A Rollover for Business Startups (ROBS) is a way to invest $50K+ funds from your retirement account – like a 401k or IRA – into your business without paying early withdrawal penalties or taxes. A ROBS isn’t a business loan or even a 401k loan, so there’s no debt to repay or large interest payments to make.
Studies have shown that business owners who use a ROBS often see higher success rates than those who rely on traditional business financing. But, every ROBS is different. That’s why it’s important to consult with an expert to see if a ROBS would work for your business. If you have $50k or more in a 401k/IRA and want a free, no-obligation consultation from one of the top ROBS providers in the industry, click below.
How a Rollover for Business Startups (ROBS) Works
A ROBS gives you access to your retirement funds to use in your business without having to borrow or cash it out. It can be used to fund a new business (or franchise), buy an existing business, or recapitalize your business. When you use a ROBS your business retirement account owns shares of your new business.
Still, you have complete control of your funds and if your business is profitable, the percentage of profits that your retirement account owns can be returned to it. This can result in significant tax savings and allow your profits to grow tax free. A ROBS is not a withdrawal of funds from or loan against your retirement account. It is a rollover that invests in your new business instead of more traditional retirement investments like mutual funds.
Normally, if you take money out of a 401(k) or other tax advantaged retirement account before reaching age 59 ½, you must pay income taxes on the money as well as a 10% early withdrawal penalty. If you decide to borrow against your 401(k) you might need approval from your current employer and will have restrictions on the amount you can borrow and need to repay the loan with interest.
A ROBS is a popular way to start or buy a franchise. In fact, more than 60% of all new ROBS clients helped by the best ROBS providers we reviewed were franchisees. Just like any other type of startup financing, a ROBS has pros and cons that should be carefully weighed before deciding if it’s right for you, which we’ll discuss later in the article.
A Rollover for Business Startups is a very specialized financing tool that is dependant on your personal circumstances. Depending on your business, your retirement accounts, and what your goals are, the answers to your ROBS questions might be different. This is why we recommend getting a 1-on-1 consultation with an experienced ROBS provider who will answer all of your questions related to your personal ROBS opportunities for free.
How To Setup a ROBS in 5 Steps
Setting up a ROBS is a complicated process that typically requires the help of CPAs and attorneys who are experienced with ROBS transactions. Many professionals will claim they can manage any legal transaction, but setting up a ROBS isn’t just handling some paperwork. This is why most people work with a dedicated ROBS’s provider.
Here are the 5 steps involved in setting up a ROBS correctly:
1. Form a C Corporation
The first step when using a ROBS to fund your startup is creating a C corporation. A ROBS doesn’t work for an LLC, Sole Proprietorship, LLP, or S Corporation. Your business must be a C corporation to qualify for a ROBS because the IRS prohibits certain transactions involving qualifying employer securities which only a C corp can pass. Meaning, a C Corporation is the only business structure that can legally sell shares of the business to a retirement account.
2. Create a Retirement Plan for Your New C Corporation
The second step in setting up a ROBS is establishing a retirement plan, like a 401k, for your new business. You have a few options when deciding on what retirement plan you want to use. Some of the most popular ones include:
- 401(k) Plan
- Profit Sharing Plan
- Defined Benefits Plan
- Defined Contribution Plan
- A combination of plans, such as a 401(k) with a profit sharing component
You’ll need to find a custodian to manage the actual investments of the retirement plan (such as Wells Fargo, Merrill Lynch, or Schwab). Most ROBS providers don’t offer those services but will help you find a custodian to work with, and the custodian can help you identify the right retirement plan for you.
3. Transfer Funds From Your Personal Retirement Account to the New Company Retirement Plan
The third step is what makes the transaction a rollover. Once the company retirement plan is set up within your new C corporation, your existing personal retirement funds are transferred to the new retirement plan.
