If you’ve always dreamed of running your own business but don’t have a unique or groundbreaking idea, consider buying into a franchise. Franchising is a popular way to learn the basics of business operation with the guidance and support of a larger company.
Plenty of businesses have franchise options, from fast-food restaurants to retail outlets. However, buying into a franchise requires startup funds like any other business. What options for funding do you have at your disposal?
Many aspiring small business owners opt to use their 401(k) retirement funds to roll over into a new account in their business’s name. This innovative financing method is referred to as Rollover for Business Startups (ROBS). Is ROBS financing a valid funding option for purchasing a franchise, though? Let’s take a closer look at how ROBS funding works and how you can make it work for your franchise.
The Basics of ROBS Funding
Are you unfamiliar with how a Rollover for Business Startups (ROBS) works? It’s a relatively simple set of steps that allows you to avoid early withdrawal fees and tax penalties while providing funding for your new business.
- First, enlist the help of a financial expert to help you incorporate your franchise business as a C-corporation.
- Next, set up a 401(k) plan in your newly incorporated business’s name.
- Transfer or roll over your funds from your existing 401(k) to the new plan. You can do this by investing the funds in stock in your new franchise business.
- Now your funds are available for business use!
To remain compliant with your 401(k) Rollover for Business Startups, you must use the funds in that account solely for legitimate business purposes. The C-corporation you created (see above) must be an active operating company, which is no problem for a franchise—it’s already established!
Additionally, you must offer your employees the option to buy into your new 401(k) plan. That program is designed to benefit everybody at the company, not simply as a business account for you. As a business owner, this is a great recruiting tool, and as an employee yourself, it gives you the opportunity to continue to build your nest egg.
If you want to use your 401(k) to roll over into your new business, you’ve got to commit to your new business ownership fully. You cannot roll over a 401(k) from a company where you’re still employed; you’ll have to quit your day job to gain access to that account.
Is a ROBS Right for You?
Not everyone with a 401(k) account is a prime candidate for a Rollover for Business Startups. ROBS financing works most effectively if:
- You are older than 59 and a half years of age or have quit your day job.
- You have more than $25,000 vested in your 401(k) account.
- You don’t qualify for other forms of business financing.
- You want to avoid taking on any debt.
While 401(k)s are the most popular type of retirement account used for ROBS financing, you can also roll funds over from 403(b)s, 457(b)s, or traditional IRAs. Roth IRAs, however, are not eligible to get rolled over.
Advantages of Franchise Financing With ROBS
Why is a ROBS plan a good option to finance a franchise? How is a rollover superior to a business loan or investments from venture capital firms?
Control Over Your Funds
When you let your 401(k) accrue interest, it’s likely sitting with a brokerage house. Your savings fluctuate based on the whims of the stock market or the decisions of an investment manager; you’ve got limited control there.
However, when you invest those funds in a franchise, you’re making decisions that can grow your savings exponentially! Franchises are a smart investment option because the business has already proven successful enough for multiple locations.
No Debt Involved
Because 401(k) business financing is not a loan, you don’t have to factor repayments into your monthly or quarterly budget. Starting your business debt-free will be a great boon to you in the future. It’ll be easier to build a strong credit score and have more cash flow at your disposal in those crucial early days.
A Low-Risk Investment
Using 401(k) ROBS financing always carries some level of risk with it, as you’re putting your retirement savings into a business that may succeed or fail. A franchise operation is low on that risk scale because it’s a pre-established company with sufficient success to provide franchising options in the first place.
Plus, when you buy into a franchise, you gain access to business support and training from the parent company. Franchises are great options for first-time business owners who require that extra support to learn how to run a successful business.
Potential Drawbacks of ROBS Franchise Financing
Any business financing option with plenty of advantages is bound to have a few potential downsides. If you plan to use ROBS financing to buy into a franchise, consider the following before you make your decision.
A Slower Process
Short-term business loans are often processed in as little as 24 hours. Meanwhile, the ROBS process can take a few weeks to complete. Be prepared to wait two to three weeks for your rollover funds to be ready for use!
Chance of an Audit
When the IRS learns that you’ve bought a franchise with 401(k) ROBS financing, there is a chance of being audited. Make sure you’re keeping meticulous financial records and only using your rolled-over 401(k) funds for business purposes. Audits can be stressful and irritating, but if you remain compliant with the terms of your financing, you’ve got nothing to worry about.
So, can you use ROBS financing to purchase a franchise? The short answer is yes, you can. Franchises are a smart option for rollover financing, as they are more established and likely to succeed than unique startups. Whether you want to buy into your favorite restaurant chain or operate a downtown retail store, franchising with ROBS financing could be the perfect option.
Curious about the other financing options at your disposal as a new or aspiring business owner? Head over to Pango Financial’s funding solutions tool to find various ways to inject cash flow into your new franchise.