Rollovers as Business Startups: The Pros and Cons of ROBS
Starting a business is a spendy venture no matter what your business is, and it’s often the first hurdle that prospective business owners have to overcome.
There are many different ways for small business owners to get the money they need: go to the bank and get a traditional loan, crowdfunding such as a Patreon or Kickstarter, or find investors. For people who don’t have those options (or dislike the idea of taking money from others), rollovers as business startups (ROBS) may be an option.
What Is a Rollover as Business Startups (ROBS)?
Rollovers as business startups, or ROBS for short, allows current or prospective business owners to use their 401(k), IRA, or any other retirement fund to pay for their business costs. This could be startup business costs, business acquisition costs, or even existing business refinancing costs.
ROBS are not a withdrawal or loan from your retirement account. Rather, it’s a rollover that allows you to invest in your business rather than in the more typical investments that are made with your savings, such as mutual funds. These rollovers also allow you to invest your retirement funds into your business without having to pay any early withdrawal penalties or income taxes. Because of this, ROBS have become an increasingly popular option for prospective business owners over the last few years.
But, are ROBS too good to be true? We discuss the pros and cons of ROBS here so you can make an informed decision.
Pros of ROBS
There are a lot of short-term benefits that come with a ROBS financial agreement.
No (Immediate) Taxes
In a ROBS agreement, your money comes right from your tax-exempt retirement fund and is transferred to your startup. Since the money you are using is tax-exempt, there won’t be any taxes on your ROBS agreement in the beginning. This can buy you some valuable time to get your business up and running before you have to start paying these taxes. It’s also worth noting that the IRS doesn’t set a limit on ROBS business financing, meaning you can take out as much as you want.
Avoiding a Loan
Nobody likes owing money. This is especially true when you are starting up a business. You don’t want your decisions to be altered by the cloud of debt hanging over you. With a ROBS financing agreement, the only person you are taking from is yourself. This means that you are free to run your business the way you want to rather than the way that will guarantee the bank or other investors get their money back as soon as possible.
It May Be Your Only Option
Although starting a business is a dream of many, it’s a reality for far fewer. Sometimes, your idea just doesn’t catch the attention of an investor or a bank. You still believe in your idea and don’t want to let financing get in the way of you and your vision, so rather than borrowing from someone else, you decide to take from your retirement fund. If things work out, it could be one of the best decisions you will make in your entire business venture.
Cons of ROBS
However, there are a lot of downsides to ROBS that must also be taken into consideration.
The IRS Is Watching You
Although technically the IRS is always watching you, using a ROBS financing agreement only draws extra attention. The IRS views ROBS agreements as “questionable,” so it’s important to make sure that everything you’re doing is correct and on the books. If you use ROBS incorrectly, the IRS can deem your funds as taxable, and you run a risk of being exposed to costly fees and penalties.
Service Fees
To make sure everything they are doing is correct (and legal), most people seek out the counsel of financial, legal, and/or tax professionals. While this is always the right decision in the long term, it can also take a toll on the already limited wallet of a startup business.
Operating as a C Corporation
One of the rules of filing for a ROBS financing agreement is that your business must operate as a C corporation. C corporations are the most common type of corporation in America, but they are far more often seen in large companies than small businesses. While C corporations offer enhanced credibility and unlimited growth potential, they are also expensive to start and live under a long list of regulations and formalities. It’s important to do the research to find out how operating as a C corporation would affect both your business and your budget.
New Businesses Can Fail
Nobody likes to think about failure — especially not prospective business owners. Starting a business is a huge risk, and if your business fails and you used a ROBS agreement, it can hurt a little extra. You’re basically gambling your retirement savings on your new business, and if your business fails, you can end up with no business and no savings. It’s a risk that you need to fully grasp before you take the plunge.
Proceed with Caution
When it comes to starting and running a business, money is everything (read our blog post on being financially smart when starting your small business to get more tips).
The idea of taking money that’s technically already yours and using it tax-free may look like the ideal scenario on paper, but when it comes to ROBS, caution is key. There are a lot of things you must take into consideration with these financing agreements if you want to succeed. It’s important to get all of the information and carefully consider everything you’ll have to do in order to make it work.
If you want your business to succeed, efficient and effective accounting is key. We understand that business accounting can be a headache, but it doesn’t have to be. Corneliuson & Associates offers free consultations to those who want to relieve themselves of the headache of managing their finances. We can help you with all of your business financing needs, including ROBS agreements. Reach out today and get started building the business of your dreams.