What is a ROBS (Rollover as Business Startups)?
ROBS, or rollovers as business startups, allow entrepreneurs to use their own retirement funds for business startup costs. This strategy helps business owners avoid debt and provides access to capital without paying taxes or penalties.
The process starts with a tax-free rollover of retirement funds into a new corporation. The business owner sets up an operating company and then rolls over their retirement savings. Then, the business owner can use the retirement to purchase stock in the company. This means they can use these funds to cover expenses like equipment, inventory, and salaries.
However, aspiring small business owners should be cautious. ROBS has specific rules and regulations. If not followed correctly, they could lead to penalties or taxes on the rolled-over funds. Entrepreneurs must understand both the advantages and risks involved in using ROBS.
How does a ROBS plan work?
ROBS requires specific steps to legally apply the existing retirement account funds. Prospective business owners should follow these crucial steps.
Step 1 – Form a New C Corporation (C Corp)
You must form your business as a C Corp when you plan to fund the enterprise with ROBS. This is because part of the process involves using the funds to purchase stock, also called Qualified Employer Securities (QES). Other business entity types, such as LLCs, LLPs, S Corps, and sole proprietorships, cannot issue QES.
C Corps have rigid corporate structures and rules. Your business will also be subject to corporate taxes. The process involves:
- Choose a board of directors.
- Assign officers (e.g. CEO, CFO, Secretary).
- File articles of incorporation with the state.
- Obtain an Employer Identification Number (EIN) from the IRS.
- Create corporate bylaws.
- Hold an initial board meeting to approve bylaws and appoint officers.
- Issue stock certificates to shareholders.
Step 2 – Establish a New Retirement Plan for the New C Corp
The next part of the plan involves creating a new retirement plan for the C corporation. The most common strategy is to form a standard 401(k). However, you can choose a different retirement plan if you prefer. It’s crucial to ensure your selected option is a qualified retirement plan. Consider working with a financial advisor to ensure your retirement plan qualifies.
Setting up a plan requires choosing a custodian to manage the investment accounts associated with the retirement plan. Some examples of retirement plan custodians include Merril Lynch, Fidelity, Vanguard, and Schwab. These plans typically have fees, so ensure you factor that into your costs.
Step 3 – Roll the Funds Over to the New Plan
This part of the process is the rollover portion of ROBS. By rolling over the retirement savings from your current retirement account to the new plan, you can avoid the tax penalties of withdrawing funds. This is one of the most significant benefits of ROBS funding.
Step 4 – Use the Funds to Purchase Stock in the Company
You can now use the retirement plan funds to purchase company stock via QES transactions. This provides the necessary startup funding to fuel your operations. However, you must pay fair market value for the stock and provide employees access to the retirement plan.
Step 5 – Use the Funds
After completing the transaction, your business will have the funds to purchase equipment, hire employees, lease or buy real estate to operate the business, and more.
What are the advantages of ROBS?
ROBS offers several benefits for entrepreneurs. One significant advantage is the ability to access retirement funds without penalties. Many people have savings in their 401(k) or IRA accounts. With ROBS, they can use these funds to start a business.
Another benefit is that ROBS allows for tax-free money. The funds used in a ROBS transaction do not incur taxes at the time of withdrawal. This means more money goes directly into the business. Entrepreneurs can use this capital for various startup and ongoing expenses like equipment, inventory, or marketing.
With ROBS financing, entrepreneurs can avoid taking on debt or giving up equity in their business. Business loans often involve high interest rates and frequent repayments that can strain cash flow and reduce profit margins. Equity financing involves selling shares in the company to raise funds. ROBS allows you to finance your business without diluting ownership or making debt payments.
ROBS also provides flexibility in business ownership. By becoming business owners, individuals can take control of their financial future, create jobs, and contribute to their community. This empowerment can lead to personal satisfaction and growth.
What are the disadvantages of ROBS?
Using ROBS can have several significant drawbacks. First, risk is a primary concern. Business owners put their retirement savings on the line. If the business fails, they may lose their entire investment. This can lead to financial hardship during retirement.
Another disadvantage involves compliance issues. The Internal Revenue Service (IRS) has strict rules about how ROBS must operate. Failure to follow these rules can result in penalties or taxes. Business owners need to stay informed and compliant to avoid these problems.
ROBS also requires a lot of paperwork. Setting up a ROBS plan takes time and effort. Business owners must create a corporation and maintain proper documentation. This can be overwhelming for those unfamiliar with business regulations.
ROBS also has costs associated with it. Legal fees and setup costs can add up quickly. Ongoing maintenance of the plan may also incur additional expenses, draining resources that could be used to grow the business.
ROBS Financing Pros & Cons
Pros:
- Access retirement funds without penalties.
- Tax-free money for the business.
- Avoid debt and equity financing.
- Flexibility in business ownership.
Cons:
- Risk of losing retirement savings.
- Compliance issues with IRS rules.
- Requires significant paperwork.
- Costs associated with legal fees and setup.
How do I know if a ROBS is right for my startup business?
Deciding if ROBS financing is the best move for your startup requires careful planning and consideration. It’s crucial to weigh the benefits versus risks and consider other options.
When to Consider Using ROBS
The following criteria may indicate ROBS is a solid business financing option.
Substantial Retirement Savings: If you have a significant amount of money saved in a retirement account, using a ROBS could allow you to access these funds for your startup without incurring early withdrawal penalties.
