When launching or growing a small business, entrepreneurs are often challenged by two financial questions: How to fund your business and, if an SBA loan is the answer, then how to meet the owner-equity requirement for SBA loans. If you have an existing 401(k) or non-Roth IRA account, a Rollover as Business Startup, or a ROBS 401(k) or IRA, it may be a solution.
In this overview, you’ll learn how small business owners can use funds in existing and eligible 401(k) or IRA accounts, without taxes or penalties, to meet the owner-equity requirement for SBA financing with the ROBS plan.
Please note that this information is intended for you to become more aware of potential options and should serve as a starting point for important conversations with your lender, financial planner, or an attorney or consultant specializing in small businesses.
What are SBA loans and their owner-equity requirements?
The U.S. Small Business Administration (SBA) created several types of loans to help entrepreneurs access funding to launch and grow their businesses. This is because it’s often difficult for small business owners to secure traditional financing, like bank loans.
Here are some of the most popular SBA loan options:
- SBA 7(a) loan: This is the most popular SBA loan program for its tremendous range of uses, generous financing amount (up to $5 million), and longer repayment terms (up to 10 years) than similar traditional loans.
- SBA 504 loan: This is ideal for small business owners who need financing to purchase, build, or renovate commercial real estate for their businesses or for major equipment purchases, as well as to refinance debt used for these purposes. The SBA 504 loan program offers loans from $50,000 to $5.5 million, at fixed, below-market interest rates with repayment terms up to 25 years.
- SBA Microloan: These loans are ideal for small businesses with smaller funding needs, offering loan amounts ranging from $10,000 to $50,000. This can give you sufficient financing to launch or boost inventory, for example, while offering a simplified application process and a quicker approval and funding timeline.
Each of the SBA loans, as well as many other small business loans, requires you to provide an owner-equity investment toward the project. This helps to ensure that you have a financial stake in your business’s success, along with the risk that lenders take on.
For SBA loans, the owner-equity requirement is typically equivalent to 10% of the total financing cost – in some cases, it may be 15-20% for new or special-use deals. This is far more affordable for most small businesses than the 30-40% or more that’s required for traditional loans.
How can eligible retirement funds fulfill SBA owner-equity requirements?
For SBA loans, including for the SBA 7(a) and the SBA 504 programs, there are multiple eligible sources that business owners can use to meet the owner-equity requirement. These may include one or a mix of savings, gifted funds, and home equity, as well as the use of funds from eligible retirement accounts.
When used toward the owner-equity requirement to launch or expand a small business, this rollover program – known as a ROBS 401(k) or ROBS IRA plan – can make it possible for you to tap into accumulated retirement funds for a tax- and penalty-free rollover, as long as very specific steps are taken and requirements are met.
What are the steps for using eligible retirement funds for SBA owner equity requirements?
Before you make any withdrawals or rollovers from a 401(k) or IRA plan, it’s essential to speak with your CPA or an attorney, as well as your potential SBA lender. Using a 401(k) plan or an IRA for the ROBS program has many benefits, but there are some important IRS, US Treasury, and federal Department of Labor requirements, as well as SBA requirements, to ensure that you don’t incur any taxes or penalties for the rollover.
You should fully understand any requirements and potential penalties or taxes you could incur if the process isn’t completed correctly before taking any action. Here are some of the important considerations and requirements that you’ll want to cover when you meet with your professional team:
- Talk to your potential SBA lender: Your lender can help you determine whether you can use the ROBS plan and your accumulated 401(k) or IRA funds to meet the equity requirement. Together, you’ll review the amount, eligibility, and business-structuring requirements. Your lender will also provide you with a breakdown of the specific documentation that you’ll need.
It’s important to note that the ROBS plan requires that your business is a C-Corporation, which will then act as the sponsor of a new 401(k) plan, allowing it to invest in your corporation’s stock. - Reach out to a professional: You’ll want to seek counsel from an attorney, business consultant, or other firm that specializes in small businesses and has experience in the ROBS program. This will ensure any changes made to your retirement account are set up correctly.
- IRS documentation: Another document you’ll need before you proceed will be a favorable determination letter from the IRS. This provides the SBA with assurance that the terms of the retirement plan satisfy the initial qualification requirements.
- Other required documentation: There will be additional documentation required by your lender and the SBA. This can include:
- An annual report or report of your employee benefit plan.Your C-Corporation-formation documents.
- A 401(k) or IRA plan-adoption documentation, stock-purchase documents, and related corporate resolutions.
As you can see, the process is complex. While the ROBS plan can be a good tool to use to meet SBA equity requirements, you should only move forward after speaking with your lender and your legal and financial advisors.
An example of using the ROBS 401(k) plan to meet SBA owner equity
Let’s say you worked for a healthcare business. During that time, you contributed to a pre-tax 401(k) retirement plan. When you left that job to start your own dream business, a home-improvement business, you had accumulated more than $300,000 in your retirement account. To launch your business, you needed a total of $600,000 for equipment, a truck, your crew, and a lease on a building for your office and equipment storage.
- Although your bank can’t provide financing because your business is new, they recommend that you contact an SBA lender in your region.
- When you meet with the SBA lender, they review potential loan options and agree that the SBA 7(a) loan program is a good fit. It requires you to contribute a 10% down payment – $60,000 – to the deal.
- After considering several options, you decided a ROBS 401(k) could be a good option.
- You speak with your SBA lender about using the ROBS plan for your startup business. After receiving information on the documentation that you need, you contact an attorney who specializes in small businesses and can help you set up your business as a C Corporation. You also discuss your plans with your accountant and financial planner.
- Working together, your team pulls together the information to complete the requirements for the IRS, the US Treasury, the Department of Labor, and the SBA.
- Although it took some extra steps, time, and planning, your request is approved by all necessary entities, and you can move forward. Soon after, you are approved for the SBA 7(a) loan.
As a result, you launched your dream home-improvement business, providing good jobs to your team of six and doing work that you truly love.
Pursuit’s experienced team can help
Pursuit is a leading small business lender serving businesses across New York, New Jersey, Pennsylvania, Connecticut, Illinois, and Delaware. Our experienced team can help you determine the best ways to finance your business, from launch or acquisition through growth.
We offer more than 15 loan programs and a line of credit for working capital, commercial real estate, equipment, and much more. We can also help you determine the best way to meet the owner-equity requirement so that you’re comfortable at every step in the loan process.
We’ve helped thousands of small business owners get the funding they need to achieve their goals, and we can help you, too.