Being able to obtain funding is key to the start, survival and growth of any business. Business owners have many options for funding, including obtaining a loan or raising venture capital funding. But what happens when you can’t qualify for a loan or pique investor interest? A Rollover as Business Startups (ROBS) plan is a creative way to use money from your 401(k) account and invest in your business. Normally, if you withdraw from your 401(k) account before reaching the age of 59½, you will face a 10% early withdrawal penalty as well as hefty income tax deductions. ROBS, however, allows you to rollover your retirement account into your business without the penalties of early withdrawal.
How Does a ROBS Plan Work?
In order to take advantage of a ROBS plan, your business has to be a set up as a C corporation and you must hold a qualifying retirement account. A qualifying retirement account includes plans that fall under 401(k), 403(b), 457(b), Keogh Plan, Simplified Employee Pension (SEP), Thrift Savings Plan (TSP) and Traditional Individual Retirement Account (Traditional IRA). A Roth IRA, however, is not compatible with a ROBS plan.
Most retirement accounts usually invest in a complex portfolio of various company stocks to hedge economic risks over time. Under a ROBS plan, however, you are investing all your funds into just one company’s stock—your own. You are using your retirement funds to purchase equity in your own business so that your business will have money to operate.
First, a business owner rolls over his or her qualified retirement account into a retirement account owned by the business (which must be set up as a C corporation). Next, the business directs the retirement account to purchase corporate stock in the business. Finally, the business is able to use the proceeds from the sale of stock as working capital.
Pros and Cons of a ROBS
Like many other financing options, a ROBS plan comes with its own share of advantages and disadvantages. The main advantages include easier access to funding and the avoidance of immediate taxation and early withdrawal penalties on those funds. With a ROBS plan, business owners don’t have to worry about credit checks or loan payments. Having monthly loan payments can restrict a business’s working capital when they need it most to grow.
The main disadvantages include the risk of losing your retirement savings if the business fails and increased scrutiny by the Internal Revenue Service (IRS). A ROBS plan also limits what type of legal entity your business can form as it must be a C corporation. Given tough IRS scrutiny, business owners with a ROBS plan will likely end up paying service fees to third-party providers to keep the plans legally compliant and will have to offer employees the option to buy stock when the ROBS transaction takes place.
Starting a ROBS Plan
While it is possible to administer a ROBS plan yourself, it is much easier and safer to use a provider given the numerous legal and tax considerations. ROBS plans require continuous maintenance to ensure that the plan remains in compliance with legal and tax regulations. The IRS issued a memo in 2008, detailing common legal issues that previous ROBS plans have run into. These issues included failures to offer the option to buy stock to other company employees and the performance of prohibited transactions relating to the valuation of stock and promoter fees.
Given increased IRS scrutiny, third-party providers are useful for setting up and maintaining ROBS plans to meet regulatory requirements and avoid legal pitfalls. In addition, providers are able to assist with filing the required annual tax information return (Form 5500) and any audits. Providers will often impose an initial setup fee as well as ongoing maintenance fees. Typical fees are around $5,000 for initial setup and $100 per month for maintenance.
Providers who specialize in ROBS plans include:
Guidant Financial is one of the older and more well-known ROBS providers given the large number of customers they have serviced through the years. Guidant Financial offers a free consultation phone call and the ability to prequalify through their online application.
Benetrends offers ROBS plans under their flagship product known as the “Rainmaker Plan.” Although Benetrends services both franchise and non-franchise businesses, Benetrends is known for its expertise in the franchise business industry.
FranFund services both franchise and non-franchise businesses, and similar to Benetrends, they are a good choice if you're looking for an expert in the franchise space. Costs are slightly cheaper than a plan through Guidant, but FranFund is also much smaller as well.
CatchFire Funding is a newer operation compared to the previous providers, having been founded in 2008. They offer a “no-risk, money back guarantee” for the 401k funding process as well as for any retirement plan audit.