The Next Generation of Small Business Funding September 1, 2009
Posted by Jeff Nabers in : Money, Personal Enjoyment, Personal Productivity , 10comments
Each year entrepreneurs pitch Venture Capital firms in hopes that their startup company or business expansion will get funded by them. The vast majority do not get funded. Furthermore, “getting funding” almost always means the entrepreneur must sell a sizable piece of his company to the VC.
Getting funded by a VC is a dream, but it can easily turn into a nightmare for both the entrepreneur and the VC. Because the VC owns a piece of the company, if further rounds of funding are needed in the future it could mean diluting only the founder’s ownership, depending on how the contracts were setup. It’s not too uncommon for founders to eventually wind up with a minority stake in their own company and to lose control of it. For the VC, there’s a big chance of failure. They usually need an exit strategy, such as taking the company public to sell its shares to the marketplace or to sell the company to a private party. But before they sell it, they need to try to juice up the revenue of the company to max out the sales price. When maxing out revenue becomes the primary unconditional focus, it’s easy for the business to go in a very different direction than the founder had intended.
The above horrors can happen when an entrepreneur does get funding. Let’s not forget that most entrepreneurs seeking capital just don’t get funded.
These are problems. And yet the world has a way about finding solutions to problems and getting them to those who can benefit. Sometimes the solution can be so incredibly simple that it’s hard to believe. In the case of funding a small business, the solution I see is a matter of (more…)
Bail Yourself Out May 7, 2009
Posted by Jeff Nabers in : Money, Self Directed IRA Solo 401k , add a commentMy new article on Forbes.com…
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For entrepreneurs, getting through these financially turbulent times may require some imaginative [read whole article on Forbes.com]
Financing a business with retirement funds April 29, 2008
Posted by Jeff Nabers in : Self Directed IRA Solo 401k , add a commentBy far, one of the most luring propositions is
Fund your dream business with your retirement fund
“But, how?” you ask, “isn’t it a prohibited transaction to invest your plan (IRA/401k) into something that involves myself as disqualified person?”
Yes. As a general rule, it is prohibited for your plan to invest in a business that you own or run. An exception to that rule is what is promoted through:
The arrangement works with a prohibited transaction exemption [IRC 4975(d)(13)] for what is called “qualifying employer securities”. This is how these arrangements are structured:
- A C Corporation is formed
- This new corp then sponsors a qualified plan (such as a 401k or profit sharing plan)
- The customer’s existing retirement funds are transferred into the new plan
- The plan then purchases a significant portion of the new corp’s stock as qualifying employer securities
Ordinarily, this would be a PT, but based on the special exemption, it is okay that the plan is buying shares in the participant’s company, the participant is paid a salary from the company which is funded mostly from the plan, and the participant works for the company which is owned mostly by the plan.
For this “qualifying employer securities” arrangement to exist, the plan documents must allow for investment into QES and the corporation’s bylaws must allow for QES and a corporate resolution must be made to approve the QES transaction.
Theoretically this can be a very powerful concept. In my honest opinion, however, this arrangement is often being promoted regardless of suitability.
Sales Pitch A – Access your retirement funds NOW
“Do you want to benefit now from your retirement funds before age 59 ½? Just use this QES arrangement!” Let’s examine this further below in some examples. I hate to spoil it for you, but of all the options to receive your retirement funds earlier than 59 ½, the QES arrangement results in maximum taxation.
Sales Pitch B – Make your business income tax deferred
This is simply a half truth. The business income is taxed at the corporate level. Let’s examine:
QES funds legitimate business, but there’s no profit
Jerry wants his retirement funds NOW, but he’s only 45. He doesn’t want to pay distribution taxes & penalties, so this sales pitch appeals to him. He sets up a Rainmaker plan, but his business never makes a profit. That’s okay, he thinks, because I really just wanted access to my retirement funds. But at what cost was this access granted? Firstly, the only money he makes is what his corporation pays him through a W-2. So he pays taxes on this personal income after all that work to “get around the distribution taxes”. Any money he has spent on trying to get the business off the ground would likely exceed the 10% penalty he would have incurred for just directly distributing from his retirement accounts. Plus, he’s spent $4,000 to $5,000 to setup the arrangement in the first place.
Conclusion: He would probably receive less money (net of taxes) through his QES arrangement than he would through direct plan distributions.
QES funds questionable business, but there’s no profit
Joyce wants her retirement funds NOW, but she’s only 50… so she sets up an ERSOP. She never really tries very hard to make the business successful, so her situation is just like Jerry’s except she hasn’t spent that much money on business expenses outside of paying herself a salary. She still ends up paying taxes on her personal income. She thinks she’s clever because she kept her expenses low, but all in all the IRS & DOL may question whether this business was truly created with the intentions of making or selling products or services for a profit. If they conclude “no”, then the entire arrangement may be deemed a “sham” and past due taxes, interest, and penalties assessed.
Conclusion: Joyce’s income (which comes from retirement fund money) is taxed as ordinary income. She receives no tax beneift. Further, she is operating a sham entity that will upset the IRS in an audit.
QES funds legitimate, profitable business
Jill has a great business idea, uses the Guidant’s Audeo QES arrangement to fund it, and lo and behold, it’s a success! As the first example with business income,
- She is still paying ordinary income taxes on the compensation she personally receives (She did not circumvent the taxes she would have paid to distribute her retirement funds to herself)
- Her plan receives its income after corporate taxes are paid. This means her plan’s income will be taxed once at the corporate level and once again later at distribution. This is just bad planning that results in maximum taxation.
Conclusion: Jill still paid taxes on her personal income (that came from her retirement money and its further returns) and the income of her retirement plan is subjected to corporate taxes. This strategy accomplishes little to nothing in the way of tax minimization.
A better way to access your funds NOW
Did you know that you can distribute your retirement funds to yourself at any age without triggering the 10% penalty? All you have to do is agree to abide by a regular payment schedule until you either turn 59 ½ or take distributions for 5 years… whichever is longer. There’s plenty of strategies to follow that make these schedules flexible for anyone who has a fair amount of retirement funds. More on this in a later post…
Sales Pitch C – Quit your job and follow your dreams
Like most people, you probably have a dream or two about starting a business that you would love running. I think this plays a bit strongly on most people’s emotions. Most people are tired of working for someone else, and they want the flexibility and freedom that can be made possible by starting a small business.
The problem is that 90% of small businesses fail in the first 7 years. 90% of the survivors fail in the second 7 years. This famous Department of Commerce study tells us that if you are starting a small business, you have a 99% chance of failing. How do you like those odds? They are worse than the odds you get from a casino… many times over. To complicate matters, many people cite that the #1 reason for small business failure is not enough capital. Now, my goal isn’t to deter you from starting a business. For me, starting and running businesses has been extremely gratifying. I’ve started over a dozen businesses, some of them were profitable successes, but probably the most (more…)
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