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Part of our series on the top funding methods for small business.

With a Rollover for Business Startups (ROBS) plan, you can fund a new business by leveraging funds intended to fund your retirement—either a 401(k), an Individual Retirement Account (IRA) or similar IRS-approved account. Unlike a business loan from the Small Business Administration (SBA) or other funding source, ROBS financing involves no credit application in the traditional sense, no debt, no monthly payments and no interest expense. It’s a sophisticated and demanding way to fund a business.

There’s a 5-step setup procedure: (1) You create a Chapter-C Corporation for the new business  and (2) create a retirement plan for its employees. Then you (3) transfer funds from your existing qualifying retirement plan(s) into the retirement plan for the new C corporation. It’s this new retirement plan that (4) buys into the new business by purchasing stock. (5) The proceeds of this stock purchase transaction become available to operate the business. Because each of these steps has its own rigorous requirements, the setup process is typically handled by a processor who specializes in ROBS plans.

ROBS comes with its own unique set of requirements, benefits and downsides.

Key requirements

The plan must meet a series of criteria. In general, these are:

  • The ROBS funds must originate in a qualified tax-deferred account as defined by the IRS.
  • You can’t use funds in a retirement account with a company that currently employs you.
  • You must be employed by the new business that is funded by the ROBS.
  • The overall fund must be large enough, often $50,000 or more, to meet any minimums established by the provider.
  • You and your family cannot derive a personal benefit from the use of funds earmarked for the new business.

Benefits of funding a business with a ROBS

  • The retirement funds that form the basis of the plan continue to grow, as they did in their original tax-advantaged account(s).
  • The business operates without the cash-flow burden of repaying a traditional loan.
  • There’s no interest cost, so money you’d be spending on interest can be used for more growth-focused activities.
  • Industry studies suggest that businesses funded through a ROBS are more likely to succeed than those funded through traditional financing.
  • There’s no risk to personal assets or credit standing because the business is essentially self-funded.

Downside factors of funding a business with ROBS

  • If the business ultimately fails, you and other investors risk losing your retirement savings.
  • Your business must be established as a C Corporation. No other business structures qualify.
  • Because rules surrounding a ROBS plan are so complex, there are significant setup and ongoing maintenance costs. These vary depending on the processing company.
  • The IRS prohibits a series of transactions if your business is funded through a ROBS. In broad terms, these involve deriving personal benefits from use of the company’s assets or drawing compensation that’s considered excessive. You’ll need to know and follow these rules carefully to avoid unanticipated taxes and penalties.
  • You must setup and administer a qualifying retirement plan and allow all employees to buy into it, with access to the same investment opportunities as yours.

ROBS is a small business funding option that offers tremendous advantages over the alternatives—but it also comes with downside risks. It’s not for everyone. To learn more about funding your business with a ROBS plan, visit Pango Financial or call 1-855-WHY-PANGO (1-855-949-7264). Our specialists will take the time to walk you through the variables help you determine if ROBS is right for you.