March 20, 2023

Wealth Matters: Financing Start-Up Dreams With Retirement Savings

They had three very different dreams, but these women had one thing in common: they all lost jobs and decided to use sizable retirement accounts to start their own businesses in very different fields. They did so by converting traditional 401(k) accounts into new retirement plans — known as “rollovers as business start-ups,” or ROBS — that they could invest in their companies.

“It’s fueled by the fact that stock market has returned to all-time highs, real estate is up, consumer confidence is up — but we’re also suffering from a credit crisis, and unemployment remains high,” said David Nilssen, chief executive of Guidant Financial, which specializes in helping people use 401(k) assets to invest in businesses or other nontraditional assets, like property. “People look at this because they can capitalize a business without taking on any debt.”

While this may sound like an easy solution to finance a company, it is incredibly complicated, and the risks of running afoul of the Internal Revenue Service or the Department of Labor, which has jurisdiction over 401(k) plans, are significant. The worst possible outcome is a triple-whammy loss of a person’s retirement savings, the business and a source of income if the idea fails.

Adding to the complications, ROBS exist in a parallel financial universe, where those who promote the plans see them as solutions for retirement-rich but cash-poor entrepreneurs, while many other financial advisers see the plans as treading the line of legality.

“The I.R.S. has said that they don’t view them as tax-avoidance schemes per se,” said Carol J. Ventura, retirement specialist at H.D. Vest, a broker-dealer with $33 billion under management. “They’re not illegal, but the I.R.S. is saying that they have to be perfectly put in place. They’re very complicated.”

Failure to do everything right could lead to anything from penalties to having the entire retirement plan disallowed, which would mean a big tax bill.

Still, Mr. Nilssen said the idea had been gaining in popularity. He said his company had its best year in 2012 with 1,300 new ROBS and expects to do 1,700 this year. I wanted to know what the attraction was to something that seemed so complicated and magnified the sizable risk of starting any business.

Here’s how ROBS work: People take their 401(k) account (or other qualified retirement plan) and roll it over into a new plan that buys shares in an operating company that will own their business. Unlike most small businesses, which are set up as limited liability corporations or S-corporations, a business financed through ROBS has to be a C-corporation, which can issue shares and does not prohibit ownership by trusts.

In many cases, people turn to ROBS because they don’t have other sources of financing and have not been able to secure a small-business loan.The companies of the people I spoke to were owned by anywhere from 90 percent of one person’s 401(k) to 100 percent of two entire plans.

That might sound simple, but what effectively happens is that the plan, not the person, owns the business. That means the person cannot act in his best interest but must act in the best interest of the plan. For example, if he wants to give himself a raise, he needs to find out what similar business owners make.

“I have counseled people on how to do them correctly and then I typically say, ‘I find it to be a bad idea and you’re probably going to get yourself in trouble,’ ” said Bill Smith, a tax lawyer and managing director in the CBIZ National Tax Office. “The I.R.S. is not consistent on what it considers correct. It’s very easy to mess these things up.”

Mr. Nilssen said Guidant helped people set up the initial plan and managed the reporting requirements. He said that of his firm’s 8,500 clients, about 50 had been audited, but none had had action taken against them.

Ms. Jones said that in the course of putting $260,000 of the $340,000 she had in her retirement account into buying a Decorating Den franchise in Nashville, she had several lean years during the recession, but that she is now doing well. She says she is also happier than when she was working in health care technology.

But she said the paperwork to comply with the I.R.S. rules could be complicated — and managing paperwork was part of her previous career. One requirement of these plans is that she and any employees pay into the 401(k) set up to buy the company. “That check has to be out the door seven days after payroll,” she said. “If I’m late at writing a check to deposit my 401(k) money, there are penalties, and I’ve paid penalties.”

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Bucks: Tips For Managing Your Increasingly Lumpy Income

Carl Richards

Carl Richards is a certified financial planner in Park City, Utah, and is the director of investor education at BAM Advisor Services. His book, “The Behavior Gap,” was published this year. His sketches are archived on the Bucks blog.

Graduate from college, get a job with a stable paycheck that grows each year by a little, work for 30 or 40 years and retire with a pension.

While it may have been common among Tom Brokaw’s book “The Greatest Generation” and even with many baby boomers, the idea of working at the same place your whole life, having a stable paycheck and getting a pension check afterwards seems like a fairytale now. It’s hard to pin down the numbers, but increasingly it seems like we’re facing the new reality of living in Daniel H. Pink’s book, “Free Agent Nation”.

It is a place where many of the structures we used to rely on have either gone away or are predicted to go away. Retirement accounts we manage ourselves have replaced company pensions, and in many cases our income has become more variable.

The issues that come with variable or lumpy incomes are not new. Think of farmers, small business owners and artists. Add to that list all the real estate agents, trial attorneys and other jobs that rely heavily on commissions or bonuses. These jobs come with fat years followed by lean ones.

But most of the personal financial literature focuses mainly on the nonlumpy, on people with steady incomes and a paycheck every two weeks.

For this group, it’s logical to think of saving a percentage of your income each year and allocating that savings to different buckets, like college and retirement. It’s a strategy that works fine if your income is steady and steadily growing over time.

This approach gets confusing when you fall into the lumpy category though. In one year you may have X amount, then the next year you may may earn 10 times X or one-tenth of X. The variation can be incredibly difficult to predict, making it a challenge to plan for your financial future.

For example, think of artists who have a big art show and make two to three times their annual income from that one show. They may not make any income during the next two years while preparing for a new show.

You may not be an artist, but it’s hard to miss the drastic changes in the job market. How many people still work for the same employer for 30 years? I predict that over time more of us will face the challenge of lumpy incomes even if we don’t right now.

