Here's a Clever (if Risky) Way to Fund Your Start-Up: Use Your 401(k)

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Two years ago, Suzie and Todd Ford of Charlotte, N.C., transformed a layoff into a lifelong dream by starting their own craft brewery, NoDa Brewing Company. What makes the Fords' new business venture a bit unusual is how they funded it -- with their 401(k) retirement savings.

Their story highlights a newer phenomenon in the marketplace, called "ROBS" -- which can either stand for "rollover as business start-up" or "retirement owned business," and is sometimes called "401(k) small business financing."

It's a complex, high-risk gamble that allows Americans to tap into their retirement savings (e.g., a 401(k) or IRA that might normally be invested in traditional retirement fare like stocks and mutual funds) and use the money to invest in a franchise or their own business. And if executed correctly, would-be entrepreneurs can avoid paying the usual early withdrawal and tax penalties of cashing out early.

The practice is, by some measures, gaining popularity. A spate of recent news articles, including one in Inc. magazine, have covered the practice.

One company providing programs that allow for such funding, Guidant Financial of Bellevue, Wash., reports 40 percent growth year over year of clients in its marquee ROBS program. This year alone, the company reports, some 1,700 entrepreneurs will use ROBS to invest in their own businesses.

Here's how this little-known practice works -- and what the Fords have put at stake to accomplish their remarkable business success.

From Layoff to Local Beer Barons

Just a few short years ago, Suzie was a banker, and Todd, who has a degree in chemistry, was a busy commercial freight pilot flying routes all over the world, from Brussels to Nigeria. But his passion was home brewing, and the couple loved to throw house parties and share their tasty home brews with friends.

After Suzie's 2009 layoff from the banking world, the couple began investigating to determine just what it would take to open their own brewery. "We'd determined the path we were on then wasn't for us," says Suzie, a feeling that many longtime corporate-ladder climbers can probably relate to.

So they put together a detailed business plan, pricing out the cost of equipment, fitting out a building, and staffing the operation. But how to fund the business was a seemingly unsolvable problem. (Even small breweries are capital-intensive operations.)

"We looked at all options and kept coming back to our 401(k)," Suzie says. "It seemed like we should be able to use it without paying penalties, but we couldn't come up with anything."

A tip from a CPA friend eventually helped the Fords discover and make use of Guidant's ROBS program.

How the ROBS Program Works

Guidant CEO David Nilssen describes ROBS as a way for an entrepreneur to invest in the stock of his or her own business. The program requires a handful of steps. Here is how Guidant manages the process for its clients:
  • The client establishes a C corporation to serve as the operating entity of the business or the entity that acquires the existing business.
  • From there, a 401(k) plan is designed -- and sponsored by the corporation.
  • Then Guidant takes a client's existing retirement assets -- from one or many accounts -- and rolls them into the new 401(k) plan.
  • From there the 401(k) plan invests in the corporation or the stock of that new business in a cash-for-stock transaction.
The entrepreneur doesn't incur early-withdrawal penalties in this scenario. (Explicit exemptions that allow for this come from the Employee Retirement Income Security Act of 1974, and it must be noted that the rules for IRS compliance are complex and extensive .)

While it may seem risky -- putting what is probably the vast majority of one's retirement savings on the line for an untested business venture -- Nilssen asserts, "Starting a business is risky no matter how it's financed, but a traditional loan requires a down payment, credit, and personal assets on top of interest. Using retirement funds doesn't."

Who's Using ROBS?

Nilssen says that typical Guidant clients are 40- to 55-year-olds "who have worked in corporate America for more than 15 years, have great credit, and own homes. They're folks who are looking to start their dream careers without having to tap friends and family or loans to source funding."

%VIRTUAL-article-sponsoredlinks%The Fords fit that profile, as relatively prosperous 40-somethings with significant retirement savings who wanted to use it to fund their business.

"We were a little older than most people opening a brewery," Suzie says, "but thankfully, that meant we had more retirement and 401(k) savings built up."

Though it meant putting their retirement savings at risk, Suzie says they were excited by the option: "Instead of investing in someone else, we invested in ourselves. That was pretty empowering. We controlled our destiny instead of some mutual fund or company our retirement was previously invested in."

The Taste of Success; the Risk of Failure

On Oct. 29, 2011, Suzie and Todd opened their brewery with a tap and tasting room that serves beer by the pint. It's open seven days a week.

"Beer is our passion and expertise, so we do not have a kitchen," she says. "We do, however, partner with local food trucks who come on-site five days a week. And our beer is now sold in over 300 bars, restaurants, bottle shops, and specialty stores, from Earth Fare to Whole Foods and Total Wine." The Fords have also branched out to begin distributing in the neighboring state of South Carolina.

Their beer has received national attention as well. In 2012, a NoDa brew, Coco Loco -- one of Todd's old home-brew recipes -- won a silver medal at the Great American Beer Festival, a competition widely known as the "Oscars of Beer."

The Fords are pleased with the direction they've taken and the success they've tasted thus far. But they are certainly aware of the risk they took.

"A couple days before we opened our doors and sold our first pint of beer, we looked at each other and said, 'What if we fail? We have no retirement savings left,'" Suzie recalls. "At that point, even more so than before, we said failure was not an option and we haven't given that a second thought."

Could you ever take the risk of using your precious 401(k) savings to fund your big business idea, DailyFinance reader? Share your take in the comments section below.
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