Do NOT use ROBS 401(k) to Fund Your Business

My first job out of college was in lending at JPMorgan Chase’s headquarters in New York City. From a young age, I became well versed in the numerous ways to finance business startups and acquisitions. During my time at the bank, I helped underwrite mortgages, business lines of credit, and derivatives for investors ranging in net worth from $200,000 to well over one billion. When it became time to finance my first business, Visa Franchise, I explored a plethora of options. I decided on self-funding through savings. Also took on a business partner, and drew down a 0% interest credit card that I later paid off in full.

I briefly considered using the retirement funds that I had saved at JPMorgan Chase. I had discovered a financing mechanism called a Rollover as Business Startup (ROBS). The ROBS plan allows you to self-fund your business by transferring funds out of your existing 401(k) plan. My father, who is an attorney, advised me against using this structure under the basic premise that the retirement account is just that, an account meant to support your later years in life. In fact, many states, like Florida, protect against creditors going after your retirement accounts. Should my company had failed, and I could no longer pay credit card bills, the 401(k) account with thousands of dollars would have remained intact.

What is the Process to Create a ROBS 401(k)? (Simplified)

1.      Set up a New Company as a “C” corporation. It cannot be an LLC, S-Corp, or other business structure.

2.      In the New Company set up a qualified retirement plan that allows for the purchase of company stock.

3.      Transfer funds from your existing retirement plan into the New Company’s plan.

4.      Purchase company stock with New Company’s plan.

5.      Use the funds in the New Company’s bank account to start or buy a business.

Most business owners and franchisees will engage a firm that specializes in establishing the ROBS structure.

High Expenses to Establish and Maintain a ROBS 401(k)

Most firms specializing in creating and maintaining the ROBS structure are neither law firms nor accounting firms. These consulting firms generally charge an upfront fee of $5,000 plus a monthly 401(k) administration fee of $100 to $200 as long as the business is open. This can be a substantial expense, especially, for service-based businesses that might anticipate less than $150,000 in revenue the first year.

90%+ of U.S. small business owners structure their business as an LLC or S-Corp to protect themselves from liabilities and for tax planning purposes. “C” corporations are required by the ROBS plans and taxes are generally higher as the beneficial owner and company are both taxed. In an S-Corp, the income/losses pass through to the beneficial owners, and they are only taxed once.

There are also increased audit and compliance risks by the IRS, which considers ROBS plans as “questionable”. The IRS also states: “Although there were a few success stories, most ROBS businesses either failed or were on the road to failure with high rates of bankruptcy (business and personal), liens (business and personal), and corporate dissolution by individual Secretaries of State.”

What to do if You Want to Sell or Close Your ROBS Business?

As only 30% of family-owned businesses make it through to the second generation, it is important to consider what happens when you want to sell or close the ROBS business. The two most common avenues are:

1.      Business Asset Sale – Once the business assets are sold, the proceeds must first pay outstanding liabilities and admin obligations. The remaining funds then can be distributed to the owners of the business, including your retirement plan.

2.      Closing Down / Bankruptcy – The stocks still need to be removed by the plan and valued before completing the transactions. More expenses and services are needed by attorneys, plan administrators, and certified valuation analysts (CVAs).

In the process of winding down your ROBS 401(k) plan, you will incur thousands of dollars in legal and accounting expenses.

Conclusion

Your career “Plan B” should not involve potentially having to live off your children by spending away your retirement accounts. Prospective business owners should consider more traditional financing paths such as SBA loans, home lines of credit, or funds from family & friends to kick start their business. This way your retirement account remains diversified by 500+ companies and grows substantially over the long run. Stay tuned for my next article on the best ways to finance your business.