Starting a new business often needs significant capital, but some entrepreneurs don’t prefer traditional financing methods like loans or venture capital. However, there is another alternative that has become a popular choice among entrepreneurs lately, i.e., Rollovers as Business Startups (ROBS). This financial method leverages retirement funds to support people’s entrepreneurial dreams, but it offers both benefits and risks. This blog will enlighten you about ROBS and how it works, along with its advantages and risks. So, let’s get started!
What is ROBS?
Rollovers as Business Startups (ROBS) is a financial method to let entrepreneurs use their existing retirement savings to support new or existing businesses. The ROBS financing can help you avoid taking unnecessary business debt or trading equity for funds. Also, it offers tax-free transactions when entrepreneurs move money from their retirement savings account to support a new business.
How Does a ROBS Work?
The process of using a ROBS for business financing includes the following steps.
- Setting Up a New Corporation: Start by establishing a new C Corporation, as ROBS needs a C Corporation structure to be compliant with IRS regulations.
- Creating a New 401(k) Plan: Once your C Corporation is established, you have to set up a new 401(k) plan for the corporation. This will help you accept the rollover from your existing retirement accounts.
- Rolling Over Retirement Funds: After that, you roll over funds from your existing retirement accounts, be it a 401(k) or IRA, into the new 401(k) plan. You must do this in a way that complies with IRD rules to avoid penalties.
- Investing in Your Business: After the funds roll over, the new 401(k) plan invests the capital directly into your C Corporation. This investment is primarily used to buy stock in your business, providing the funds you need for operations or expansion.
- Maintaining Compliance: The business must adhere to certain compliance and reporting needs, like filing annual Form 5500 reports and maintaining proper plan documentation.
Advantages of ROBS Financing in Your Business
- No Debt Incurred: Unlike conventional loans, ROBS does not involve taking loans. So, you will not have to pay monthly repayments or interest costs, reducing financial pressure on the new business.
- Avoid Early Withdrawal Penalties: By using ROBS, you avoid the early withdrawal penalties and taxes associated with taking money out of your retirement account prematurely.
- Equity Financing: As the funds are treated as an investment in your business rather than a loan, you will not have to give up any equity or control in your company to secure funds.
- Flexibility: ROBS can be used for various business purposes, including purchasing an existing business, establishing a new venture, or expanding an existing company.
Risks of ROBS Financing
- Compliance Risks: ROBS structures must adhere to IRS regulations. Any failure to comply can lead to fines, such as the potential disqualification of the 401(k) plan, which can trigger taxes and penalties on the rolled-over funds.
- Investment Risk: Investing retirement funds in a new business can be risky. If the business fails, you can lose a substantial portion of your retirement savings.
- Cost of Setup: Setting a ROBS structure can be complicated and may involve legal and administrative fees. These costs can influence your decision-making process.
- Ongoing Administration: Managing a ROBS includes administrative responsibilities, like compliance reporting and plan management, which require time and resources to ensure all regulations are met.
The Final Takeaway
Rollover as Business Startups (ROBS) can be a powerful tool for entrepreneurs to seek funds from their retirement savings. However, it comes with both advantages and risks. So, you have to measure all aspects before pursuing a ROBS and making it fruitful for your entrepreneurial journey.
