Lauren Smith is Co-Founder and Vice President of Marketing & Operations at Ascendify.
When it comes to financing your startup, there are plenty of options. Many of these options involve hitting the pavement and getting others excited about your vision. For early stage startups, the fundraising process may be time-consuming and distracting from your early business needs. You might wonder if there's another option when your startup is just getting started.
The IRS program, Rollovers as Business Startups, or ROBS, allows you to rollover your 401(k) plan into your company's retirement plan to fund your business. If used correctly, the ROBS project allows entrepreneurs to avoid the penalties and taxes usually associated with withdrawing your 401(k) early.
This is the route we decided to take when launching, Ascendify, a talent acquisition platform for businesses. We wanted to focus our time and efforts on identifying market needs, responding to customer requests, and developing an award-winning product. So, we decided to use the ROBS project and invest in ourselves.
This won't be the right choice for every startup, so here are six questions you should ask yourself before starting down this path:
Why choose ROBS instead of other funding options?
Before starting down a path lined with accountants and IRS laws, ask yourself why ROBS is right for you and your business. While it might be rewarding to avoid outside funding and self-invest, think of the flip-side. Strategic angel investors can be incredibly beneficial to shaping the early direction of your company. But, if you're determined to chase that sense of pride and ownership in self-funding, be sure that you've researched all of the risks.
What resources are available to help?
So you've decided to use ROBS to fund your startup, but where exactly do you start? If you're about to wade into the complicated world of IRS tax laws: stop. It's generally not a good idea to set up your ROBS solo. You might have an entrepreneurial, do-it-yourself spirit, but this method of funding is complicated and best left to the professionals.
You need someone on your side who understands complicated tax laws and can navigate IRS regulations. We partnered with the firm Benetrends, but firms from SDCooper to Guidant Financial Group are also great resources that have been helping entrepreneurs for decades. While there are fees associated with these firms, it's worth it because they'll partner with you throughout the whole process, and help prevent negative IRS implications.
How much should I roll over?
The answer to this question will certainly be different for every business. The typical rollover amount falls somewhere between the $150,000 to $174,000 range, according to experienced firms. Once you've determined how much to invest, the remainder can be set aside in the new 401(k) plan that you've set up for your company
How do I stay compliant?
Staying compliant with the IRS regulations when it comes to ROBS can be tricky, which is why you should always work with a specialist. The reason ROBS is a viable funding option is thanks to the ERISA, or Employee Retirement Income Security Act of 1974. This act allowed workers to be responsible for their own retirement plans, but it's also extremely complicated.
Staying compliant is absolutely essential for getting the value out of your 401(k) rollover. And the IRS is paying attention. In 2008, they released a statement promising to pay special attention to ROBS plans for possible infractions.
One of the ways you can step out of line with the guidelines is by preventing employees from purchasing stock once your ROBS funding is approved. This practice is prejudicial in favor of existing or high-ranking employees and can result in an IRS crackdown. You certainly don't want that, since a prohibited transaction can cost you 110 percent or more in penalties. So you'll want to set aside an employee stock option pool, which will not only help you stay compliant, but also help you attract top performing talent.
Am I ready for the risks?
You now understand the value of seeking help and staying compliant. But perhaps the most important question to ask yourself is if you can live with the risks. An IRS investigation into ROBS uncovered many businesses financed this way had gone under, resulting in financial difficulties for the owners. Before deciding to use ROBS to fund your startup, make sure you understand the risks inherent in putting it all on the line, and that you've identified a plan for recovery.
Do I want to offer profit sharing to employees?
Using ROBS, you'll be rolling your 401(k) into a new retirement plan for your company. Now you have a decision to make about this retirement plan. Do you want it to be a robust 401(k) or a simple profit sharing plan. If you go with a 401(k), you can choose whether or not to match employees' contributions. If you choose to go the profit sharing route, you can choose to reward employees when the company has a profitable year. Both 401(k) matching and profit sharing are benefits that will help attract top talent to your company.
Using the ROBS project to raise capital for our company was the right choice for us as an early stage startup, focused on innovating and product development at the time. But it won't be the right choice for every entrepreneur. Before starting down this funding path for your startup, make sure to ask yourself these six questions.
The views expressed are those of the author and do not necessarily reflect the views of BusinessNewsDaily.