completing a ROBS, according to Barbara Weltman, author of “J.K. Lasser’s Small Business Taxes 2017″
As a result, mistakes made during the transaction could wind up disqualifying the ROBS plan, which in turn could result in IRS penalties and may make the transaction taxable, Weltman says.
Guidant Financial CEO David Nilssen states only 0.33% of its ROBS clients faced an audit last year.
That suggests the likelihood of an IRS audit is extremely slim.
Does a ROBS make sense for you?
Weigh the pro’s and con’s of a ROBS for you personally. Please seek the advice of a qualified attorney or tax expert. Alternatives include: personal savings, bootstrapping or partners.
A ROBS is great for people with the confidence to invest in themselves.