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Over the decades, a handful of misconceptions about 401(k) business financing have cropped up. To clear up the confusion, we’ve addressed the most common myths in this chapter.

Separating Fact from Fiction About ROBS

Despite its existence since 1974, 401(k) business financing, formally known as Rollovers for Business Start-ups or ROBS, is still not a well-known option for those wishing to become small business owners. Even with increased popularity in the last decade, there remains a large amount of misinformation regarding this business funding option. Let’s take a minute to address a few myths surrounding Rollovers for Business Start-Ups:

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ROBS is tax avoidance.

Using ROBS to fund your business or franchise is in no way tax-avoidance. Congress enacted the Employee Retirement Income Securities Act of 1974, which, in conjunction with a specific section of the Internal Revenue Code, provides American workers with another vehicle for building retirement assets through ROBS.

ROBS is a loan.

ROBS is NOT a loan – rather, it’s a completely debt-free financing solution. With this funding solution, you’re investing your retirement funds into your new business or franchise. This is one of the major benefits of ROBS: you enter business ownership without the burden of loan payments or interest. In fact, 81 percent of Guidant clients who utilize ROBS are still in business after 4 years – nearly double the success rate of entrepreneurs who start a business with only debt financing.

Absentee business owners can use ROBS.

This is not the case: anyone who uses Rollovers for Business Start-ups must be a bona fide employee of their business. This is the fifth pillar requirement of the ROBS structure, which we discussed in-depth in Chapter 1. We suggest you work at least 1,000 hours per year (part-time) to be considered a bona fide employee — which means silent investors and absentee owners are ineligible to use the ROBS structure.

Your company must be a C Corp to use ROBS.

This one is true: one of the requirements of the ROBS structure is that the operating company be a C corporation. However, we have many clients who form subsidiary LLCs underneath the umbrella C corp, where the C corp is the parent company and a 100 percent owner of the LLC. This may add a protective layer of liability between the operating business (the LLC) and the C corp.

Getting funding with ROBS can take months.

Negative, Ghostrider. The ROBS funding process can take as little as three weeks if you use a qualified and experience provider. Because there are few eligibility requirements and no application, the process moves very quickly. The factors that most impact timing are how quickly you file the necessary paperwork, the speed at which your current custodian (the firm that handles your original retirement account) releases your funds and which state the corporation is filed in (some states are faster than others). Most ROBS transactions are completed in 30 days or less.

Your retirement account is not diversified with ROBS.

A typical retirement account is invested in a variety of options within the stock market, keeping it diversified between industries and types of investments. The fear here is that by rolling over your retirement assets to invest in a single business (your own), you’ll lose the diverse investment portfolio.

However, many people roll only a portion of their retirement funds into the new business – the rest can remain in the 401(k) plan and invest in more traditional investments (stock, bonds, mutual funds) or can be in another retirement account altogether. Additionally, ROBS can be used in conjunction with other financing options (SBA loans, seller financing, portfolio loan, etc.) to further increase your investment options.

ROBS and self-directed IRAs are the same thing.

While ROBS and self-directed IRAs (SDIRAs) both serve the purpose of financing a business, there are some major differences between the two. First, people who use an SDIRA cannot work for the business they invest in or take a salary, while ROBS users are required to work for the business and to take a salary. Second, the amount invested with an SDIRA may be liable for the unrelated business income tax (UBIT), which can get very expensive very quickly.

Learn more about the differences between ROBS and SDIRAs here.

ROBS cannot finance franchises.

While the name ‘Rollovers for Business Start-ups’ suggests ROBS can only be used for small businesses, this is not the case. After all, a franchise is a small business too! Each franchise location is still owned and run by independent business owners, regardless of the large franchise system it operates under. At the end of the day, ROBS can be used with a variety of business purchases: start-ups, first-time franchise locations, existing small businesses and existing franchises. At the end of the day, these are all small businesses and can be funded with ROBS.

In fact, many top franchise brands point their franchisees toward ROBS as a quality financing option. It does not matter if you want to build a new location or purchase another franchisee’s existing one – ROBS can be used for both.