A Rollover for Business Startups (ROBS) is a way to use your retirement savings account, such as IRAs (Individual Retirement Accounts) or 401k plans to fund your business startup. With ROBS, you can access capital to start a new business without incurring early withdrawal penalties or tax liabilities that would typically apply to early distributions from retirement accounts.
Is ROBS Right for You?
Before you decide to withdraw your funds from your retirement account to invest in your new business venture, it’s crucial to know if ROBS is the best business funding option for you. In general, ROBS may be suitable if you:
- Have a substantial amount of money in your retirement plan: You need a significant amount of money in a retirement account that is sufficient to cover your business funding needs. Most ROBS providers may require a balance of at least $50,000 in a retirement account to qualify.
- Don’t want to incur debt: Since ROBS is not a loan, you don’t need to worry about repaying a debt or getting charged with hefty interest. This allows you to manage your business finances more efficiently without the need to make monthly loan payments.
- Cannot qualify for a business loan: Generally, ROBS is easier to qualify for compared to a traditional business loan. If you cannot qualify for a business loan due to a lack of time in business, low credit score, low revenue, or unavailability of collateral, ROBS may be a better option.
- Plan to set up a C-corp: ROBS involves setting up a C Corporation, so it’s essential that this business structure aligns with your business goals and plans. If you plan to set up a sole proprietorship or a limited liability company (LLC), ROBS is not a good fit.
How Does ROBS Work?
With ROBS, you essentially roll over your funds from an eligible retirement account to fund your new business. To do this, you need to set up a ROBS rollover. This process involves the following steps:
Step 1: Form a New C Corporation
The first step involves creating a new C Corporation (C-corp), which will be the business structure for your startup. This corporation can be specifically structured to receive the investment from the retirement account.
Step 2: Set Up a Qualified Retirement Plan for the C-corp
You need to establish a qualified retirement plan for the newly created corporation. You, the business owner, become an employee of the C-corp and the beneficiary of the new retirement plan.
Step 3: Rollover Your Retirement Funds into the New Plan
Once the new retirement plan for your corporation has been established, the next step is to roll over funds from your eligible retirement accounts into the new retirement plan.
Step 4: Use the Retirement Funds to Invest in Your New Business
The rolled over funds are then used to invest in the business. Typically, the funds are used to purchase shares of company stocks in the corporation, providing you with funds that are available for use. You can then use these funds as working capital or to buy assets for the business.
How to Qualify for ROBS?
The qualification requirements for ROBS are generally more lenient compared to most other types of business financing. To qualify for a ROBS transaction, you must meet the following:
- You must have at least $50,000 (or more) in your retirement account
- Your business must be structured as a C Corporation
- You must establish a new retirement plan for the C Corporation
- You must be an active employee of your business and pay yourself a salary
- To be an active employee, you must work at least 1,000 hours per year for your company
- You must allow other employees to contribute to the C Corporation’s retirement plan
- You must comply with all applicable tax laws and regulations
If you meet all of these qualification requirements, you may be able to use a ROBS as a method to fund your business startup. However, it is important to consult with a business or financial advisor to ensure that ROBS is the right funding method for you.
Pros & Cons of Using ROBS to Fund Your New Business
Rollover for Business Startups can be a useful option for some new business owners, but it’s essential to consider both the advantages and disadvantages before deciding if it’s the right approach for funding your business.
Benefits of Using ROBS
- Access to Retirement Funds Without Taxes and Penalties: ROBS allows you to access your existing retirement funds to invest in your business without incurring early withdrawal penalties or tax liabilities that you would face with traditional distributions.
- No Debt: Unlike traditional business loans, ROBS doesn’t create debt for your business. You’re using your own retirement funds, which means you won’t have loan payments or interest to worry about.
- Control: Since you’re using your own funds, you retain full control over the investment in your business, including how the funds are used and the business’s direction.
- Faster Funding: ROBS can potentially provide quicker access to capital compared to seeking loans or other traditional funding methods. After all, it does not require credit checks, personal guarantees, and/or collaterals.
- No Impact on Credit: Since it is not a loan, ROBS doesn’t impact your personal or business credit.
