Get expert advice on every topic you need as a small business owner, from the ideation stage to your eventual exit. Our articles, quick tips, infographics and how-to guides can offer entrepreneurs the most up-to-date information they need to flourish.

Subscribe to our blog

Everything you need to know about rollovers as business startups

Posted by Kanika Sinha

June 13, 2022

With funding representing the biggest challenge for most entrepreneurs, a growing number are seeking out a variety of nontraditional financing options to fund their startups. Among these options is a lesser-known financing method known as rollovers as business startups, or ROBS.

Typically, a ROBS involves leveraging funds from an eligible retirement account to provide capital to the business to cover the initial costs of starting up. In fact, it can be a great way to start or purchase a business using existing resources without saddling your startup with debt, in addition to letting you tap into your retirement funds tax- and penalty-free. 

However, using a ROBS can also be a risky move, jeopardizing your retirement if things don’t go as planned. Additionally, a ROBS transaction can be extremely complicated to execute, requiring several carefully orchestrated steps and the assistance of a specialized provider. We will delve into this and more below, including the potential benefits and possible downsides of ROBS.

What is a rollover for a business startup?

ROBS have existed in the U.S. for decades. This alternative form of business financing first came to be when Congress decided to provide American workers with another option for growing their retirement assets, allowing 401(k) plans to invest in Qualified Employer Securities (QES) — which then allow the individual to fund a business — representing an exception to the tax code under IRC Section 4975(d)(13) 

Simply put, ROBS can perhaps be better understood as a setup in which a prospective business owner rolls over their retirement funds from an individual retirement account or a 401(k) into a new business venture without having to pay any early-withdrawal penalties, or without incurring any distribution income and excise taxes that would ordinarily apply to the transaction. There is no limit as to how much of your retirement funds you can move in a rollover. 

What’s more, the ROBS setup allows you to be personally involved in the business as a bona fide employee and draw a salary, without breaking any of the prohibited IRA transaction rules.

How does a ROBS work?

With the entire ROBS structure hinging on the sale of Qualified Employer Securities, the new business entity you start or purchase has to operate as a C corporation, which can sell stock. All other business structures are prohibited from issuing QES and are therefore ineligible for leveraging the ROBS funding mechanism.

That means it all starts with establishing a C corporation and setting up a new 401(k), after which the business owner’s retirement funds are rolled over into the new 401(k) — which are then used to purchase capital stock in the C corp. Eventually, this sale translates to cash that’s invested into the business entity toward financing its initial startup costs. 

Pros and cons of a ROBS

A common concern of potential business owners considering ROBS is that if their new venture isn’t successful, they could lose their investment, that is their retirement assets. However, the financial risk involved with any business startup and the risk of failure isn’t unique to a ROBS. According to the U.S. Bureau of Labor Statistics, roughly 15% to 20% of small businesses fail within their first year of operation, and about 45% cease to exist within five years.

Here’s a more comprehensive look at the pros and cons of leveraging a ROBS.

Pros Cons
You won’t take on debt. ROBS is not a loan taken out against a retirement account, so there is no debt to repay or interest payments to cover monthly.  Your retirement is at risk. Despite the potential payoff, ROBS has a significant downside. You could wipe out your retirement nest egg if your startup fails.
You won’t pay penalties or taxes. There are no early withdrawal penalties or taxes for pulling out funds from IRA or 401(K) before age 59 ½.  You must operate as a C corp. Operating as a C corp might not be a suitable option for every business owing to legal and tax implications. 
Your funds could have better returns. The rolled-over funds have major potential for growth and better returns being invested in a growing business or successful startup. Besides, you have more control over your investment funds as compared to traditional retirement accounts which are majorly invested in common stocks, bonds and mutual funds. You could be at greater risk of an IRS audit. Being a ROBS-funded business, you may face increased scrutiny from the IRS. Besides, the audit process may be more complex owing to the IRS likely to review a whole lot of documentation including those for the retirement plan, business operations and more. 

In the light of the above, the decision to put your retirement eggs into one basket can be risky, but the current state of your account and your other options for income upon retirement also play into determining whether a ROBS is a good option for you.

Let’s take two scenarios as an example. John has more than $200,000 in a retirement fund and has a projected startup need of $100,000. His spouse is a salaried employee who can cover daily household expenses. Along with funding, he also brings business acumen and a strong business plan for his startup. Based on these facts, John would make a good candidate for a ROBS.

Meanwhile, Robert has $150,000 in a retirement fund. He is nearing retirement age and seeks to open a convenience store in his locality, which as a brick-and-mortar business is likely to have significant overhead. With little business experience and no other source of income available, Robert is not an ideal candidate for a ROBS.

How to set up a ROBS

Setting up a ROBS is a complex process that entails many steps that must be painstakingly executed, making it necessary to seek the help of a specialized ROBS provider, attorney and accountant. Further, some eligibility requirements must be satisfied before considering a ROBS.

The eligibility requirements:

• You must have a retirement account that is tax-deferred, such as a traditional IRA, 401(k) or 403(b).
• You must be an active employee in your business and draw a salary that aligns with the average for your position and responsibilities.
• You must offer all employees the opportunity to invest in the C corp’s retirement plan.

A ROBS transaction takes the form of the following sequential steps:

Step 1:

Establishment of a new C corporation.

Step 2:

Adoption of a qualified retirement 401(k) plan that allows for the purchase of company stock.

Step 3:

Roll over the existing retirement plan into the new 401(k) plan.

Step 4:

Purchasing the C corp’s stock at fair market value using the retirement plan.

Step 5:

Sale of the stock to generate the capital needed to fund the business.

Some additional information

Setup costs: Typically, having a ROBS provider to help you with the sequential steps described above would involve an initial fee of approximately $5,000. Additionally, there may be an ongoing monthly administrative fee of approximately $100 to $150 to cover the cost of administering the new retirement plan and submitting annual IRS filings, such as Form 5500.

Prohibited uses: IRC Section 4975 outlines prohibited transactions that could incur unexpected taxes and penalties. The most common prohibited transactions impacting ROBS arrangements include excessive business owner compensation and personal use of business funds or paying promoter fees.

Compliance and audits: Both the IRS and DOL hold ROBS investments to certain compliance standards and are likely to hold audits as and when required. Those ROBS-funded businesses not in compliance with regulations could face tax penalties and fines.

Unwinding a ROBS: Similar to establishing a business using a ROBS, the IRS has specific requirements to unwind a ROBS during a corporate transaction. 

Bottom line

While ROBS may be an attractive funding method as opposed to a small business loan that often comes with high-interest rates, there are pros and cons, costs and requirements that need to be given serious attention. Your financial standing may lead you to weigh the advantages (tax-free, zero loan costs) and disadvantages (no retirement funds, potential audits) differently than a fellow entrepreneur. Consider speaking with an accountant or ROBS provider to thoroughly review the opportunity.


Kanika Sinha
Kanika Sinha

Kanika is an enthusiastic content writer who craves to push the boundaries and explore uncharted territories. With her exceptional writing skills and in-depth knowledge of business-to-business dynamics, she creates compelling narratives that help businesses achieve tangible ROI. When not hunched over the keyboard, you can find her sweating it out in the gym, or indulging in a marathon of adorable movies with her young son.

We provide you with essential business services so you can focus on growth.