4. The Retirement Plan Purchases Stock in the Corporation
The fourth step is to use the funds in your new retirement plan to purchase stock in your new C corporation. In order to do this the business will have to issue ownership shares of the corporation.
Typically the number of shares that are given to the retirement plan is equal to the percentage of funding the plan is providing for the business. The percentage of startup financing the retirement plan is providing won’t always be 100%. That’s because a ROBS can be used in conjunction with other financing like SBA loans, personal savings, or additional partners and outside investors.
You might not want to issue 100% of your business’s shares during this round of funding. It may be advisable to issue only a fraction of the shares in case you want to raise money by issuing additional shares at a later date (bringing on new investors, partners, etc.). This can get a little complicated, but a good ROBS provider will be able to walk you through it.
5. Funds Become Available to the Corporation
The fifth step in setting up your ROBS is the fun part because you can now put the proceeds from your ROBS to use. The funds are now available to be used to start, buy, or grow your business.
But keep in mind that there are ongoing administrative duties after your ROBS is set up. This includes a number of reporting requirements outlined by the IRS and DOL, which we will discuss in more detail later in the article. A ROBS provider will handle these reporting responsibilities for you.
If the 5 steps involved with setting up a ROBS sound complicated, you’re right. It is. That’s why so many small businesses have entrusted the ROBS process to a ROBS provider that has had lots of experience with all the ins and outs of setting up a ROBS. If you have $50k or more in your retirement account click below to get a free, no obligation ROBS consultation with one of the top ROBS providers in the industry.
The 4 Requirements for a ROBS
A ROBS is not a loan, so you don’t have to meet traditional underwriting criteria like a credit check or cash flow analysis to qualify. This doesn’t mean that there aren’t requirements, however. To qualify you’ll need to have enough funds in your retirement account to make the transaction worth it, and you’ll need to be compliant with certain government rules.
The 4 requirements to be eligible for a ROBS are:
1. Currently Hold an Eligible Retirement Account
Your current retirement account must be a tax deferred account. Here are some popular tax deferred accounts that are eligible to be rolled over when doing a ROBS:
- Traditional IRA
Note: Roth IRAs and Roth 401(k) accounts are not eligible for ROBS.
2. Have $50K+ in Retirement Funds
Anything less than $50k and the fees (which we discuss below) will be cost prohibitive. Most ROBS providers won’t be willing to work with you if you’re trying to roll over less than that.
3. Retirement Account Not From Current Employer
The retirement account you’re rolling funds over from can’t be administered by your current employer. Most employers will prohibit you from rolling over a retirement account while you still work for them.
You can, however, use a retirement account from a previous employer, no matter who the current custodian is. You can also use funds in a self directed IRA, a 401k you’ve opened up on your own, or any other eligible account you have that you opened up outside of your employers.
4. Be a Legitimate Employee of the New Business
While there is no published amount of hours you must work in your new business, a conservative approach is to work 1,000+ hours per year. This means that a ROBS may not be a good fit for absentee owners or for passive income businesses like real estate investing unless there is a constant flow of work for you to do.
Those are the only four technical requirements, but there are other things that could impact your success with a ROBS. Typically these things depend on what you’re using your funds for, what type of retirement account you have, and what your business situation is. This is why it’s so important to have a consultation with a ROBS provider before deciding whether or not it’s the right decision for you.
For example, if you’re using a ROBS to recapitalize a current business, you should also keep a few things in mind before deciding to do it.
Robert Newcomer-Dyer, Sales Manager at Guidant, says that:
“If you’re planning to use a ROBS to recapitalize an existing business, the business should be generating some revenues already. While the business doesn’t have to be profitable, there needs to be a plan for profitability once you get access to the rolled over funds.”
These are not requirements in the way that a loan has minimum requirements. However, a ROBS provider might not be willing to work with you if you’re trying to put a band-aid on business losing a lot of money. It’s better to invest your retirement funds into a business that can develop and grow because of your injection of capital.
