Starting a business requires capital, and a lot of it. Many small business owners get that capital from small business loans, investors and perhaps most frequently, their own wallets, which can lead to a lot of debt. An alternative to these methods of financing is Rollovers as Business Start-Ups (ROBS).
ROBS allows you to invest up to 100 percent of your retirement fund, without distribution tax, to start your business, according to David Nilssen, co-founder and CEO of small business and franchise financing company Guidant Financial. Nilssen explained that, with ROBS, you're investing in your own business and your 401(k) becomes a shareholder in your business, and it will profit if you're successful.
So how does it work? You have to create a corporation for your business, using a C corporation structure, and then you can roll your existing 401(k) plan into a new 401(k) plan under the corporation. That investment then goes into a corporate checking account, making you the majority owner in your business, Nilssen said.
With other methods of financing, a significant amount of your initial profits usually goes to paying off your debts. ROBS is a great alternative, especially for franchisers, because it eliminates that need and allows you to profit faster. Businesses funded through ROBS might even be more successful than other businesses: After four years, 80 percent of Guidant's clients who used ROBS are still operating (not including those who have sold their businesses), whereas 39 percent of regular startup businesses are still in operation. [Can't Get a Business Loan? A Guide to Alternative Business Financing ]
While ROBS is a great method of financing, it may not be the best solution for every entrepreneur.
"ROBS are not absentee owner arrangements," Nilssen told Business News Daily. "If you want to buy a business and not work there, you're not eligible. You're setting up a 401(k), and 401(k)s are only available to eligible employees."
Using ROBS may also not be an option for you if you're just starting out in your career. Nilssen noted that you have to have a sizable amount of money (typically $180,000) to make a small business investment, and you have to have worked in corporate America long enough to have that amount of money in a 401(k).
New business owners who choose to use ROBS should also be aware that they're not limited to buying a business or franchise that is equal to or less than the money they have in their 401(k), according to Nilssen. That money can also be used as a down payment, if the entrepreneur has good credit, Nilssen said.
Regardless of your investment choice, Nilssen said that there's no such thing as a sure thing. His advice? Be confident not only in your business model, but also in your ability to lead and grow the enterprise.
Originally published on Business News Daily.