This month we’re taking a look at who is buying lower middle market manufacturing companies. One of our featured articles tells how an increasing number of middle-aged executives are leaving corporate America for business ownership. While this might not be news to you, how they’re funding the acquisition to be debt and interest free may be information that sparks your own entrepreneurial pursuit.
Normally, if you take money out of a 401(k) before reaching age 59 ½, you have to pay income taxes on the money as well as a 10% early withdrawal penalty. There is a mechanism that allows you to pull money from your retirement, interest and penalty free, to finance the acquisition of a manufacturing company. It’s called a Rollover for Business Startups or ROBS. ROBS allows you to invest your retirement funds in a business without paying income taxes or early withdrawal penalties. It can be used to fund a new business or franchise, buy an existing business or franchise, or recapitalize an existing business. A ROBS is not a loan, so there’s no debt or interest to pay back. Just like any other form of financing, there are benefits and risks.
No debt or interest payments
As a new business owner, the first few years are critical and that’s the time when most companies fail. Using a ROBS allows owners to navigate this time without debt or interest payments. That means the business has more cash flow in those critical first years. This is YOUR money and it doesn’t have to be paid back.
Better business success rates
Recent studies show that companies funded by ROBS have a much better survival rate than other startups. This is partly because of the increased cash flow. It’s also likely that new entrepreneurs work harder to build the business when their own retirement funds are involved.
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 account balance. By structuring the transaction as a ROBS, you avoid these costs.
No impact to personal credit
When you do a ROBS, there’s no credit check, and you do not have to sign a personal guarantee. Most loans require a personal guarantee, 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
With an SBA loan you have money flowing from your account to the lender to pay back the loan. With a ROBS, a 401(k) plan is created for the company, which you can contribute to and grow.
Critics of ROBS cite the fact that there is danger in using your own retirement money to fund an entrepreneurial endeavor. I would argue that risk is much less if you are buying an established manufacturing business with a rich history and great cash flow to minimize the risk. Manufacturing businesses are the most sought after type of business for executives leaving corporate America.
Setting up a ROBS is not a do-it-yourself proposition. You’ll need a professional advisor and you can expect to pay several thousand dollars to complete the process. Your ROBS advisor can show you how to fund a manufacturing business acquisition without debt or interest payments.