Venture capital. Angel investors. Personal savings. All of these are common-knowledge ways to get your company the funding it needs to launch. But what about the IRS’s ROBS project?
When evaluating ways to fund our startup, Ascendify, my co-founder and I looked at all of the options available to us. One thing was clear — we were so passionate about making an impact in the recruiting industry with our talent acquisition platform, that we didn’t want anything (not even fundraising efforts) to deter us from bringing our solution to market. That’s when we discovered the ROBS project, or Rollovers as Business Startups.
In a nutshell, ROBS allows startup founders the ability to rollover 401(k) savings into their new corporation’s profit sharing plan to fund the business. The silver lining is that, by using ROBS, you can avoid withdrawal penalties and taxes usually associated with withdrawing your 401(k) early.
Entrepreneurs are inherent risk takers, and investing your life savings into your business is certainly one of life’s ultimate risks. One thing that made the decision clear for us was the notion of investing our retirement funds into our own business, instead of a public company that we have no control over on the stock market. And a lot of other entrepreneurs have realized this as well. In 2010, an estimated 10,000 businesses were launched using retirement funds. This created more than 60,000 jobs and added $8.3 billion to the economy, according to a survey from FRANdata.
According to firms dealing with these rollovers on a daily basis, the typical rollover amount falls somewhere between the $150,000 to $174,000 range. We’re thrilled with our decision to leverage the ROBS project. It allowed us to focus on listening to our customers’ needs, iterating the product, and deploying an industry recognized, award winning solution in less than a year. However, not every startup will fare similarly, so it’s not a decision to be made lightly.
In fact, without a solid plan in place it could be a dangerous path to travel. The IRS investigated ROBS plans from 2009 to 2010 and discovered this financing option for your business could be tricky. Three years after starting a business, many of the companies started using ROBS financing had already gone out of business. It’s tough enough to lose your business, but by rolling over your 401(k) into your company, you’re also putting your savings at risk. It was a scenario we definitely considered before moving forward with ROBS, and one any entrepreneur should take under consideration.
If you’re interested in using ROBS for your startup, here are some tips you should consider before rolling over your money:
Get a specialist
It’s important to have someone on your side who understands the law. We partnered with the firm Benetrends, but there are a few others like SDCooper and Guidant Financial Group that know the ins and out of the IRS laws and will facilitate the entire process for you.
The mechanism allowing for ROBS is the ERISA, or Employee Retirement Income Security Act of 1974, which allows employees to be responsible for their own retirement plans. Unfortunately, the ERISA is extremely complicated — and extremely easy to violate. In 2008, the IRS started to crack down on rollover violations. That’s why you should enlist a specialist who keeps close tabs on the changing regulations and mandatory IRS filings so you stay in good standing.
Offer employees stock
Whether your company has two employees or 200 employees, it’s important your workers understand they can purchase stock options. Some business owners using ROBS make stock transactions a one-time only affair, which can discriminate against new or less highly compensated employees. If you amend your plan to prevent other employees from purchasing stock after your ROBS funding is approved, this could get you into hot water with the IRS.
Most companies using the ROBS project to get off the ground won’t have much to worry about with few employees. But as your company grows, this is certainly one rule to keep an eye on. In our case, we’ve carved out an employee stock option pool to make sure our employees have a chance to participate.
Educate yourself and understand the risk
You don’t have to become an expert in IRS tax law, but you should know the bones of how the ROBS project works and where your money is going. After all, it is your business, and if you plan to use rollovers for funding, you should understand all the implications.
The ROBS project won’t be right for every startup or small business owner, but it was the right decision for us. If you educate yourself, get outside help, and stay compliant, it just might be the right means to kick-start your startup.
Have you used ROBS to fund your startup? Would you? Share in the comments!
Funding photo via Shutterstock
Lauren Smith is co-founder and VP of marketing of talent-acquisition platform Ascendify. A former advertising executive at three agencies, Lauren has launched global campaigns for major brands including Dell, Johnson & Johnson, and Comcast. You can connect with her on LinkedIn .