Finding the initial funding to start your new business can be a daunting task. Even with a great business plan, savings, and connections that allow you to move in every required direction at once, it is still easy to wind up in a situation where you need some kind of extra financing to guarantee steady cash flow during that initial launch period and critical first year. Luckily, there is a way that works very well, that does not involve taking on debt or giving up ownership shares to investors, and that the U.S. government designed specifically to help entrepreneurs: 401k financing.
How it Works
Under the ERISA Act, you are allowed to roll over existing tax deferred retirement accounts, IRAs and 401k plans, into new accounts that can be used to invest in businesses outside of the traditional stock and bond markets. You will need a facilitator who knows the law to properly structure the new account, but the general process involves setting up an S Corp and then investing in it. Since S Corps typically exist to invest in other corporations, this basically creates a company owned by your 401k that can then freely invest in other businesses, setting you up to fully fund your own company without worrying about bank approval or other hurdles.
Beyond the obvious avoidance of excess debt, 401k financing has a variety of advantages. The biggest one is that the dividends that are paid back into the 401k from your new company are regular returns on 401k investments, meaning that they enjoy the same tax-deferred status as your regular contributions and returns. This can help build your retirement account even faster than regular contributions if your business does well, and it also provides an easy vehicle for reinvestment later if you need capital to cover expansions, equipment purchases, or large inventory orders.
Any business startup comes with potential risks, and in this case those risks are being backed by your personal retirement funds. That means that there is a potential for loss that has to be recognized. At the same time, though, it can be easier to rebuild retirement savings than to recover from the potential problems posed by other forms of financing like asset-secured loans. This is a case where the risk parallels the reward, though. The potential windfall to your retirement funds is a huge balancing factor to the risk, and the risk is mediated by the fact that these are funds available free and clear, without debt collateralization and other issues.
Any business decision needs to be carefully weighed, but 401k financing represents one of the most direct ways to take control of your vision and launch your entrepreneurial start. If you have a fledgling company that needs financing and the means to set it up, it can be part of a rich and diverse set of funding mechanisms for virtually any new business.