What is ROBS Funding & How Does it Work?
Money!
Money!
Where, oh WHERE, do I get the money to purchase a franchise?
This is one of the most common questions we see. And fair enough; if you’ve never purchased a franchise before, finding $100,000 or $200,000 or $500,000 out of thin air can seem like a difficult task.
One of the most common ways to fund the purchase of a franchise is debt. You can take out a standard loan to purchase a franchise. You can also get a government-subsidized Small Business Administration (SBA) Loan of up to $150,000 for small franchises and up to $5,000,000 for large franchises.
However, debt financing has its drawbacks.
Some of the biggest drawbacks to financing your franchise with debt include:
- You’re on the hook to pay the money back. If you can’t, say goodbye to your franchise.
- You have to pay interest, which, next to taxes, is one of the worst expenses to have.
- You are subject to audit by the lender.
- If you take out too much debt, you may limit yourself from obtaining additional debt.
- If you’re credit is too low, you may be unable to obtain debt financing for your franchise.
- If you don’t have adequate collateral, you may be unable to obtain a loan.
- The process of applying for a loan can be difficult and confusing.
As you can see, there are many reasons why debt financing may not be the route for you. So…is there another way? Well, other than inheriting $1M from crazy uncle Joe, or having a similar amount of cash stuffed under your mattress, there is another way that is catching on in the franchise space.
It’s called Rollover for Business Startups (ROBS), and it has some serious advantages which are not present with debt financing. ROBS financing involves using your own 401(k) or IRA savings to fund your business.
How to get ROBS financing for your franchise or business:
- Establishing a C-Corporation
- Establishing a self-directed IRA (SDIRA)
- Funneling existing funds you have from an IRA or 401(k) to your new SDIRA
- Directing your SDIRA to purchase nearly all of the shares of your C-Corporation in exchange for all the funds in your SDIRA
At the end of this transaction, you are left with all of your pre-tax funds from your SDIRA in your new corporation, which you can use to operate your business!
Sound complicated? It is.
That is why we recommend you work with a professional who can guide and assist you in setting up your ROBS financing, if that is the route you wish to go.
Advantages of ROBS Financing
- No debt means nothing to pay back. You are using your own money and can pay back into your 401(k) when you decide you would like to.
- No interest! This is a huge advantage of ROBS financing.
- No credit, no collateral, no problem! Since you’re just using your own money, there is no credit process to worry about.
- You don’t have to fund 100% using your own money. You can do a blend, like 75/25 or 50/50 equity and debt to finance your franchise. Share some of the risk with the bank!
I know what you’re thinking. “Jason, are there any drawbacks to going the ROBS route?” The answer is yes. There are always pros and cons to any financing method.
First, the ROBS financing method involves putting your retirement funds at risk to operate your business. Typically, you would invest your retirement money in other companies’ stocks, like Amazon and Facebook. Here, you are essentially investing in yourself. That is why it is so important to do accurate projections and estimates of the franchise you are considering purchasing. Some franchisors will be eager to get you to move forward by focusing solely on the sales numbers you can achieve.
But what about the bottom line?
Your net income is the most important figure when considering what return, or ROI, you can expect from your franchise investment. So, by putting your retirement money at risk, there is the possibility that you lose it.
Second, the ROBS transactions includes a setup fee and an annual fee that you will pay forever or as long as you own the corporation. The reason is your SDIRA and C-Corporation have annual required compliance items that need to be filed. This is taken care of by the same company that sets up your ROBS transaction. Expect about $1,500 in annual fees.
Disadvantages of ROBS Financing
While this is one way to fund a franchise, it can be risky, as outlined by Zoë Schlanger for Newsweek, don’t let your dream turn into a ROBS 401k nightmare!
When considering the fees mentioned above, you may be inclined to back out of your ROBS transaction at some point in the future. However, backing out of your ROBS transaction is quite complicated, and requires technically proficient assistance to do so.
See our blog on ROBS Reversals for more info on the potential disadvantages of ROBS 401k Funding, and how we can start a ROBS Reversal for you.
The method you ultimately choose to finance your franchise is up to you. If you are not sure what route is best for you, and would like professional guidance, we invite you to reach out to us by following the link here: https://myfranchisecpas.com/appointments/
If we’ve already helped you we would love a Google review!
