The usage of rollovers for business startups, or ROBS, is growing at a rapid pace and sadly, many financial professionals attempting to provide oversight do not properly understand the ERISA and Internal Revenue Code guidelines. Working with inexperienced firms comes solely at the retirement plan owner’s risk and can easily be avoided by working with a reputable, experienced firm.
As the largest provider of these services in the country, having helped nearly 8,000 people invest greater than three billion dollars in small business and franchising, we have come up with a list of the top five mistakes we see people make and how you can avoid them:
- Using a profit sharing plan instead of a 401(k) plan. Why would you buy a Hummer as a commuter car? It is way more than you would need and very expensive to maintain. Have you ever worked for a company that had a profit-sharing plan? Probably not. It’s expensive to maintain, mandates contributions and 99% of the companies we serve cannot utilize its benefits. Have you ever worked for a company that had a 401(k)? The answer is most likely yes. It makes your contributions and matching flexible, less expensive to maintain and is completely adequate for saving significant monies for your retirement. Profit sharing sounds enticing but it does not provide a tangible benefit to most companies. Although we could charge a premium to offer a profit sharing plan, we made a strategic decision to use a 401(k) plan instead because it is our belief it’s in our clients’ best interest.
- Taking incompetent or unethical legal advice. It baffles me that many companies who help individuals form ROBS arrangements have no in-house legal personnel. Most that do are limited to one attorney. It’s clear that someone who’s not an attorney cannot provide legal advice. But some providers claim to provide unlimited legal support. By deliberately using the term “support” they are intentionally misleading clients into believing that their in-house team can give them advice. They cannot. They are not a law firm and their team of attorneys represents their company, not their customers. There is a clear conflict of interest. In fact, this is considered unethical under the Rules of Professional Conduct (RPC). My company – Guidant Financial – is not a law firm and we do not provide legal advice to any client—ever.
We have the largest team of in-house attorneys in this industry and they are available to answer your questions any time. We provide unlimited support, but it is not legal advice. Guidant does believe, however, that you should have competent legal advice when entering into a ROBS arrangement. For that reason, we will pay for you to have two separate consultations with a tax or ERISA attorney early in the process to provide you with advice from a professional who clearly understands this strategy. This is an outside attorney who is not on Guidant’s payroll and we will never interfere with their independent judgment. They represent you and you alone. Our solution was crafted to ensure you get unlimited support from the industry leader and have independent legal advice from a firm who can legally and ethically represent you. We will pay for you to have an hour consult with them every year as part of our ongoing services.
- Paying a salary before generating revenues. Many organizations promote the fact you can pay yourself a salary from day one. That is only half true and as you’ll see; it’s for marketing gain, not structural integrity. I wrote an article on this issue and I encourage you to read it HERE. The bottom line is that you must qualify as an operating company (being open and engaged in the sale of exchange of a product or service) before you can pay yourself a salary. In addition, there is a common sense issue that is rarely addressed by ROBS providers. A salary is subject to federal employment taxes at a rate of 15.3%, plus state employment taxes in addition to federal income tax. In contrast, a client who takes a taxable distribution from the plan will pay federal income tax plus a 10% early distribution penalty if under the age of 55. Thus, from a tax perspective, it is not optimal for the individual to roll over the distribution and take the plan benefits as salary. Our recommendation is that you work that out with the attorney in our outside counsel program. Have a professional help you decide what is best for you.
- Placing value in a cash-basis appraisal. There is a growing trend of ROBS providers who promote a cash basis appraisal upon the initial formation of the structure as a tangible benefit to a client. I also wrote an article on this issue. You can read it here. In most ROBS arrangements, the plan is acquiring shares of a new business that has never sold anything. The new business has no assets, no income, no customers—nothing. So at this time, the shares’ value is equal to the sum paid in cash. Because there are no other assets or liabilities at this start up phase, it is reasonable to assume that this simple exchange represents adequate consideration. Some ROBS promoters will tell you that you need an appraisal to determine the value—but—one plus zero does not equal two. There is no value to a piece of paper that tells you that $100,000 is worth $100,000. Your cash contribution is what you have as the basis of value—nothing more.
- Misunderstanding the benefits of a C Corporation. I wrote about this in my book Making the Jump into Small Business Ownership—specifically on pages 110 -114. Here I published a letter sent to me from a tax professional who believes that a C Corp has many great advantages. In addition to fully deducting benefits, C corporations can lower your taxable income because it is taxed separately—apart from the individual stockholders. This professional cites that most tax advisors default to an S Corp or LLC. I offer no opinion specifically for you—however—in order to use ROBS, you must operate under a C corporation. For that reason, you will want to work directly with a tax professional that is willing and able to help you maximize the structure.
Choose a firm to help you structure this arrangement carefully. There are good companies who can help you correctly market and utilize this strategic wealth-building tool without taking on additional risks.