Risks of Using ROBS
- Complexity: ROBS is a complex transaction that requires careful planning and execution. If you are not familiar with the rules and regulations, you could make mistakes that could jeopardize your retirement savings.
- Risk of Losing Your Retirement Funds: Using retirement funds for your business involves risk. If your business doesn’t perform well, it could impact your business venture and you could lose your retirement savings.
- Compliance Burden: Ongoing compliance is essential for ROBS to avoid penalties. This includes maintaining proper records, annual filings, and ensuring that the retirement plan remains in compliance with all applicable rules.
- Tax implications: You may have to pay taxes on the earnings from the stock that was purchased with the rollover funds. This is something that you need to be aware of before you decide to use ROBS.
- Cost: There are fees associated with setting up and maintaining a ROBS transaction. These fees can add up, so it is important to factor them into your decision-making process.
What Expenses ROBS Funds Should Not Be Used For
ROBS funds should be strictly used for business purposes only. With a ROBS transaction, it’s important to adhere to IRS regulations and guidelines to ensure that the transactions remain compliant. Certain uses of ROBS funds are considered prohibited transactions and can result in penalties, taxes, or even the disqualification of the retirement plan.
Here are some examples of uses that are generally not allowed for ROBS funds:
- Personal Expenses: ROBS funds should not be used for personal expenses, such as paying off personal debts, purchasing a primary residence, or covering personal vacations. The purpose of ROBS is to invest in or start a business, and personal uses are not allowed.
- Excessive Compensation: While reasonable compensation for services provided to the business is acceptable, paying yourself or other key individuals excessive compensation could be considered a prohibited transaction.
- Investments in Non-Business Ventures: The funds should be used exclusively for the business venture outlined in your business plan. Investing in non-business assets like stocks, real estate properties, or collectibles is typically not allowed. In addition, investing in other businesses or ventures not directly related to the approved business plan is generally prohibited.
- Employee Benefits: Using ROBS funds to provide employee benefits that are unrelated to the retirement plan is not allowed. These include health insurance or non-retirement-related bonuses.
- Purchase of Personal Assets: Using ROBS funds to purchase personal assets, such as a personal vehicle or personal real estate, is not allowed. The funds should be used for business-related assets. Similarly, you cannot use your business assets that were purchased using ROBS funds for personal purposes.
Alternatives to a ROBS
If you don’t want to put your retirement funds at risk, you may consider other financing alternatives to fund your new business. Here are our top recommendations:
- Traditional Bank Loans: Traditional bank loans, including term loans, lines of credit, and Small Business Administration (SBA) loans, are common sources of business financing. These loans often have competitive interest rates, but they may require a strong credit history and collateral to qualify.
- Business Credit Cards: Credit cards specifically designed for small businesses can provide a quick and flexible source of capital. However, they may come with higher interest rates and fees compared to traditional bank loans. It’s best to find a business credit card with no annual fee to minimize your credit costs. In addition, look for a credit card that offers a long 0% APR period so you can take advantage of interest-free financing.
- Angel Investors: Angel investors are individuals who provide capital to startups in exchange for equity ownership. They can offer not only funding but also valuable advice and connections. However, giving up equity means sharing ownership and decision-making. If you don’t mind having co-owners, this funding method may be right for you.
Frequently Asked Questions
How much does ROBS cost?
The cost of ROBS depends on the provider you choose. In general, you need to prepare for a one-time setup fee that could go as high as $5,000. In addition to this fee, there are monthly charges for ongoing support and maintenance, and this could range from $75 to $150 per month.
How to choose the best ROBS provider?
The best ROBS provider offers an easy process and can typically get your transaction done in three weeks or less. Make sure to find a provider with low fees and offers ongoing legal and audit support.
Can I terminate my ROBS?
Yes, you can terminate or “unwind” your ROBS. Make sure to follow the right procedure to avoid penalties. Typically, business owners terminate their ROBS when their businesses fail. But you can also unwind your ROBS if you want to sell your business or discontinue the C-corp.
Takeaways
ROBS is a great option for those who don’t want to incur a debt to start a business. It’s worth noting, however, that you are putting your retirement funds at risk once you use them for your business. Make sure to have a solid business plan to minimize the risks associated with starting a company. Also, make sure to research the different funding sources available to determine the best business financing option for you.