A New Source for Business Capital

When it comes to owning and operating a business, finding the right form of financing can be an arduous task. Where do you find the necessary funding to seed a business, buy a new one or raise additional working capital? Traditionally, business owners have used bank loans, SBA loans, personal loans, credit cards or home equity to satisfy their funding needs. The biggest downside to these sources of financing is the debt load and corresponding payments. Additional debt can impair one’s ability to access money in the event that “life happens.” That is why the idea of using retirement funds to inject cash into a business has been gaining popularity. Although relatively few know about this concept, it has been growing in popularity, especially among those purchasing small businesses and franchises. When structured by experienced retirement account specialists, this strategy allows for an individual’s retirement account to invest directly into their business venture… without taking a distribution and paying taxes and penalties.

The Background

The IRA and 401(k) were created in 1974 when Congress passed the Employee Retirement Income Security Act (ERISA) to address concerns that private pension funds were being mismanaged by employers. At that time, the IRA and 401(k) transferred the responsibility of retirement investing from the employer to the employee. There are only two types of investments into which employees can’t invest retirement-account monies: life insurance and collectibles. Consequently, retirement accounts are far more flexible and practical than most people realize. And there are many more investments that can be made with them –- like buying a personal business — than the greater population realizes.

New Trend in Financing

In order to invest in their business, many entrepreneurs have taken early distributions from the IRAs and 401(k)s and, as a result, have incurred thousands of dollars in taxes and penalties. If they had known of this unique account structure, they could have invested in their business as a legitimate retirement account investment. This investment strategy provides less business debt and greater long-term potential for retirement funds. Using retirement money instead of traditional business or home equity loans enables more money to be reinvested back into the business instead of toward debt. In addition, since the retirement account owns a portion of the business, profits from the business can be returned to the account tax-deferred.

For those looking for financing their current or new business venture, their own retirement account just might be the answer.

More and more individuals are looking to make the jump from employee to employer through business ownership. Determining how you will finance a new business purchase is one of the most critical choices you will have as an entrepreneur – one that is oftentimes not explored early enough in the process. Researching your financing options should be one of the first steps in the process after you have decided business ownership is right for you.

Although there are many great business opportunities available, how you finance your venture often determines the level of success you will ultimately enjoy. Traditionally, there have been four ways that people finance a business:

Home Equity Line of Credit (HELOC)

The real estate market has enjoyed a nice run in the past decade, and many people, perhaps you, have home equity you could use to purchase a franchise. A benefit of using a HELOC is that it is relatively cheap money and can be closed fairly quickly. If you choose this route – be prepared for a delay in the process when you explain to your lender you want this money for investments, as this will likely raise many more questions.

Bank Loan

It seems that if you tell a bank you want a loan to start a new business, you won’t get any money unless you can prove you already have so many assets you don’t actually need the loan! A bank loan means collateralizing the business with other assets such as cash, stocks and home equity. In addition, most banks will require a significant down payment.

SBA (Small Business Administration) Loans

The SBA doesn’t lend money. The SBA guarantees loans and is primarily for those people who still could not borrow money even if they have the necessary collateral. The SBA provides this guarantee to the banks so they will provide loans with less stringent qualifications. SBA loans work best with franchise opportunities or businesses that have been in existence for two or more years. An SBA loan will likely be more expensive (and time consuming) to obtain than other methods (45-120 days).

Retirement Funds

Many entrepreneurs will take a taxable distribution from their retirement plan in order to come up with the necessary capital to purchase a business. There is, however, a much better way to use your retirement funds top help purchase your business. This funding solution is a combination of a 401(k) and a corporation. In this structure, your retirement account invests directly into your new business via a corporation, thus providing the necessary capital to purchase, open and operate. Your retirement account actually takes ownership by purchasing stock in the corporation – similar to your IRA purchasing shares in a publicly traded company. The benefits? You have 401(k) plan for your new business. As the company prospers, the value of the retirement plans investment increases – tax deferred. And, there is no loan and thus no payments..

An increasing number of investors are discovering the many benefits to utilizing their retirement funds to invest in a business or franchise helping to secure a healthy financial future. You may find that you, too, are virtually sitting on undiscovered capital!