Resources abound for individuals looking to start new businesses, from multiple loans options to crowdfunding. But the Rollovers as Business Startups (ROBS) strategy, also known as 401(k) business financing, stands out as a unique opportunity for older aspiring business owners.
Rollovers as Business Startups (ROBS), also known as 401(k) business financing, is a business funding strategy that allows you to use your retirements funds to start a small business.
If you think taking cash out of your retirement funds to start a new business sounds risky, you’re not alone. In the wake of the Great Recession, it seems like even the experts are being reckless with their patrons’ money. This makes bootstrapping an appealing option.
But, depending on what kind of business you want to own, you’re looking at a significant initial investment that’s usually beyond what you’ve saved up or are comfortable parting with. It’s admirable to take the risk and believe in yourself enough to start a new business, but you also want to be prudent and strategic with your money. So where should you raise that cash?
Business Funding Options for Baby Boomers
What’s the best, most effective way to raise startup capital? Should you borrow, whether from family or friends or the Small Business Administration? Should you take out a mortgage (or a second mortgage) on our house? Or should you invest your own hard-earned cash to seed the business? Equity, after all, is powerful, both personally and professionally. Having ‘skin in the game’ is likely the first test of a business owner’s commitment to their business. Being able to invest in one’s own business establishes authority, and it commands respect. It also denotes leadership. While it doesn’t guarantee success, equity counterbalances debt and gives the new business owner a firmer foundation for their business.
While you might not have a lot of cash on hand, you probably have something tied up in a retirement account, whether a 401(k), traditional IRA, or similar. The problem with pulling money out of your retirement accounts is that the cash is subject to taxation (and an additional 10 percent penalty if we’re younger than 59 ½). You’d pay a penalty just to get your business off the ground — not a great incentive.
Here’s where the ROBS strategy makes sense. The single most important aspect is that the rollover from an existing 401(k) or other qualifying retirement account is 100 percent tax-free. Of course, the IRS will eventually get their slice when you pay taxes as a business owner, but just not now, when you need every cent to launch your business.
Whatever investment level you’re comfortable making to seed your business — whether it’s 20 percent or 100 percent of your retirement funds — doing it through the ROBS financing vehicle means that every dollar will go towards investing in and supporting your business. Even if you use ROBS as a down payment on a business loan – including those from the SBA – you’re leveraging your buying power and preserving your existing personal savings. You could also consider using ROBS as a vehicle to partner with other investors for your new business. Whatever your plan, you will reap the advantages of the tax-free rollover.
Why is ROBS superior to SBA loans for Baby Boomers?
There are a few reasons ROBS is an outstanding small business financing choice for senior aspiring business owners. First, many of the best business loans, such as SBA loans, are restrictively competitive. They also, in some cases, have a restrictively long application process.
While it’s illegal for lenders to discriminate based on age when it comes to mortgages, age can play a factor in other personal loans. Age can intentionally or unintentionally influence the loan tenure, amount, or even interest rate.
Finally, self-funding business strategies such as crowdfunding are often complex and require experience in graphic design, marketing, and more.
Rollovers as Business Startups requires no expertise: your 401(k) Business Financing provider takes care of the hard bits of the process for you. It’s also faster than many funding vehicles — your business could be funded in as little as 4 weeks! Finally, ROBS is exemplary because it doesn’t require you to go into debt.
Best Practices with ROBS
Here’s how the ROBS process works:
ROBS transactions are carefully monitored by the IRS and DOL, meaning there are very specific guidelines that must be met. This process may seem complicated, but the operational guidelines make good common sense and are in line with other organizational practices we’re all familiar with. Some of the key considerations are:
- Fiduciary requirements for ROBS are intended to prevent conflicts of interest that could undermine the integrity of the business. This should be a no-brainer, as we all want to build businesses that are sound and sustainable. This ROBS guideline can actually ensure we’re not tempted or distracted by bad practices that could damage our business.
- A ROBS-funded business must be an “operating” business that is investing in commerce, not a hobby, nor a vehicle that is intended to simply pay the owner a salary or help out a friend or family member. Again, this requirement helps avoid making an unwise business decision and forces us to scrutinize our venture thoroughly before making the investment.
- Management of the new retirement plan established to fund the business must be fair and transparent, allowing proportional participation by all qualifying employees without giving undue advantage to corporate officers and/or leadership. This is another incentive for us to regard the business as a real entity and to act responsibly.
Guidant Can Help
Ready to learn more about ROBS? Then check our Complete Guide to ROBS.
Ready to get started, have a special case, or want more detailed information? Pre-qualify and talk to a Guidant agent by filling out the form below!