Have you heard of 401(k) business financing, also known as Rollovers for Business Startups (ROBS)? While 401(k) is the most commonly used, ROBS lets you use various retirement funds to finance your business. But is ROBS safe?
Like any other business loan, using ROBS is investing in your business. Unlike a business loan, you don’t have to worry about over-hanging debt. That’s the thing: ROBS isn’t a loan. And that’s why it’s become an increasingly popular financing method among entrepreneurs looking to start their business debt-free and cash-rich.
Keep reading for an in-depth breakdown of what ROBS is and how it works — and a review of its key advantages and possible disadvantages.
Maximizing Your Retirement with ROBS
People who invest usually choose from several asset classes: stocks, bonds, real estate, and more. Each has a risk/reward profile. For example, the stock market and mutual funds can appreciate well but also lose value in market fluctuations. But an alternate form of financing, Rollovers for Business Startups (ROBS) or 401(k) financing, is also a type of investment. If you run a small business or are an aspiring entrepreneur, ROBS can be an investment in your business’s equity, a salary from the business, and your future.
ROBS is an increasingly popular form of small business financing in which entrepreneurs use their own retirement funds, such as 401(k)s, to fund their company, rather than financing methods such as a bank loan or trying to raise equity from outside investors. In fact, in our Small Business Trends 2024, over half of respondents used ROBS as their financing choice.
Let’s briefly discuss how a ROBS program works and its advantages. We’ll also look at its possible disadvantages to help you make an informed decision about an investment in ROBS.
How ROBS Works
Utilizing ROBS allows small business owners to invest in their businesses by using their own retirement plans. While the use of 401(k)s is common enough that “401(k) financing” is an often-used term for ROBS, a number of retirement plans using employer contributions and employee contributions are qualified, including traditional Individual Retirement Accounts (IRAs), 457(b)s, 403(b)s, Thrift Savings Plans (TSPs), Savings Incentive Match Plan for Employees (SIMPLE) IRA Plans, Simplified Employee Pension Plan (SEP) IRAs, Keogh Plans and other plans, such as pensions.
If you withdraw money from tax-advantaged retirement plans, you usually have to pay tax if you’re not yet 59½ years old — and you are subject to fines for early withdrawal. ROBS protects you from both taxes and fines.
So, how does ROBS work? In ROBS, you set up a C Corporation (C Corp) and establish a new retirement plan for the C Corp, open to all employees. Once that is established, your retirement funds are rolled into the new C Corp’s retirement plan. The money is used to purchase stock in a new C Corp. Once that is done, the money can be used for virtually any business purpose.
Advantages of ROBS
Effectively, utilizing ROBS is investing your chosen retirement accounts into your business. ROBS can confer many advantages on small business owners and aspiring entrepreneurs vis-à-vis other funding options.
Debt and Penalty-Free Financing
Many people turn to business loans as their first funding choice, for example. But business loans can have significant drawbacks. The first is monthly debt payments. Debt payments can sap the cash flow that businesses need to stay afloat. Remember: ROBS lets you start your business debt-free and cash-rich. Why? Remember: ROBS isn’t a loan. That means you aren’t stuck with paying expensive monthly debt payments.
What’s more, ROBS allows you to withdraw from your retirement funds early without facing expensive taxes or penalty fees, giving you complete control over your funds.
No Collateral or Credit Required
In addition, business loan lenders often have requirements that are onerous for small businesses. They generally want collateral, such as personal assets (like a house), as protection against risk. If you default on the loan, your collateral goes to the bank. They often also want large down payments of up to 30 percent of the loan. That’s a large cash outlay, especially for a startup.
With ROBS, you don’t have any collateral requirement (which means no risk to your collateral), and no down payment requirement. ROBS can even be used in conjunction with a loan, and for all or part of a down payment. Learn more in Using Your 401(k) as an SBA Loan Down Payment — Penalty-Free.
Unlike traditional business loans that heavily rely on creditworthiness, ROBS also bypasses this requirement entirely. This aspect of ROBS is invaluable for individuals who may face challenges obtaining approval for conventional financing due to their credit history. By leveraging funds from eligible retirement accounts, such as 401(k)s — without incurring early withdrawal penalties or taxes — aspiring business owners can sidestep the credit barrier entirely.
Complete Freedom
Another popular financing choice for small businesses is raising equity from outside investors. This can seem very attractive. Angel investors and venture capitalists often specialize in businesses of a certain size and industry. Family and friends can potentially be a source of outside investment. But raising equity isn’t without risk.
The chief risk is that equity investors in your business have a stake in it. That means they have the right to weigh in on the decisions and direction — meaning your business can become less subject to your control. In fact, business owners have been known to lose control entirely to outside investors.
