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401(k) Business Financing: Who Should Use It and Who Shouldn’t

Here’s a look at both what makes someone a great fit for ROBS and who should fund their business through other avenues.
It’s no wonder that more and more people are funding their businesses using 401(k) business financing. Also called Rollovers as Business Startups (ROBS), the benefits of using this method can be especially attractive. First and foremost, you can utilize your retirement funds to start a business debt-free, which puts you at an advantage as a new business owner with limited capital. Working with an experienced ROBS provider also ensures that your funding transaction doesn’t trigger any tax penalties when accessing your retirement funds. And finally, qualifying for 401(k) business funding is fast and easy — there’s no lengthy application and the entire process takes about three weeks.

Not surprisingly, ROBS business funding is a great option for many people looking to launch or buy business or franchise without taking on debt. However, for some, it’s not always the best choice, and other options should be explored. Here’s a look at both what makes someone a great fit for ROBS and who should fund their business through other avenues:

Who should use 401(k) business financing?

First-Time Entrepreneurs

Traditional funding methods are typically less accessible for first time entrepreneurs. When assessing the borrower, lenders like to see a successful history in business as well as a strong business credit score. It’s obviously tough to present either one if you’re just starting out, which makes ROBS a smart choice for first-timers. Qualifying for ROBS is easy and doesn’t require any checks on your personal or business credit scores. Whether your credit history isn’t robust enough or has a couple dings, you can still access business funding up to the full amount of your rollable retirement funds.

Those Who Don’t Have Enough Cash for a Loan Down Payment

ROBS can still help you achieve your goal of small business ownership if you need more funding than what’s available in your retirement account. Many people turn to 401(k) funding when they need money for the down payment on a business loan from the Small Business Administration (SBA). SBA loans provide up to $5 million in small business funding, but typically require a down payment of at least 20 – 30 percent of the total loan amount. Most hopeful business owners don’t have this amount of cash in their personal savings or prefer not use it toward business funding. Fortunately, the money rolled over during a ROBS transaction can be used as a down payment — making it much easier to qualify for a business loan.

Those Who Aren’t Comfortable in Debt

Large amounts of debt can cause a vicious cycle for business owners. The first couple of years in business can be challenging from a financial perspective as businesses strive to maintain cash flow in the midst of start-up expenses. Finances are made even more stressful when the business needs to make a loan payment with interest. Equity financing options, like ROBS, give your business a huge advantage because the money used to fund your business is not a loan and there are no payments to make. Using ROBS, revenue earned can be put back into growing the business. Anyone who is interested in avoiding taking on debt to launch their business should consider funding with ROBS.

Who should not use ROBS business funding?

Passive Investors

While ROBS is a great funding arrangement for launching or buying a business, it’s not a good fit for those who would like to their retirement funds for passive investing. This is due to the IRS code and DOL regulations that make ROBS funding legal, which require any business funded through ROBS to be an active, operating company. For example, if you’d like to purchase a vacation home and rent it out when it’s not in use, this scenario does not qualify for ROBS funding. There are a few other instances that don’t meet the IRS requirement for ROBS funding — any third party provider should be able to help you determine if your situation qualifies before you start the funding process.

Those Who Need Less Than $50,000 in Business Funding

The cost to start or purchase a business can range from just a few thousand dollars into the millions — making business ownership accessible to almost anyone. The amount of funding available to you when using ROBS is completely dependent on the amount of rollable funds in your retirement account. While there’s no minimum funding amount, it’s typically not in your best interest to use ROBS if you plan to roll less than $50,000. Even though ROBS helps you avoid paying any tax penalties for withdrawing funds, most providers charge around $5,000 to perform the rollover along with monthly administration charges. Paying the fees to roll less than $50,000 means you lose the financial benefits of tax-deferred funding.

Those Who Don’t Want to Maintain a 401(k) Plan

In today’s competitive job market, offering a 401(k) plan to employees is a great way to attract top talent. And as part of the requirements for the ROBS structure, your new company must sponsor a 401(k) plan, which you and your eligible employees can participate in. While maintaining a retirement plan may seem too complex, most ROBS providers offer 401(k) Plan Administration as part of their monthly services, which can simplify the burden on you. However, it’s important to note that you will be required to submit documents to your Plan Admin team so they can complete your plan’s required annual reporting. If for any reason you’re not willing to commit to offering the plan to your employees, ROBS may not be a good fit.

The ROBS arrangement can be a versatile, accessible funding option that puts many people into business who otherwise wouldn’t be able to fund their venture. However, even with all of its advantages and simple qualification process, it’s not the right fit for everyone. So do your due diligence before jumping in.

To learn more about the ins and outs of ROBS, check out our Complete Guide to Rollovers as Business Startups.

Want to Use ROBS to Start a Business?

Our step-by-step Guide to Rollovers for Business Startups is a complete handbook of everything you need to know about using ROBS to start or buy a small business or franchise.

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