Many entrepreneurs interested in starting a small business seek out a variety of financing options to fund the startup. Among these options is a lesser-known financing method known as Rollovers as Business Start-ups (ROBS).
Find Out: How to Get the Best Business Loan Rates
Related: How to Get an SBA Loan
How does this method allow you to finance a small business, and what are the benefits of setting up a ROBS transaction?
Rollovers as Business Start-ups (ROBS) Explained
ROBS is a type of 401(k) business financing. Individuals that have retirement funds in a 401(k) or another eligible account can use these funds to start a business. ROBS allows you to move retirement funds from eligible accounts into your business without incurring early withdrawal fees or tax penalties.
Kirsten Curry, J.D., AIF, CEO at Leading Retirement Solutions, said that the ROBS strategy works by using retirement funds to invest in the stock of a business venture.
“Because it is an investment and not a withdrawal, this allows the individual to then use the invested money for their business venture. This strategy works both to help the business off the ground or expand an already established business,” said Curry.
Learn: How and Where to Get Startup Business Loans
Advantages of Using ROBS To Finance a Business
Aside from not incurring expensive withdrawal fees or facing potential tax consequences, there are several advantages to funding a business with ROBS.
Access to Tax-Deferred Funds
Colby McFadden, founder and CEO of Quiver Financial, said ROBS offers several benefits from a tax perspective. Because of ROBS, entrepreneurs may access financing from assets that traditionally have been inaccessible without large tax ramifications.
“ROBS provide access to tax-deferred funds to help a business grow. And, assuming the business is successful, any capital gains that may be created from its success are deferred as well,” said McFadden.
ROBS also helps save money from a cost perspective. Because ROBS is not a loan, using this type of financing means business owners don’t have any involvement with interest payments. This gives entrepreneurs the chance to start a startup without getting heavily into debt.
“Using ROBS in place of a loan to finance an enterprise saves the entrepreneur the associated costs with loans like interest and origination fees,” said McFadden.
No Credit Score Requirements
Does your credit score factor into using ROBS? Not at all. Unlike taking out a traditional business loan, where good credit is a requirement and collateral like homes may be necessary to access funding, none of that is necessary when using ROBS. You do not need to meet any credit score requirements.
Less Reliance on Outside Loans or Investors
Taking out a business loan means repaying back the loan. Getting outside investors to invest in a business means providing shares in the business in exchange for capital. Using ROBS positions business owners, not investors or lenders, to have full authority and equity over their business in its early years.
“From a control and cap table view, ROBS help an entrepreneur rely less on outside investors keeping greater control of the direction of their enterprise as well as helping an entrepreneur avoid adding debt to their cap table,” said McFadden.
Read More: What Is a Working Capital Loan?
How Does ROBS Work Step-by-Step?
Here’s an overview of how ROBS works to finance a business.
Find a Licensed ROBS Promoter
“Performing the ROBS strategy correctly is pivotal to the process being implemented correctly,” said Curry. “Using a licensed ROBS promoter ensures that the process will be overseen by a professional and in line with current regulation.”
Establish a New C Corporation
Once you have chosen a ROBS promoter, Curry said the next step is to establish a C Corporation. It is an IRS requirement that all companies funded through the ROBS arrangement must be C Corporations.
Invest in the New C Corp
“Your ROBS provider can claim that your current retirement plan has the capability to invest in private stock the company also operates,” said Curry.
Adopt the Retirement Plan
Next, Curry said the ROBS provider will assist in making your retirement funds available to be adopted by the C Corporation.
Rollover and Transfer
“The individual can now transfer the retirement funds from the previous retirement account to the new retirement plan under the C Corporation,” said Curry.
Buying Corporate Stock and Confirmation
Curry said that the individual can purchase private stock in the company. The newly cash rich C Corp may now start a business.
Remember to get a final confirmation from your ROBS provider regarding processes made under the Employee Retirement Income Security ACT of 1974 (ERISA).
“Make sure that your ROBS provider confirms that all processes are made under current legislation under ERISA,” said Curry.
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This article originally appeared on GOBankingRates.com: What Are Rollovers as Business Start-ups?