Costs of a ROBS
A Rollover for Business Startups is a not a loan so you don’t have debt or interest to pay back. Instead, you’ll only be charged by the professionals you need to hire to set up and manage your ROBS. While you could do this on your own with CPAs and Attorneys, an experienced ROBS provider is the recommended solution.
Guidant and other ROBS providers will typically charge you 2 fees:
1. ROBS Setup Fee
A ROBS provider charges approximately $5,000 upfront to setup your ROBS, and the fee must be paid out of your own pocket. The funds being rolled over can’t be used to pay the setup fee.
The setup fee pays for setting up your ROBS through a provider like Guidant. This includes setting up the C Corporation, a financial valuation of the business, the creation of the company retirement plan, and filing paperwork with the IRS.
2. Ongoing Monitoring Fee
Your ROBS provider will help you administer your ROBS for a fee of $120 – $140 per month. Plus, you may be charged a per employee fee if you have more than 10 retirement plan eligible employees. Some providers may charge you an annual fee instead of a monthly fee, but the total yearly cost will be the same either way.
The monitoring fee typically covers providing employees notifications when they become eligible for the plan, adding and subtracting employees from the plan, annually submitting required IRS filings like the 5500 form, and keeping track of any owner’s obligations for the plan.
Because of these fees, it generally doesn’t make financial sense to do a ROBS for amounts below $50,000. Anything below $50k and you’re looking at setup costs that run more than 10% of your funding. Considering that most startup loans have origination fees of under 4%, this level of expense is generally deemed too costly.
It’s possible to avoid some of these fees if you do a ROBS on your own without the help of a ROBS provider. However, we don’t recommend this because it’s easy to run into legal troubles and tax violations when administering a ROBS unless you’re experienced.
What’s more, you would likely need to hire individual attorneys and CPAs to work on your behalf anyway. Few professionals have the experience necessary to fully protect you from the potential tax and legal liabilities a ROBS could bring if done incorrectly. It also isn’t likely to save you much money, if any at all, by using these professionals instead partnering with an experienced ROBS provider.
A ROBS comes with a number of potential compliance issues, including which employees you offer retirement plans to and what investments those employees can choose from. While it doesn’t happen often, the IRS and DOL can audit your business to make sure you’re in compliance with all ROBS rules.
The ROBS providers we’ve reviewed report the rate of audit at under 1%, and none of our recommended ROBS providers have ever had a plan disqualified during an audit. These professionals give you the support you need to prevent an audit, and to help you through one if needed.
ROBS Requirements if You Have Employees
ROBS are designed to benefit the employees of the C corporation in which the funds are invested. This includes the owner of the business, who themselves must be a legitimate employee.
If you have employees there are 2 strict ROBS requirements that you must follow:
1. Eligible Employees Must Be Offered the Opportunity to Invest in the Company Retirement Plan
When using a ROBS, your business is required to educate eligible employees about your retirement plan, provide them with plan documents, and make sure they have sufficient time to invest in it.
Who qualifies as an eligible employee may vary by state or your plan design, but generally they must be at least 21 years old, have worked for your business for 1 year, and have worked at least 1,000 hours during that time.
Once the employee decides to invest in the retirement plan, you must process contributions and take care of any employer tax obligations related to the plan. Keep in mind that employees can become eligible to participate in retirement plans at different times throughout the year.
When employees become eligible you need to inform them of their eligibility and provide them with information about their investment options within a reasonable time period. Having a ROBS provider makes it easier to know when to do this, and helps prevent you from breaking any rules.
2. Employees are Entitled to Invest the Same Way You Are
All employees that are eligible for the company’s retirement plan must have the ability to invest in the same offerings as everyone else. In other words, you can’t offer some investments to owners but not to employees. If you make shares of the company part of the retirement plan offerings, then eligible employees will get to buy in.
