Bad Credit Business Funding Option – Use Your 401k to Start a Business

Are you an aspiring entrepreneur with bad credit? In that case you know well that financing a business with bad credit is no easy task.

Even for a small business owner with good credit, access to financing from traditional sources such as banks, credit unions can be challenging.  According to the Harvard Business School “The State of Small Business Lending” report, the credit market has not returned to pre-crisis levels and has been markedly  more constrained for the small business segment. [1]

For an aspiring business owner with bad credit, the options are even more limited and those lending options that are available are expensive.  For example, an individual with bad credit (typically defined as a credit score below 630) could easily pay 20% or more for a business loan from an alternative lender or finance company.

Other than taking on a loan with credit card-level interest rates, other sources that are typically considered are borrowing money from friends or relatives or perhaps seeking a grant.

Even if these options might be possible, they are less than ideal.  An aspiring entrepreneur will want to avoid the financial pressure of paying back a high-interest loan or the social pressure of being in debt to friends or relatives.  Even if a grant may be possible, the entrepreneur may not have the time to apply for a grant that ultimately may not be awarded.

There is another way to acquire the small business financing you need.  This alternative does not require a credit check nor is it a loan that needs to be paid back.  The strategy entails investing your retirement funds in your own business and is referred to as a rollover as business startup (ROBS) or 401k Business Financing.  If properly structured and executed, you can access all of your retirement funds without paying taxes or penalties.

The high-level steps of a ROBS transaction are as follows:

  • The first step is to form a corporation which must be taxed as a C-corporation.
  • The corporation then adopts a 401k profit sharing plan.
  • As an employee of the corporation, you would participate in the 401k plan and then transfer your retirement funds from your existing retirement account (e.g., former employer 401k, Rollover IRA, etc.)  into the 401k plan.
  • You would then invest your 401k funds in company stock by transferring funds from the 401k to the corporation.
  • The corporation would then be able to use the funds for legitimate business purposes (e.g., buy the assets of an existing business, start a new franchise, etc.).

There are important ongoing compliance requirements (e.g., annual reporting, offering employees the 401k, etc.) as well as specific issues that have to be considered on a case-by-case basis (e.g., whether funds in your existing retirement account are eligible, etc.).

To learn more about how to start or buy a business or franchise with your retirement funds, please visit our 401k small business financing page and the related links.

To learn more about how our 401k Business Financing plan would work for you please call us at 800.489.7571.

Notes:

  1. Mills, Karen, and Brayden McCarthy. “The State of Small Business Lending: Credit Access during the Recovery and How Technology May Change the Game.” Harvard Business School General Management Unit Working Paper 15-004 (2014). http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2470523

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About George Blower

I have the privilege of educating our clients about our products and services so that they can make informed and confident decisions about their financial future. Prior to joining My Solo 401k Financial, I served as the general counsel for a subsidiary of a Fortune 500 financial services company. Learn more about George Blower and My Solo 401k Financial >>

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