Outside equity investors can also dilute your own holdings in a business. If your business gains value over time, you will not own 100 percent of that value because outside equity investors will own some percentage of it.
With ROBS, you are your own angel investor. You retain complete control over your business — the decisions and its direction. Outside investors can’t oust you.
Fast Financing
Both debt-heavy and equity financing methods can also sap the time of small business owners. Loans require time-consuming applications, and equity financing requires compiling shareholder material and pitching to investors. ROBS, on the other hand, is relatively streamlined and can be completed in roughly one month — much less time than any other financing method.
ROBS can also be particularly advantageous if you’re dealing with specific situations. First, if you want to start a business while you’re still employed, it can be challenging to get a loan or equity investors. ROBS puts funding in your control. (You can even use ROBS while keeping your job.) Second, if you’ve had past challenges with credit, you may not have the credit score a loan requires. ROBS removes all need for a credit score since the money is your own.
Learn the ins-and-outs of 401(k) Business Financing in What is ROBS? How 401(k) Business Financing Works.
Disadvantages of ROBS
Potentially Losing Your Nest Egg
ROBS has, candidly, several potential disadvantages as well. The first is the risk of losing your retirement nest egg and not having a comfortable retirement. Don’t forget: All small businesses carry some risk of failure, whether because of a lack of profits, a macroeconomic downturn, or any other reason. If your ROBS-financed business fails, you will lose the retirement funds you used, as well as the business itself and any income you received from it.
This can be a daunting prospect, but it’s helpful to remember that the risk of failure exists for other investments you might be considering. You can also lose money invested in the stock market. If your investments are in bonds or cash, the interest rates you earn on them may not outpace inflation (they currently don’t), which means the money is effectively diminishing in value over time.
All potential financing sources also pose risks if the business isn’t successful. If you obtain a small business loan and your business closes, you’ll still have to make the debt payments on the loan while losing the business itself and any income you received from it. Additionally, there’s the potential to lose the valuable collateral you’ve pledged for the loan. If you get outside equity investors and the business looks likely to fail, they could take it over entirely or sell their shares.
Remember: While using ROBS, you can continue to grow your nest egg as your business grows. You can choose how much funds you want to borrow from your retirement and how much to put back in over time.
Lack of Diversification
One of the investment risks ROBS carries is a lack of diversification, as your business, your salary, and your retirement could all be centered on the same business. One strategy to protect against that is only using part of your existing retirement funds for ROBS. Another is to invest your new retirement funds in investments other than the new C Corp stock.
More Complicated Administration
In addition to risk, ROBS also comes with more complex administrative work. You will need to make sure you follow all requirements specific to ROBS, such as being an employee and operating a business legal on the Federal level. You’ll need to provide documentation about the business and the new retirement plan for both the Internal Revenue Service (IRS) and the Department of Labor. Your chance of an IRS audit won’t necessarily be greater, but if one occurs, it may be more complex if you use ROBS than if you don’t. You’ll need to administer the new retirement plan.
In most cases, your ROBS providers help with the administrative burden and provide access to legal and accounting guidance for a fee. Your ROBS provider will help you set up and administer ROBS — and provide advice about regulations and requirements.
Get a comprehensive look at 401(k) business financing in Our Complete Guide to Rollovers for Business Financing (ROBS).
Is ROBS Right for You?
So, is ROBS a good investment for you? Now that you know its potential advantages and disadvantages, you can make an informed decision on whether ROBS is the right for you or not. For many, ROBS has been their ticket to business success and financial freedom.
Ready to learn more about ROBS? Be sure to check out our Top 10 Resources and Guide to Getting Started with ROBS.
Guidant Financial: A Partner for Your Business
If you’re looking for a reliable ROBS provider — and business partner — look no further than Guidant Financial. Guidant is the No. 1 ROBS provider in the U.S. Since 2003, we’ve helped fund and support over 30,000 small businesses nationwide. Our goal is simple: We’re here to support your business and its path with business financing solutions and services designed to help you succeed. Whether you have a small business idea to establish, a franchise to purchase, or a business to grow, we’d love to be your trusted partner.
At Guidant, we understand your goals and financial situation is unique. Whether you’re looking to finance your business with ROBS, SBA loans, or a combination of methods, our team of experts can help tailor the best strategy to meet your needs and goals — taking the stress out of business financing.
Call us today at 425-289-3200 for a free, no-pressure business consultation to get started — or pre-qualify in minutes for business financing now!
“When Falling Sky Brewing presented itself as a great opportunity for me, I needed the capital. Traditional lenders weren’t going to do it. I took a chance on myself that I could grow my business and my 401(k)… And I thought, ‘You know what? I could do this without overhanging debt.‘”
— Stephen Such, Falling Sky Brewing
Read the stories of REAL small business owners who work with Guidant.