Keep in mind, however, that investment options within a retirement plan can change. While your plan may offer the option of investing in your new C Corp for a period of time, it may change later on. If your retirement plan changes its investment options before employees become eligible, then the newly eligible employees are not entitled to invest in past offerings. This can stop your employees from owning part of the company, if you desire.
You must meet the “effective availability” requirements when educating your employees on the retirement plan. Essentially this means you must make investment vehicles available for a significant amount of time for the employee to make an informed decision on whether to invest or not.
Abiding by the rules for eligible employees can be difficult without the right guidance. This is another reason we recommend partnering with a ROBS provider who is experienced at both setting up a ROBS and getting their clients successfully through audits. You can read our ROBS buyers guide for our top 3 recommended providers.
Government Audits of ROBS
ROBS are held to certain compliance standards by both the Internal Revenue Service and the Department of Labor. While either of these government agencies can initiate an audit of the business to determine if the business’s retirement plan has violated any rules, the chance of an audit is extremely low. In fact, our recommended ROBS provider, Guidant, reports that less than 0.35% of their clients have been audited.
If you do face an audit some of the things checked for compliance include:
- The retirement plan was set up correctly. They want to make sure that all requirements we discussed above have been met.
- All required annual filings have been completed. They will double check that forms such as the annual IRS 5500 have been properly filed for each year the ROBS has been in place.
- You meet all employee requirements. The business is required to educate employees about the plan, provide all necessary forms, and take care of all employer taxes related to the retirement plan. We cover this in greater detail below.
Pros & Cons of a ROBS as 401k Business Funding
A top concern that many entrepreneurs have when using retirement savings to fund a business is if their startup isn’t successful, they could lose their investment. What many people don’t realize is that the financial risk involved with a startup and the possibility of business failure aren’t unique to a ROBS.
No matter how you fund a small business, there’s something on the line. If you go with a ROBS, there certainly is a chance that the business could fail, and you could lose your nest egg. However, if you go with another option and take out a business loan, for example, you’ll likely have to sign a personal guarantee and put up collateral. If the business fails while owing on a loan you could lose your home or other personal assets.
The risk of entrepreneurship exists no matter how you finance your business, so as with other types of business financing, we recommend balancing the pros and cons of a ROBS before deciding whether it’s the right choice for you.
No Debt or Interest Payments
It can be difficult and expensive to obtain capital to start or purchase a business. Many loan providers to small businesses, particularly for startups, charge interest rates that are over 55% per year. A ROBS is not a loan, so you do not incur debt and do not have to pay interest. That means the business is more cash rich, and more gross income can be reinvested back into the business.
Better Business Success Rates
Guidant commissioned a study showing that companies funded by ROBS have a much better survival rate than other startups. This is partly because they are not starving the business for funds in order to make debt payments. About 81% of Guidant clients are still operating after 4 years or have successfully sold their business, whereas the standard is around 39%.
No Income Taxes or Early Withdrawal Penalties
If you were to simply take money out of your retirement account and use it for your business, you would have to pay income taxes and, if you’re under age 59 ½, early withdrawal penalties. The penalty is typically 10% of the amount withdrawn. By structuring the transaction as a ROBS you avoid these costs.
No Impact on Personal Credit or Personal Assets
When you do a ROBS, there’s no credit check and you don’t have to sign a personal guarantee. Most loans require both, which means the personal credit of the business owner can be damaged and personal assets taken if the business can’t afford to pay back the loan.
In contrast, with a ROBS the failure of the business means only that the funds you invested are lost. It won’t impact your personal credit or other personal assets.
Retirement Funds Can Grow in a Tax Advantaged Account
A loan is one-sided with money flowing from your business to the lender to pay back the loan. When doing a ROBS, a 401(k) plan is created for the company. You can contribute to that account as your business produces revenue and use the funds for retirement.
