Financing a Deal With Retirement Funds

Most small transactions are financed using an SBA loan, a bank, or the seller. One additional source of financing to acquire small businesses includes rollovers of retirement funds and seller financing. The buyer can avoid a small business loan altogether and use their retirement funds to finance the purchase of a business. Because the buyer is buying stock as an investment in their own company, the buyer doesn’t have to take a taxable distribution. 

A buyer can invest in a business or franchise through this process by utilizing existing retirement funds without taking a taxable distribution or getting a loan. This arrangement allows an individual to invest up to 100% of their eligible assets to finance their venture debt-free.

Advantages of using retirement funds to buy a business include:

• Easy Access: Retirement funds are easy to access. For the buyer, retirement funds can be accessed quickly and with a high success rate, whereas bank financing is often difficult to access. Many offers are contingent on the buyer receiving bank financing to purchase a business. Most sellers are reluctant to accept these offers because of the traditionally high failure rate of obtaining a bank loan to purchase a business.
• High Success Rate: Once an initial screening takes place, the likelihood of accessing retirement funds to purchase a business is well above 90%. 
• Cash at Closing: Using retirement funds creates a win-win situation for the buyer and the seller. The buyer can easily access funds to purchase the business, and the seller can receive cash at the closing.
• Streamlines Process: The process of accessing a 401(k), IRA, or other retirement funds to purchase a business is quick and easy. Contrast this to the process of obtaining a bank loan, such as an SBA 7(a) loan, which is time-consuming for the buyer and seller. These strict requirements are not present when a buyer accesses funds from their retirement kitty to purchase a business. 
• Creative Deal Structures: The use of retirement funds allows for creative deal structuring. This structure can be combined with other sources of financing, such as traditional or SBA bank loans, without causing complications. Because the retirement funds are treated as the buyer’s own money, there is no issue with subordination.
• No Credit Score: The buyer’s credit score doesn’t matter when accessing retirement funds. It is the buyer’s money. The buyer isn’t borrowing money from a bank, and therefore no minimum credit score is required.
• Maximizes Cash Flow: Less interest to pay equates to higher cash flow for the buyer. This can help justify a higher purchase price if cash flow is strained when preparing financial models that incorporate some form of bank financing.

Requirements and Other Criteria:

• Individuals Only: This source of financing is available only to individuals. Companies must use alternative sources of financing.
• Costs: If the buyer has less than $50,000 in their retirement funds, it’s often more practical to simply take the distribution, and then pay the associated taxes and penalties.
• Qualifications: While numerous qualifications exist, plans should be fully accessible and be enabled to roll over into another plan.
• Penalties: If done correctly, there are no penalties when using a 401(k) or IRA to buy a business.

How the Process Works

The buyer creates a new entity, typically a C Corporation. The C Corporation creates, but doesn’t issue, stock. The corporation then forms a profit-sharing plan, and the buyer rolls over the retirement funds into the new retirement account. Next, the funds are exchanged for the newly issued shares in the new entity. The cash in the corporation can then be used to purchase a business or other corporate assets. 

Warning: Do not do this alone. Always use the advice of a professional when setting up this type of account. ERISA and IRS penalties apply if you don’t comply with all of the rules.

Why should sellers love this strategy? 

It’s a win-win situation for both the buyer and you. There are many benefits for the buyer, including ease of access and low fees. For you, it creates a simplified and streamlined process with a high success rate. This means a buyer can make an offer without worrying about the ability to obtain financing.

Who can use a rollover plan, and what are the limitations? 

Most retirement plans qualify for this type of funding structure; however, Roth IRAs don’t.

Is there a minimum amount that can be rolled over? 

There is no set minimum amount. But I suggest entrepreneurs use a rollover plan only if accessing at least $50,000 from their retirement funds unless there are extenuating circumstances, such as needing the funds to secure additional funding. Other than extenuating circumstances, if a buyer needs to access less than $50,000, it may make sense to withdraw the money and pay whatever taxes or penalties are tied to the transaction.

Are most accountants and attorneys familiar with this type of rollover plan? 

Yes and no, and that is the problem. Those who are aware of it typically support it, but there are those who have no idea it exists. The problem arises when it is dismissed as a prohibited transaction, rather than learning about this specific structure. The IRS permits the rollover of funds to qualified plans without taxes or penalties.

Conclusion

Many a solid deal has lived and died by financing. Knowing what you can get away with, what buyers are looking for, and what is best for your business, will be a huge boon during negotiations. That understanding will allow you to get the best price and incentivize your buyer to continue to grow your business. What sellers often get wrong is digging in their heels at the wrong time, turning away good buyers because they want all cash, or shying away from SBA loans because of a single rejection from a local bank. Understanding the financing process will help you know when to compromise and when to hold your ground. 

Financing the purchase of your business is a critical aspect of the negotiation process. It’s healthy to have skepticism about your buyer early on. But keep in mind that how the deal is financed is, in fact, a point to be negotiated. That means the end result will probably be different from your ideal payment. And that’s alright.