What Are ROBs and How Can You Use Them to Fund Your Business?
Starting a business requires cash. The problem is that few entrepreneurs have a ready supply handy.
If you're looking to fund your new venture, you have several options. Yes, you can borrow from the bank or find investors, but you'll be starting your business in debt. But did you know you may be sitting on a pile of cash, which can allow you to start your business cash-rich and debt-free? If you have money in a qualified retirement plan, you are (cash-rich) and can (start your business) with a process known as ROBS (Rollovers for Business Start-ups).
What Are ROBS?
With a ROBS plan, you withdraw money from your 401(k) or other tax-advantaged retirement fund to finance your new business venture. Normally, if you withdraw money from one of these accounts before the age of 59 1/2, you'll pay both income taxes and an early withdrawal penalty. In the example below, your $200k retirement plan, once subjected to penalties and taxes, leaves you with $120k to use for your new business.
ROBS is a particular program election that allows you to use these funds without the income tax or withdrawal penalty. That means, the entire $200k is available to use. You can use ROBS to start a new business or to purchase an existing business. The money from your qualified retirement plan is not a loan, so you don't begin your business in debt.
However, you should be aware of both the pros and cons of using a ROBS before you make your choice.
The Pros and Cons of Using ROBS
The biggest benefit to using a ROBS is that you don't have to worry about debt with your new business. Depending on your credit situation, some lenders hit small businesses with exorbitant interest rates for loans, which could stifle your cash flow.
Another benefit to the ROBS option is that your business has a higher chance of success. One lender sponsored a study that showed 67 percent of companies who used ROBS were still in business after five years compared to the standard rate of 30 percent.
A ROBS also won't have any impact on your personal credit, which can't be said for other borrowing options. If you borrow any money for your business, your personal credit will suffer. Because of the way a ROBS is structured, you can still contribute funds to a tax-advantaged retirement account as your business grows. PLUS, if you have issues with your credit, you can still use the ROBS for your start-up. It’s your money, after all.
There are a few downsides to choosing a ROBS for your business funding. If your business fails, you've lost those retirement savings that you've invested. On the other hand, if you borrow money and your business fails, you'll have a closed business and existing debt to pay. And, chances are, you’ll be tapping into your retirement funds, paying taxes and possibly an early withdrawal penalty.
There is a possibility of an IRS audit or Department of Labor audit with a ROBS. However, these instances are few, and most ROBS providers offer support and assistance through the process.
Finally, a ROBS plan has specific requirements, and it is best to work with a firm that specializes in these types of plans.
How ROBS Funding Works
There are 4 basic steps to setting up a ROBS, which you can easily navigate with the help of retirement plan services firm that specializes in these types of transactions.
You must first establish your business as a C Corporation (step 1), and then create a retirement plan for the corporation (step 2). It can be either a profit sharing or 401(k) plan, depending on your business needs.
Once this is done, you'll transfer funds from your personal IRA/401(k) into your business' new retirement account (step 3). That new plan uses the funds to buy stock in your company, and your business uses the proceeds from that stock sale as its retirement plan funding, or business capital (step 4).
A ROBS transaction isn't for everyone, but it can be an excellent option for business funding under the right conditions. There are always risks with starting a new business, so you can minimize some of those financial risks by using an existing retirement plan as funding to eliminate debt concerns.
As with any business decision, you should weigh the pros and cons of ROBS and use a trusted provider to set up and manage your arrangement. Benetrends is not only the originator of ROBS funding, but we are the leading provider of franchise funding. Need more information? Contact us today to discuss whether using an ROBS is right for your business funding needs.