Buying a Business Using Your 401K or IRA
Posted by Kipp Krukowski on Thu, Jul 22, 2010 @ 12:15 AM
Buying a business might be possible when you thought that you could not afford to do so. I have mentioned in the past that one attractive method of financing a business is through the use of your 401k or IRA funds. This may not be the most desirable method for some individuals initially, but it may be that they are not fully education in how it can help them buy a business. Speaking from a position of knowledge of the process since I used this method to start up my own business brokerage company almost 7 years ago, it could be the right solution for you. The retirement plan must comply with the Employee Retirement Income Security Act (ERISA) of 1974 and must meet IRS requirements to allow the rollover of funds from qualified plan to qualified plan without taxes or penalties. There are steps that are important in the process to adhere to compliance regulations such as establishing a new company, selling shares of the corporation to the profit sharing plan to move the funds, having a plan that allows eligible employees to participate, and continuing administration to ensure ongoing compliance. This is not something that anyone should try to do themselves without professional help from companies with years of experience. There are also guidelines on when funds can or cannot qualify to be used in such a plan. Notably, there are two companies that we have had clients use to set-up the process successfully, Benetrends and Guidant. Both companies are first class organizations and will take care of the process to ensure that all the requirements are met.
Why would someone want to use their retirement funds to buy a business? There are many reasons. One may be the inability to receive bank financing. Another reason may be a way to avoid using banks and paying interest on a loan. It is possibly a way to create liquid funds in which could be leverage along with a bank loan.
Using the process of Benetrends or Guidant could potentially double the amount of money that you would have available when buying a business by eliminating taxes and penalties from the withdrawal. If you went the path of withdrawing retirement funds early without this process, you would be subject to a 10% penalty as well as have to claim the funds as ordinary income, which in some cases could cut the amount of money in half. So a person that has $100K in their 401k may only have $50K to buy a business versus the full $100K. In the hypothetical situation in which a bank will finance a business with 20% down, this is the difference between being able to buy a business with a sales price of $500K and $250K. Completing the analysis further, if both businesses were priced at a 3 times seller’s discretionary earnings, it could be the difference between buying a business that makes $167K versus $83K per year, before debt service. Again, speaking from firsthand knowledge, I didn’t have much in regards to liquid funds when I decided I wanted to leave the corporate world. However, I did put money away in my retirement account over the years that I thought was unavailable. Finding this solution allowed me to become an Entrepreneur. For others that are unemployed and can’t find a job, this is a perfect solution to create job security by buying a business. Just make sure that you have a professional help you set up the plan.