If you’re looking for a business to buy, it can help to have cash on hand. Why? Because the capital and cash flow issues involved in financing the purchase of a business can be significant enough to stop business owners from realizing their dreams or even cause a small business to fail down the road. An innovative business and franchise funding solution can help aspiring small business owners get the cash they need to buy a business. It’s Rollovers as Business StartUps (ROBS), also known as 401(k) business financing.
Let’s review the potential capital and cash flow issues that face an aspiring business owner and then look in-depth at how ROBS works for business owners.
Buying a Business Can Be Challenging
1. Funding and costs can present barriers
Buying a business can present immediate challenges. If you need funding, loans to start a business can be very hard to get. The Small Business Administration (SBA) offers to guarantee loans to small business owners granted by participating banks. But only roughly 25 percent of SBA loan applicants are approved.
Even if a loan application to purchase a business is approved, the bank’s financial requirements can be very steep. Many banks want a 20 percent to 30 percent cash down payment to grant a business loan. Many lenders also require that small business applicants can show 100 percent collateral for any business loan with personal, non-business assets. You may have to collateralize your home and other significant assets just to meet the bank’s requirements.
Banks also like to see that a business has succeeded before they get involved. As a result, they’re more likely to grant a business loan if you’re buying a successful existing business or a franchise. If your dream is to get your business idea off the ground, a bank may be of little — or frankly, no — help.
You need an excellent credit history to get a loan to purchase a business. Business owners with less-than-stellar credit history may be knocked out of the box before they begin.
It doesn’t help that prices for buying a business can be high, either. Common business acquisition costs, according to the SBA, include office or physical plant space, equipment and supplies, inventory, any licenses and permits, lawyer fees, accountant fees, utilities, insurance, any employee salaries, market research, and communications. You may also need to factor in the cost of developing and maintaining a website and advertising and marketing costs. Outlays specific to your industry or sector need to be added to these costs.
The end result is that purchasing a business of any type can require a considerable spend. Even franchises categorized as “low cost” need up to $60,000 to start. A more expensive franchise, such as a McDonald’s, requires $500,000 of personal capital before the company will even consider a potential franchisee.
2. Loan payments may tie up needed capital
It’s not just the initial purchase of a business or franchise that can be a financial issue for business owners. If business owners are successful in purchasing a business through a loan, they will need to make ongoing loan payments.
Monthly payments on an SBA loan of $250,000 can run $2,775. Monthly payments on an unsecured bank loan of the same amount are even higher, at $3,881. These payments can be a drain on business cash flow, hampering business development, expansion and ultimately, success.
Business Owners Need Cash on Hand
The problems of getting a loan and making ongoing payments mean that it can be a very smart move to have cash on hand when you’re searching for a business to buy. Currently, only 10 percent of purchases of existing businesses are done with all cash. But there are multiple advantages to an all-cash purchase.
1. You can avoid loan payments, freeing up cash flow
Cash enables you to buy a business outright and frees you from ongoing debt payments. That means business cash flow can be entirely utilized for the success of the business, rather than making debt payments.
Cash flow shortages can be a significant risk to a growing business, and an all-cash purchase eliminates part of that risk.
2. You have greater flexibility
All-cash purchases increase an entrepreneur’s purchasing flexibility. If you’re buying an existing business with cash, the seller might be more inclined to sell to you if you don’t need outside funding. Why? There’s less risk to the seller. Risk can increase if a lender is involved, because a lender’s requirements may cause delays or result in the financing deal not going through at all.
Sellers can also find the faster closing possible with an all-cash purchase appealing. A loan closing with a lender can take months. All-cash purchases can be accomplished in a few weeks.
It’s even possible to benefit in terms of price. A cash purchase gives you the opportunity to negotiate with a seller for a discount on the purchase price.
An initial cash purchase also gives you the flexibility to expand the business later on, using financing. Once the business is underway and successful, you may want to enlarge a product line or add a new location. Purchasing with cash means you can grow the business with financing and not be overburdened with debt payments.
ROBS: A Method of Cash Purchase
So, cash on hand is the way to go if you’re looking to buy a business. But how do you get cash on hand? What happens if you don’t have thousands of dollars sitting in your checking or savings account? After all, most people don’t.
That’s where ROBS comes in. All you need to utilize ROBS as a funding method is $50,000 or more in your eligible retirement funds. Thirteen percent of small business owners surveyed in the 2019 Small Business Trends report using ROBS, making it the second most popular financing method for purchasing a business, after cash.
Using ROBS as a method of cash purchase has multiple advantages to a business owner.
1. ROBS provides flexible financing
ROBS can be used with multiple business types: cash to purchase an existing business or franchise, seed capital to start a new idea and working capital to fund the business. You can be cash-rich, giving your business excellent prospects for success from the very beginning.
ROBS leaves your personal assets, such as a home, boat, or other financial assets, free from collateralization by a lender.
ROBS can also give you cash for a down payment on a larger loan. If the funds available in your 401(k)s are not sufficient to purchase a business outright, you can use these funds to provide a down payment on a bigger SBA loan.
Finally, ROBS provides time flexibility. Most ROBS close within three weeks. There’s no waiting on lenders or the SBA.
2. ROBS leaves you debt-free
You’re using your own money in a ROBS purchase so that all the cash generated by your business can be used for operations or expansion. ROBS leaves you free of loan obligations that can sap your cash flow and drain your business.
Business owners think minimizing debt is one of the most important benefits of purchasing a business with retirement funds, according to a recent Guidant Financial customer survey.
3. ROBS doesn’t incur taxes and penalties
If you’re younger than 59 ½, you may be wondering about the taxes and penalties usually incurred if you withdraw money from a 401(k) or IRA before that age. But you do not incur taxes or penalties when setting up a ROBS business funding structure, whatever your age.
There’s no better testimony to the efficacy of ROBS as a business financing method than the fact that 81 percent of Guidant Financial clients who use ROBS were still in business when their fourth anniversary came around, versus an industry average of 39 percent.
We’ve helped over 20,000 businesses get off the ground – it’s your turn. Learn more about ROBS today.