Desire to Avoid Debt: If you prefer not to take on debt to finance your startup, a ROBS could be a good option since it involves using your own retirement assets rather than borrowing money.
Long-term Commitment to the Business: ROBS involves investing your retirement savings into your business, which indicates a long-term commitment to the company’s success.
Risk Tolerance: ROBS carries significant risks, such as losing your retirement savings if the business fails. You must be comfortable with taking that risk.
Patience for Regulations & Compliance: Not everyone has the patience to deal with the extensive paperwork and regulations associated with ROBS. You should be comfortable navigating bureaucratic red tape, dealing with the IRS, keeping meticulous records, and filing reports.
When to Consider a Different Startup Financing Strategy
Limited Retirement Funds Available: If you have limited retirement funds, using ROBS may not be a good option, as it could put your retirement savings at risk.
Uncertain Business Prospects: If the business idea or plan is uncertain or risky, it may not be wise to use ROBS as it involves using retirement funds that could be lost if the business fails.
Limited Business Experience: If you lack significant experience running a business, ROBS may not be the best option, as it requires sound business management skills.
Existing Debt Obligations: If you already have significant debt obligations, using ROBS to fund a new business venture may not be advisable, as it could increase your financial burden.
Short Timeline for Business Success: If your business’s timeline for success is short, using ROBS may not be the best financing strategy. Remember, it can take time for a new company to generate revenue, so consider alternative options that align better with your timeline and goals.
ROBS Frequently Asked Questions
Here are the most common questions about ROBS financing.
How does the IRS treat a ROBS plan?
The IRS scrutinizes ROBS transactions due to their tax-free nature and potential benefits for a single person. Strict rules apply to avoid issues.
Compliance with the Employee Retirement Income Security Act (ERISA) is crucial, as it sets standards for retirement plans and protects employees’ interests. Structuring the ROBS plan correctly is essential to prevent double taxation problems.
All compensated employees must have access to the retirement plan to avoid IRS penalties. Understanding the tax implications and following the correct procedures are vital to maintain compliance and avoid fines or loss of retirement funds.
Does a ROBS plan have to be with a 401(k)?
A ROBS plan can work with various eligible retirement accounts, including traditional IRAs, SEP IRAs, and other company retirement plans. However, the most common choice is the 401(k). This is because it provides a larger pool of funds and allows for easier transfer into a new business.
Can I combine ROBS with other funding sources?
Yes, you can combine ROBS with loans or personal investments to maximize your startup’s funding potential. By leveraging multiple funding sources, you can access a larger pool of capital to support your business growth.
This approach can provide flexibility in repayment terms and interest rates, allowing you to tailor your funding mix to fit your financial needs. Combining ROBS with other sources can also help mitigate risk and ensure sufficient funds are available to launch and operate your business successfully.
How long does it take to set up a ROBS?
Setting up a ROBS typically takes 4 to 6 weeks. This process involves establishing a C corporation, which includes filing necessary paperwork, obtaining an employer identification number (EIN), and creating corporate bylaws.
Additionally, rolling over funds from a qualified retirement account into the new corporation’s retirement plan is crucial. The timeline may vary depending on the complexity of the individual’s situation and any potential delays in paperwork processing.
Are there fees associated with ROBS?
Yes, there may be setup fees and ongoing compliance costs associated with implementing a ROBS strategy. These fees can vary depending on the provider and the complexity of your situation.
It’s crucial to thoroughly research and understand these costs to avoid surprises. By being aware of the fees involved, you can better plan and budget for the financial aspects of using a ROBS to fund your business venture.
What are the alternatives to ROBS?
Entrepreneurs have several alternatives to ROBS.
Using Other Savings
One alternative to ROBS is using personal savings or investments to fund a business. This option allows entrepreneurs to fully control their retirement accounts while accessing the necessary capital to start a business. Individuals can avoid the potential risks and complexities of ROBS by utilizing personal savings.
Equity Financing
Equity financing involves raising capital by selling shares of ownership in a company to investors. This can be an alternative to ROBS as it allows businesses to access funding without tapping into personal retirement savings, spreading the risk among investors.
Debt Financing
Debt financing involves borrowing money from a lender that must be repaid with interest over time. It provides a way for businesses to access capital without giving up ownership. This can be a more traditional route for businesses looking to secure funding without tapping into retirement savings.
Additionally, you can use debt financing to fuel growth and meet unexpected challenges after launching your business with ROBS. You may be interested in one of the following small business loans:
- Bad credit business loan.
- Business line of credit.
- Business loans for women.
- Business term loans.
- Equipment financing.
- Invoice factoring.
- Merchant cash advance.
- Revenue-based loan.
- SBA loans.
- Working capital loans.
- ERTC advance.
What is a ROBS (Rollovers as Business Startups) – Final Thoughts
ROBS can be a viable funding strategy to kick off your entrepreneurial journey, but understanding how it works and the regulations governing it is crucial. Putting your retirement savings on the line carries significant risk, but the potential rewards are equally significant.
Thoroughly research the IRS rules related to ROBS and any state or local regulations. Consider working with a financial advisor and tax professionals when developing your ROBS plan and preparing compliance reports.
Contact us if you have more questions about startup funding strategies or to apply for a small business loan. Our alternative funding experts can help you find the best financing options to fuel growth.
