Using Rollover for Business Startups (ROBS)

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Steady financing has always played a major role in a small business’ success. However, since capital investors and startup loans seem like the Holy Grail at times, many entrepreneurs seek alternative forms of financing that are less contentious as their businesses take off and grow. One of those alternative sources for funding is a Rollover for Business Startups or ROBS. In short, ROBS allow business owners to transfer $50,000 or more from their retirement plans to their companies as investment capital.

As with any tool of entrepreneurship, ROBS have their advantages and disadvantages, so if you’re interested in utilizing them as a source for funding, it’s important to understand the details and how they work. Each ROBS plan is different and may have requirements that create more harm than help.

How a ROBS Plan Can Help Your Business

No investment strategy should be taken lightly, especially one that involves using money specifically set aside for your retirement. But it’s easy to see why some entrepreneurs are eager to take advantage of a ROBS plan to help secure their business and their future.

One of the major benefits of the plan is that because ROBS are not considered a loan from your 401k or IRA, it doesn’t have to be repaid. Additionally, there’s no penalty for early withdrawal or taxes that have to be paid like you would with loans against most retirement plans.

Although it’s called a Rollover For Business Startups, the program isn’t restricted to new businesses. Enterprising go-getters can apply a ROBS to their established business, a franchise or a business that was started by another entrepreneur. Because you’re rolling your retirement savings into your company as an investment, any profits your business makes can be returned to your retirement plan tax-free.

Because the program is not a loan from a bank or investment group, business owners using ROBS don’t have to deal with the stress of trying to make their ventures financially successful while also making payments with high interest rates to their lenders. As a result, most entrepreneurs financing their startups with ROBS funding see a potentially higher success rate thanks to low overhead and less risk caused by fluctuating markets.

How a ROBS Plan Can Hurt You

Despite its many advantages, ROBS naturally come with their share of risks as well. The most notable drawback, of course, if you are transferring money from your retirement savings that you may never be able to return should your business fail. Possibly the worst case scenario, you’ll now have to contend with fewer savings for your retirement years and the fallout of a business that wasn’t financially sustainable.

In order to utilize a ROBS plan for your company, you not only have to have at least $50,000 in your retirement account to transfer into your business account, but your enterprise must also be set up as a C corporation. This may take some extensive re-organizing if you currently operate as a sole proprietorship or LLC. And in doing so, it may not be the right choice for you in terms of liability and tax structure. Only you can determine if the re-organization would be worth the risk should you decide to pursue a ROBS plan.

Also, if you’re an entrepreneur with limited cash flow availability, the cost to enroll in a ROBS plan can be prohibitive if you don’t have the money to pay the fees. For example, popular ROBS providers Guidant and Benetrends Financial charge roughly $5,000 to assist with establishing a ROBS. This fee is due prior to setting up the plan, and therefore the investment transfer from your retirement account cannot be utilized.

5 Steps for Setting Up a ROBS for Your Business

Using a ROBS to fund your small business may seem like an intimidating process, but with guidance and research, you can pursue it as a source for investment capital in five simple steps. It’s important to note that business owners can only use certain types of retirement plans for ROBS. Traditional IRAs and 401k plans are the most common resources tapped for the rollover, but unfortunately, Roth IRAs are ineligible.

  1. With your retirement plan funds available, the first step is to establish your business as a C corporation. A C corporation will include a board of directors and shareholders with input on how the company operates.
  2. Under this new structure, create a 401k plan for your business. 
  3. With the help of an attorney or ROBS provider, roll your existing retirement plan funds into the new business 401k plan.
  4. Use the funds now relocated into your business 401k plan to purchase company stock in your newly formed C corporation.
  5. The money from the sale of your company stock can now be used as capital to invest in your business.

Given the benefits over small business loans and 401k loans, entrepreneurs who utilize a ROBS plan can easily see why it may be the better choice for their business. However, it’s important to discuss all of your options with your company’s accountant or a tax expert to ensure if less risky avenues for funding are worth exploring first.

After examining all resources available to increase capital, as well as the advantages and disadvantages to each, only then will you be prepared to determine if a ROBS plan is the best course of action.