Possibility of Losing Retirement Money
Most new businesses fail, and if yours does, then you could lose all the money you invested. Also, consider the opportunity costs: If your retirement money was not invested in your company, it could be invested in stocks, bonds, ETFs or mutual funds. Assuming a reasonable rate of return, the money invested in the business could have earned much more had it been placed in more traditional investments.
You Could Be Audited
Doing a ROBS increases the likelihood that the IRS or Department of Labor will audit your business. If they find that you violated certain rules, you may have to pay penalties and taxes. Fortunately, the increase in risk is small.
With Guidant, for example, only about 0.32% of plans face an audit. Also, most ROBS providers will help you if you’re audited and back up their work by paying for your audit costs. Guidant even provides outside counsel to represent your best interests at no additional cost to you.
Must Administer a Retirement Plan
When you commit to a ROBS you become the administrator of a company-provided retirement plan. Although ROBS firms will provide guidance with this you will need to market the plan towards employees and help them enroll. This can take time away from your business.
Must Operate as a C Corporation
It’s only possible to do a ROBS if you’re structured as a C Corporation. Many small businesses prefer the simplicity and tax advantages of an LLC or partnership instead of a Corporation. You’re giving that up if you decide to do a Rollover for Business Startups.
Given the risks associated with a ROBS, we think it’s important to use the guidance of a professional ROBS provider. One reason we recommend Guidant as the best ROBS provider for small business owners is that they give access to independent counsel before, during, and after the ROBS setup process. They also offer a free 1-on-1 consultation upfront to answer your questions.
Unwinding or Selling Your Business After 401k Business Funding
At some point every entrepreneur has the goal of opening a business, growing that business, and eventually selling it off or exiting it down the road. Starting a business with a ROBS can add a few changes to the normal unwinding of a business. We’ll outline these below.
Business Stock Sale
If you sell the stock of your business then winding down your ROBS is very easy. Everyone who owns a percentage of stock in the business typically receives that portion of the sales proceeds, minus any funds required to wind down your investment or other potential business obligations. The funds given to the retirement plan for its owned stock in the business are rolled into an IRA for your benefit.
Business Asset Sale
Many businesses sell their assets instead of their stock to prevent the new owners from taking responsibility for any potential future liabilities that the current company may have. In these circumstances, it becomes more difficult to unwind your ROBS.
Once the business assets are sold, the funds are used to first pay off liabilities and administrative obligations. The net proceeds remaining after those payments are then distributed to the owners of the business, including the retirement plan you own.
If Your Business Fails
If your business fails then there is still a need to wind down your ROBS by closing out your retirement plan. You’ll need to educate your employees on what options they have for the funds they’ve already invested in the plan. When your business fails you do not have any obligation to pay back your original funding to anyone, but you will lose the money.
Rollover for Business Startups Frequently Asked Questions
We’ve put together a collection of frequently asked questions about ROBS from our readers, past ROBS users, and viewers of our ROBS webinar. If we don’t answer your question in this guide or in the FAQ below you can ask us a question in our forum or sign up to participate in our free ROBS webinar to learn more.
What can a ROBS be used for?
A Rollover for Business Startups can be used to start a new business (or franchise), buy an existing business, or recapitalize an existing business. According to Guidant, here’s the approximate breakdown of how ROBS funds are used:
- Start a new business – 60%
- Buy an existing business – 20%
- Recapitalize an existing business – 20%
Does the company have to be a C corporation, or can it be an LLC, partnership, or S corporation?
The company must be a C Corporation to create a Rollover for Business Startups. Read our article to learn more about business structures.
Can I change the business to an LLC later, or does it have to stay a C Corp?
As long as you have funds invested in the business the entity must be a C Corporation. This is due to your company retirement plan owning shares of your business. Only a C Corporation allows something other than a person or legal business entity to own shares.
As the business owner, do I have to offer the company retirement plan to all employees?
