Equity Injection
In a previous post, I considered four options for funding, but I missed one.
401K ROBS
Thanks to my sister’s best friend who pointed out the option of using a 401K Roll Over for Business Startups (ROBS). Essentially, ROBS plans allow you to form a C corporation and fund a business acquisition with no penalty or withdraw tax. That would be necessary to withdraw that money and purchase a business. This could also allow me to move more confidently on a deal and/or give me an edge when trying to lock up a company. Some sources of information on these plans can be found here:
The downsides to using ROBS if I use it for the equity portion of a loan with the SBA, my ROBS will own proportionally to my other contributions toward the equity injection. For example, if my ROBS is brining $450K, and I contribute $50K from my savings account my ROBS plan will own 90% of the business, and I in my own name, will own 10% of the business. Another downside is that what is necessary and proper for the business is more closely scrutinized. Being a C corporation can lead to higher taxes, which leads many small C corporations to reinvest that money as much as possible to not have to pay tax on it. This can be good for growth, but can also lead to a lower business evaluation if the sudden need to sell should arise.
401K Loans
The option of using retirement loans that was mentioned in the aforementioned previous post turns out to be a bad idea. After discussions with a lawyer on the subject, it will be a very difficult or maybe impossible to pull off. Each solo 401K plan would need to be tied to a separate business, so in my case, I would be setting up six companies and trying to run them all for a profit, while trying to buy a business. Can you see the problem? I might be able to get a couple of companies going simultaneously, but I think if I tried for six, I would assuredly be audited by the IRS. Likely that would not end well as they would probably see it as a tax dodge.
Investors
I still may seek investors as that may allow me to own approximately 75-80% of the company in my name and the rest for investors who would likely get ~2% for each 1% of capital contributed. This will force a board arrangement, and the associated reporting, which could be a good thing. The advantages are that I presumably will choose at least one investor with some relevant experience, which could be a useful resource to bounce ideas off. It will also give the opportunity for family and friends to potentially gain some of the wealth creation these opportunities provide. In turn, I could set up my 401K money as a solo 401K and invest in other business searchers. Which could diversify my wealth. Of course, there are downsides, such as, I don’t own 100% of the company, and I have to attract investors. Attracting investors is mostly done between a signed letter of intent (LOI) and closing. So while, I am trying to get due diligence done, I will also be trying to get investors. This presents some timing challenges.
Path Forward
Ultimately, I am unsure of which way to go at this time. Both paths have advantages and disadvantages. I guess the best position would be to have investors ready to fund a deal, which would lower the uncertainty. Most investors, for self funded searchers, invest in the deal, so this is unlikely. Of course, I could go ahead and set up my 401K ROBS which cost between $3-5K for initial cost, and a reoccurring cost to administer it, and have that ready to go as a backstop. This cost would be wasted if I don’t use it. I could wait and plan to set up the 401K ROBS after I have a deal under LOI. Both companies mentioned above claimed it can be done in as little as 3 weeks, but more commonly 4-6 weeks.