Using 401(k) Business Financing (ROBS) to fund a business isn’t new, but is unfamiliar to many. Learn the truth about common Myths about ROBS and how to get fast, debt-free financing.
Many aspiring small business owners are surprised to learn that one of the fastest, most equitable ways to fund their business is by using their retirement funds via the Rollovers for Business Start-ups (ROBS) arrangement. Though thousands of entrepreneurs use ROBS to fund their business every year, it’s not nearly as popular as traditional funding methods such as small business loans or lines of credit. Because it’s somewhat of a secret, there are many common misunderstandings or myths about what ROBS is and how it works.
Through ROBS, entrepreneurs can use their eligible retirement funds to purchase a business. The entire process involves about five steps and can be completed in as little as three weeks. As a result of the process, your new company sponsors a 401(k) plan that purchases stock in your new company — creating both a cash-rich business and a retirement plan for you and your employees.
Small business owners who use ROBS, also known as 401(k) business financing, enjoy multiple benefits such as low barriers to entry, no tax penalties, fast funding and increased buying power. If you’re interested in debt-free small business funding, don’t let common misconceptions stop you from pursuing your dream business with ROBS. Learn more about the top myths about ROBS f unding and the truth behind them.
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1. It’s a Tax Loophole
While ROBS funding does not trigger a taxable distribution or tax penalty for early withdrawal (not matter your age), it isn’t a way to evade taxes by any means. The Employee Retirement Income Security Act of 1974 (ERISA) was set up explicitly to encourage investment in small business, and it passed the responsibility of directing retirement funds from the employer to the employee. Just as you have the option in invest in public companies like Microsoft, your retirement money can purchase shares of your own private company and it’s perfectly legal.
2. ROBS is a Loan From Your 401(k) Account
ROBS is actually quite different from a loan from your 401(k) account. If you borrow money from your 401(k) plan, you’re provided an amortization schedule and required to make regular payments, with interest, back into your account. ROBS, on the other hand, is not a loan, but a re-direction of your retirement funds. So, there are no monthly payments to make and no interest to be paid. In other words, ROBS is truly debt-free business financing.
3. ROBS Won’t Grow My Nest Egg
In order to receive the benefits of a tax-free transaction, it’s recommended you roll at least $50,000 over when completing a ROBS transaction. However, many people only use a portion of their retirement assets, leaving the remainder in their existing 401(k) or IRA to be invested traditionally — increasing the diversity in their retirement fund. Even though ROBS funds aren’t in a traditional retirement account, the value of your 401(k) grows as your company does because it purchased stock. So, your nest egg still benefits.
4. ROBS is a Passive Investment
ROBS is not the correct funding structure to use if you’re planning on purchasing a business as a passive investor or absentee business owner. In order to meet IRS and DOL guidelines, you must be a bona fide employee of your new business. As a general rule, Guidant recommends you work at least 1,000 hours per year to be considered a bona fide employee.
5. ROBS Can Fund My LLC
As a part of the funding structure, it’s a requirement that any business funded by ROBS is formed as a C corporation. Limited Liability Companies (LLCs), S Corporations, and Sole Proprietorships do not meet the requirements. However, many ROBS business owners choose to form one or more LLCs, which are owned and operated directly under the main C corp. For those who aren’t familiar with C corporations, there are some little known tax benefits of a C corporation, which can help you save big.
6. ROBS Funding is Too Complex to be Fast
While ROBS funding does involve meeting important IRS and DOL guidelines to ensure a tax-free transaction, working with an experienced third party provider can make the process both simple and fast. Depending on the state in which you’re filing, and how fast you’re able to file the necessary paperwork, funding can take as little as a few weeks. Most are completed in less than 30 days.
7. ROBS is a Self-Directed IRA
It’s possible to finance a business with both self-directed IRAs (SDIRAs) and ROBS, but there are some major differences between the two. It’s an important distinction that ROBS business owners should work for the company and can legally take a salary, while neither are true for SDIRA funded companies. At Guidant, we provide time for our clients with assigned Outside Counsel attorneys (at no cost), who represent you and your company, who will help determine if ROBS is the best funding structure for you.
8. ROBS Can’t Fund My Start-up
As long as your business meets the requirements for ROBS funding, it doesn’t matter if you’re financing a brand new start-up or buying a business from someone else. ROBS is incredibly flexible in that you can use the funds for launching a start-up, buying an existing business (even when utilizing seller financing) or even purchasing a franchise. ROBS can also be combined with additional funding methods, such as Small Business Administration (SBA) business loans to increase your buying power. In fact, a recent survey showed that entrepreneurs who utilized ROBS funding had access to significantly more business capital than those who relied on loans or savings alone.
Funding a business and beginning your entrepreneurial journey can be an intimidating time, and one of the toughest decisions you’ll make is what kind of small business financing to pursue. However, you can find success by understanding all of your options, asking questions and doing your research. Get started by learning more about ROBS funding and how debt-free financing can benefit you and your company. Download our free, Complete Guide to Rollover for Business Start-ups here.