People with lumpy incomes need to think about financial planning a bit differently. Many of the standards will hold true, but if you find yourself looking at a lot of ups and downs in your income, you want to be aware of a few things.

1) SPENDING When you have that first big year, where your income is two, three, or even 10 times as big as your previous high mark, there’s a tendency to think of it as the new normal. It’s easy to assume that you’ll always earn that new income. It’s also very easy to start and continue spending at that level.

A friend told me the story of a trial attorney she knew who won a big trial many years ago. He made upgrades to his lifestyle that he still follows today, even though he hasn’t had another big win since the original one. It’s starting to catch up with him, but he appears unwilling to modify his lifestyle. So with your first big year, be careful that you don’t reset your expectations to a markedly higher level and then years later realize you’re in trouble.

2) SAVINGS Depending on your situation, saving a percentage of your income may still make sense, but it can also help to think in terms of setting a spending threshold. With a spending threshold, you spend a certain amount and then everything over that amount gets saved. From that savings, you’ll allocate some to retirement, education or other goals you’re working towards.

3) TAXES Often people with lumpy incomes are in for a big surprise every April. You’ll want to work with a certified public accountant to set aside enough to cover you, particularly if you’ve done really well that year. There are few things worse than having a big year, something that’s cause for celebration, and then being shocked by the tax bill.

When I think of the lumpiest incomes, it’s hard not to think of farmers and their time-tested rules. For instance, when you have a fat year, set some aside for lean years, or live on far less than you make. The problems come when you try to manage a  lumpy income using a set salary mindset. If you have lumpy income, you should act like a farmer, not a salaried employee.

We need to start rethinking some of the rules of traditional financial advice and adapting them to better fit incomes that go up and down, often without warning. It’s easy to forget that most people lived this way for years before we got used to the idea of company pensions and working at the same place for 30 years.

If you earn a lumpy income, what have you done to better align your spending and saving with your income?


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You’re the Boss: A Start-Up’s Financial Reckoning

She Owns It

Success came quickly for SolTec Electronics. The company, which Dawn Gluskin founded from her living room and financed with her savings and retirement accounts in 2008, sells hard-to-find electronic circuit board components, such as semi-conductors and integrated circuits to companies operating in the electronic manufacturing and aerospace industries.

By 2009, SolTec had annual revenue of $700,000. In 2010, it moved into office space in Rockledge, Fla., hit $2.7 million in revenue, and secured a $150,000 line of credit. SolTec, according to Ms. Gluskin, helps clients when traditional distributor relationships break down. Given the rapid pace of technological advance, critical components in a supply chain can suddenly become obsolete. Many manufacturers also have trouble keeping up with demand, which can result in long lead times as they wait for parts. In addition, counterfeit parts have flooded the global market, which is why SolTec tests all components in its lab before sending them to customers.

Last year Ms. Gluskin, a first-time entrepreneur, devoted much of her attention to sales, marketing, and business development — her areas of expertise — while simultaneously running her 11-employee company. Her efforts were rewarded with explosive growth, but she learned she couldn’t do it all. “I was so wrapped up in other activities,” she said, “that I lost sight of our financials.”

In the fourth quarter of 2010, SolTec recorded its first quarterly loss. Ms. Gluskin was unaware of the problem until the first quarter of 2011, when the $40,000 loss was revealed at an end-of-quarter management meeting. The loss, Ms Gluskin said, resulted from a “perfect storm” of low sales and high spending. “In 2010,” she said, “we tripled our staff size, moved from the home office, added a lab, and were spending, spending, spending on equipment.”

Immediately, Ms. Gluskin began to address SolTec’s weaknesses. She realized the company, which does not yet have a chief financial officer, lacked the processes to assess its financial health. Working with an adviser, Ms. Gluskin came up with the relevant numbers and ratios to track. They included net account receivables, net worth, net sales, gross margin, and operating profit margin. The figures are now recorded on a spreadsheet completed by SolTec’s bookkeeper every two weeks.

To keep closer tabs on SolTec’s finances, Ms. Gluskin increased the frequency of management review meetings — from monthly to twice a month. She also delegated the company’s financial analysis to her chief operating officer and formalized quarterly meetings with SolTec’s accounting firm. So far, the added scrutiny has revealed minor issues, such as improperly coded QuickBooks entries that could have resulted in bigger problems down the road.

Ms. Gluskin, SolTec’s top revenue generator, said she is trying to “clone” herself. She revamped SolTec’s sales training program and now holds weekly meetings with her sales representatives during which she emphasizes the importance of relationship selling. Recently, she had her sales staff read The Go Giver, by Bob Burg and John David Mann. “The moral,” she said, “is the more you give, the more sales you’ll get.”

SolTec has many competitors, but Ms. Gluskin said it stands out by emphasizing customer needs. She urges her sales staff to get to know customers on a personal level and help them even when it will not directly benefit SolTec. For example, because Japan produces 20 percent of the world’s semi-conductors, the SolTech team researched and wrote about the earthquake’s impact on SolTec customers. SolTec e-mailed the article to clients, telling them which parts and companies would be affected.

So far, Ms. Gluskin said, 2011 is off to a great start. “We have already made up for the fourth-quarter loss and then some,” she said. She expects to make at least four hires by the end of the year, has signed a lease doubling SolTec’s office and warehouse space, and says the company is on track to hit $5 million in revenue by the end of 2012. In the next month, Ms. Gluskin hopes to have an advisory board in place. She also said it will soon be time to hire a chief financial officer. She is weighing whether the position should be full- or part-time.

Has your company wrestled with the same decision? If so, which option do you think would best serve SolTec?

You can follow Adriana Gardella on Twitter.

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