Debt Financing Alternatives for Business Owners

Starting your own business is a difficult enterprise. One of the biggest challenges business owners face is finding the capital to get started. When it comes to obtaining funds, you have a few options.

As you may already know, you can borrow money from an outside source and promise to pay back the principal along with interest. By doing this, you are essentially taking on debt. Several sources provide loans to small businesses, to be repaid with interest.

Debt Financing Options for Business Owners

Banks: Bank loans are the most common, and typically the best source if you qualify for a loan. Of course, not everyone qualifies. Furthermore, banks have very strict requirements that are difficult for business owners to meet if they are just starting out.

SBA Loan: If you don’t qualify for a bank loan, business owners can obtain a Small Business Administration loan guarantee. However, SBA loans can be very time-consuming; time that can be better spent on your business/business concept.

Micro-Loans: If you don’t have the time to apply for a SBA loan, as they are very paper-intensive, you can try your hand at micro-loans. Unlike a loan from a bank, micro-loans are designed for start-ups.

Alternative to Debt-Financing

Loans have a negative connotation because you are essentially taking on debt. Oftentimes, business owners take out high-interest loans to fund their business venture and have trouble paying back the principal and the interest. A Gallup poll found that 36% of U.S. small business owners who borrowed money are “very” or “somewhat” uncomfortable with their debt. The poll also reveals that 49% of small business owners find it “extremely difficult” to pay off their current debt.

Solo 401(k) Loan

A Solo 401(k) loan is permitted at any time using the accumulated balance of the Solo 401(k) as collateral for the loan. A Solo 401(k) participant can borrow up to $50,000 or 50% of their account value – whichever is less. This loan has to be repaid over an amortization schedule of 5 years or less with payment frequency no greater than quarterly. The interest rate must be set at a reasonable rate of interest, generally interpreted as a prime rate as per the Wall Street Journal. As of February 1, 2024, the prime rate is 8.5%, which means participant loans may be set at a very reasonable Interest rate. The Interest rate is fixed based on the prime rate at the time of the loan application.

Is the Solo 401(k) Loan Legal?

Internal Revenue Code Section 72(p) and the 2001 EGGTRA rules allow a Solo 401(k) Plan participant to borrow money from the plan tax-free and without penalty. As long as the plan documents allow for it and the proper loan documents are prepared and executed, a participant loan can be made for any reason. The solo 401(k) loan is received tax-free and penalty-free. There are no penalties or taxes due provided loan payments are paid on time. The IRA Financial Solo 401(k) Plan documents will allow you to use a loan from your Solo 401(k) for any investment purposes, including real estate, funding your business or a new business, tax liens, private placements, etc. Our in-house retirement tax professionals will assist you in completing the Solo 401(k) Plan documents promptly once your Solo 401(k) Plan has been adopted.

How is a Solo 401(k) Loan Done?

As long as the plan documents allow for it & the proper loan documents are prepared and executed, a participant loan can be made for any reason. The solo 401k loan is received tax-free and penalty-free. There are no penalties or taxes due provided loan payments are paid on time. The IRA Financial Group Solo 401(k) Plan documents will allow you to use a loan from your Solo 401 (k) for any investment purposes, including real estate, funding your business or a new business, tax liens, private placements, etc.

How Can You Borrow Up to $100,000 or Your Business?

One of the main advantages of the Solo 401(k) Plan is that it allows participants to borrow up to $50,000 or 50% of their account value (whichever is less) for any purpose. Thus, if you and your spouse own a business and can set-up a solo 401(k) plan, each spouse can borrow up to $50,000 tac-free or penalty-free which can be used to help finance a business.

What is the Rollover as Business Startup Solution?

Also known as the ROBS solution, it is an IRS and ERISA approved structure that allows individuals to invest their retirement funds into a new or existing business/franchise. You can use funds from an IRA or 401(k) tax and penalty-free.

If you don’t want to get into debt, the ROBS Solution is a great alternative for business owners or individuals who wish to start their own business. If you already have your own business and need capital, you can tap into your retirement savings for immediate funds.

Although you can use all the funds in your retirement account with the Rollover as Business Startup Solution, be aware of the risks associated with this structure. As you may know, 50% of new businesses fail within the first five years, according to the Small Business Administration.

So if you decide to use ROBS as an alternative to debt financing, understand the disadvantages.

And of course, recognize the many advantages it offers business owners:

• No Debt: The ROBS solution isn’t a loan, so you don’t have to repay it.
• No Penalties: You will not incur tax and penalty on early withdrawals. Even if you aren’t age 59 1/2, you can utilize the ROBS solution.
• Receive Funding: You quickly gain funds for your business. You can put the money towards hiring employees, purchasing inventory, creating brand awareness, etc.

That is the beauty of the Rollover as Business Startup solution. It’s a great alternative for business owners who don’t want to incur debt they may struggle to repay. Another option for Self-Employed individuals is a Solo 401(k) Loan. Contact us to learn more today!

For more information on the ROBS solution, contact IRA Financial directly at 800-472-0646.