You must offer the retirement plan to all eligible employees. Without getting into the nitty gritty of the law, the government does set minimum requirements on who’s entitled to a company retirement plan. Generally speaking, an employee must be at least 21 years old, have worked for one year, and have worked at least 1,000 hours during that time. Learn more at the DOL.
Do employees have to be provided the opportunity to purchase stock in the company?
No, unless you or other owners are given that opportunity. The legal requirement is that company stock has to be made “effectively available” to employees in the same way it is available to the owners. While this will be in your initial part of your retirement plan, it can be removed before you have employees become eligible, if you desire.
However, company stock can only be purchased by the employees through the retirement plan. Since stock in new companies is usually illiquid (cannot be easily sold), most employees tend to avoid investing even when it is offered.
What happens if the business fails?
If the business fails, you could lose the money you rolled over from your personal retirement account. When a business is forced to shut down the assets of the corporation are liquidated and used to buy back as many shares of stock owned by the 401(k) plan as possible. Any funds remaining in the 401(k) plan are placed into an IRA for the business owner’s benefit, and both the plan and the corporation are dissolved.
Can you pull more money out of your retirement account using another ROBS down the road?
As long as you have $50k+ in another eligible retirement account you can do another ROBS. It would be a separate transaction going into the same business entity. This particular type of situation is very personalized to you. This is why we recommend having a free 1-on-1 consultation with an experienced ROBS provider, so you can get all of your specific questions answered.
Who is actually holding the retirement accounts?
The actual cash accounts are held by a custodian, which is typically a brokerage firm such as Fidelity or TD Ameritrade. In general, the cost of having a custodian hold the retirement accounts is negligible or free. The brokerage firms make their money through their normal charges for buying or selling stocks, mutual funds, and ETFs.
Can a ROBS be used to purchase real estate?
A ROBS can’t be directly used to purchase real estate, but it can be used to invest working capital into a C corporation which buys real estate with their available cash flow.
How many people can invest in a business using a ROBS?
There is no maximum. Anyone using their own ROBS to invest must be a legitimate employee of the business. It is fairly common for multiple business partners to invest in the same business using a ROBS. You can also take funding from as many other sources or investors as you would like to as direct investments outside of this transaction.
Can 2 people combine their own ROBS together to buy a business?
Yes they can, but the tricky part with this type of transaction is how the 401k plan would be impacted. You may want to have an individual invest in a 401k plan and another in a profit sharing plan of some sort, to keep the money separate. It really depends on your goals and your individual situation, which is why you likely need a 1-on-1 consultation, which most ROBS providers offer for free.
Does the business owner’s retirement account sell shares or get paid dividends?
Although it is not commonly done, should the corporation issue a dividend to shareholders, the 401(k) plan gets its proportionate share of the dividend since it is a shareholder of company stock. The more common practice is for the business owners to pay themselves bonuses and higher salaries as the company starts generating excess cash flow.
As for selling shares, if the company is sold, the retirement account(s) holding shares will get payment in exchange for the shares it held. Also, the corporation can offer to buy back (“redeem”) shares from the plan which provides another way to increase the cash in a retirement account.
Can I use additional financing with a ROBS?
Yes. Many forms of financing, such as equipment financing, can be used with a ROBS to give the business more capital to work with. The most popular is getting an SBA loan to handle any additional capital requirements your business may need.
A ROBS can also be used as a down payment for other financing. In fact, most ROBS providers will help you obtain additional startup financing if you need it but many will charge for this service.
A Rollover for Business Startups can be a great option for funding a small business, whether you’re just starting out, want to buy a business, or recapitalize your current business. Ultimately, you should weigh all the pros and cons of a ROBS and get all your questions answered by a professional before deciding if it’s right for you.
Ultimately, you should weigh all the pros and cons of a ROBS and get all your questions answered by a professional before deciding if it’s right for you. If you have $50k or more in your retirement account, you qualify for a free, no obligation 1-on-1 consultation with a ROBS expert.