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Equity, debt and a process called ROBS: Funding a new business

Let’s say you’ve had an idea for a new venture. Maybe you want to open a cafe specializing in Viennese pastries. Or you’d like to start a writing school offering classes for IT consultants, attorneys and other professionals. Or you want to be a one-man company that plans trips for wealthy clients and travels the world with them.

Depending on the business sector and other factors, your funding needs can be very small, or they can run ten thousands of Dollars high. (According to statistics, about a third of new companies without employees start out with zero capital. But companies in the high-tech sector start out with an average of about $80,000.) If you determine that you will need money, the question is where will it come from? Do you have equity? Or will you need a loan?

Many entrepreneurs like to use personal money rather than bank credit to fund their business. They take out personal loans, borrow from people they know, and use consumer credit cards and home equity lines of credit. Or they invest their cash savings or retirement funds.

Utilizing retirement savings

Obviously, each of these options comes with pros and cons. If you use home equity to secure your loan, you’re looking at low interest rates but you also run the risk of losing your home to the bank if your business fails. If you borrow from friends or family, they will probably not ask for a collateral but ultimately you might be putting your relationship with them on the line. If you use your cash savings or money from an IRA or a 401(k), you could be facing liquidity issues.

Just as an aside, using retirement accounts to finance your new venture relies on a process called Rollover for Business Startups (ROBS) that brings up very complex tax and legal issues. A ROBS does not work for an LLC or S Corporation. You can only use it to fund a C Corporation. And to utilize a ROBS, you must have saved a minimum of $50,000 in your retirement account. But a ROBS also comes with a significant advantage: It allows you to use your retirement funds for your business without triggering taxes or early withdrawal fees.

From my personal experience, I know how energizing it can feel to start a new business, and I understand the eagerness of many entrepreneurs to move on fast with their project. But the funding aspect, as any money matter, requires careful consideration. I suggest that any business founder seek professional advice before making decisions.

By Kevin J. Moore