Investing Your 401(k) in a Small Business or Franchise? 10 Things to Know Before You Touch Your Funds!

If you’re like most conscientious capitalists, you’ve been investing in American business as well as your own IRA or 401(k) with the anticipation that your funds will grow over time. Sometimes this has worked, and sometimes it hasn’t. And lately, mostly the latter!

When it comes right down to it: As an individual, you have no control over the whims of the stock market. The one thing you do have control over, however, is yourself. So it stands to reason that, if you believe in yourself more than in some impersonal business entity whose success you can’t control, it would make good sense to invest in yourself. Right?

There is a way to do just that. A growing number of people are reaping the benefits from the juncture where investing and business financing meet: They’re financing the purchase of their own small business by investing their IRA and 401(k) funds into the venture.

Every day, specialized financial services companies like Guidant Financial Group help people younger than retirement age invest their retirement funds into their own business or franchise. And they do this without paying taxes or penalties on the withdrawal (“distribution”) from their accounts. Many of these people have achieved tremendous success by building a business while growing their 401(k) . . . and avoiding debt.

Even if you invest your retirement funds in your own talent and business acumen, however, there are still risks to be aware of—and measures to be taken—to ensure your success. Before you tap your IRA or 401(k) to finance your entrepreneurial dream, read the following 10-tips “countdown.” It could save you some money as well as heartache.

10. If you have less than $35,000, try something else. Using your retirement funds to start a small business or buy a franchise can get you a much higher return on your investment while avoiding loans and interest payments. However, if you have only $35,000 or less in your IRA or 401(k), it is generally better to simply take a distribution out of your account and pay the tax and penalty on the amount.

9. Work with a pro or two. The laws governing reinvesting your retirement plans are complex, and you will not be able to navigate them alone. Instead, work with an independent tax attorney and a Certified Public Accountant who can advise you throughout the process. You may be able to secure this kind of expertise by working with a reputable financial services company that sets up these kinds of investment structures. (See #3 below.)

8. Understand the risks. Risk is inherent in any investment and the launch of any new enterprise. While putting your retirement funds into your own business gives you more control over them, it can’t make up for the possibility of mistakes and poor decision making. Take a long hard look at the feasibility of your entrepreneurial vision and decide if small business ownership is right for you. You may discover that running a business involves the investment of more time and money than you’re willing to risk and that you can reach your goals through some other means.

7. Create a solid business plan. Write out a detailed business plan explaining how you intend to finance your company and how long you think it will take to turn a profit. Then run this plan by your attorney, CPA and other business professionals to get their input. While you need to believe in your dream, be careful not to let over-optimism spoil your venture. It’s always better to be realistic and then outdo your own expectations. If you think it’s going to take three months to establish your business, plan for six. If you think it’s going to take one-and-a-half, plan for two-and-a-half. And when it comes to the money needed to run your enterprise day to day, expect it to cost at least a third more than what you anticipate. This way you’ll be following that wise old advice: “Expect the best, but be prepared for the worst.”

6. Build an advisory group. You can’t build a business alone. Talk to as many experts as you can. Have multiple attorneys, CPAs, brokers and consultants on your side. If you are opening a bakery, get advice from professionals in the bakery business. If you’re opening a shop that sells tropical fish, get advice from the owner of the country’s most successful tropical fish store. Even after your small business or franchise is up and running, keep in contact with your group of experts for ongoing advice.

5. Treat it like a real business. Even though you established your business by investing your IRA or 401(k) retirement funds in it, your small business must be respected as an entity separate from your personal bank account and other private ventures. It’s an extension of your retirement account, so it can’t be treated as just another pool of cash to draw from.

4. If you buy used, get an appraisal. Never buy a used business without first getting an appraisal. Hire an independent appraiser to tell you the value of the business, and don’t pay a penny more if you can avoid it. If you are hoping to buy a franchise, work with a professional franchise consultant who can put you in touch with someone who understands how to appraise the value of a franchise.

3. Select a financial services company carefully. Some firms are capable of helping you invest your retirement funds in a business; others are not. Find a firm with a top reputation and a proven track record of helping people launch successful small businesses and franchises. There are some good websites now, like Guidant Financial Group’s, which offer online information as well as free consultations. Failure to do your due diligence and select true experts in the field could leave you liable for numerous taxes and penalties.

2. Buy something with a track record. If you are buying used, buy a business that is already turning a profit. Even though a failing business will be cheaper and you might think you could “magically” turn it around, the successful business is inevitably the safer investment. When buying a franchise, you are already taking advantage of an already establish brand, which has some great benefits. But make sure that the particular unit you’re considering is in a location that has the potential for growth. An independent franchise consultant could help you explore the pros and cons of your potential purchase.

1. Do YOU think it’s a good investment? Putting your IRA/401(k) funds into a small business is a long-term investment. You are, in effect, tying the growth of your retirement funds to the growth of your new business – which won’t happen overnight. Obviously, the wiser your investment, the quicker you’ll see profits that can be realized in your retirement account or re-invested into the business. So you must believe in the small business opportunity enough to put many, many hours of time, money and effort into building it up and keeping it there. And, ultimately, you must believe in yourself. If you feel that you could never trust anyone better with your money than yourself – and if you have the entrepreneurial zeal to tenaciously pursue your goals – then using your 410(k) to buy the business of your dreams may be the perfect way to go!