Roll Over: Investing in Yourself

Using retirement plans to fund growth

Refugees from corporate America seeking capital to open a franchise business are tapping into their retirement plans to fund their fledgling businesses. So are franchisees seeking to expand.

Take Patricia Preztunik, a in Northern New Jersey who signed on with BrightStar Healthcare in May 2009. With four territories today, she purchased two up front, then two more, one at a time.

Preztunik says she spent six to eight months doing research before starting her own business. "I'd been looking at doing something for a few years. I had friends who had, but I had not taken the plunge," she says.

She rolled over funds from her corporate 401(k) after speaking with a business attorney, who informed her of the possibility of using it as start-up capital to fund her new business. While many companies offer these rollover plans, she chose the Rainmaker Plan from Benetrends.

"He was very big on Benetrends because of their strict set of policies and adherence to IRS guidelines. Once I learned how the money worked, I decided to go ahead and make a swap," says Preztunik. "I don't know if this made a huge difference, but I have at least enough of a financial background, and my Wharton MBA gave me some confidence."

Another reason was the performance of her investments. "With all the downturn in the market, I felt I could do better with my retirement than what had been done to it, so I chose to invest in myself," she says. "I pay them as a service, but I'm loaning money to myself. If you don't believe in yourself, who else are you going to ask for money?"

A year and a half down the road now, she says that anyone considering using their retirement money to fund a business "should think about what would they otherwise do with their retirement funds, and how much they believe in what they're trying to do. And I did."

At BrightStar, 25 percent or more of franchisees have used the Benetrends plan to help launch their business, says co-founder and CEO Shelly Sun. Most have taken between $200,000 and $300,000 from their 401(k), she says--not only to fund the business, but to provide themselves with an income during the startup years.

"Benetrends can approve building in a $75,000 to $100,000 salary to build a business and cover living expenses," says Sun, who was a CPA before founding BrightStar with husband JD Sun. For the typical executive who wants to replace their salary, she says, "There's no other financing vehicle able to do that."

When banks and other traditional lenders are taking longer, asking for more, and giving less, using a qualified retirement plan is an easier, quicker source of for start-up capital because you're using your own money.

Also, says Sun, franchisees have the additional benefit of not having to pay interest on a so they can use all of their money to invest in and build the business. And, she adds, "As your business makes money, you replenish your 401(k)."

Echoing Preztunik, she says, why risk your retirement funds in the stock market when you can invest in yourself and your own retirement fund, which you control?

And as a franchisor, she appreciates the comfort level of working with Benetrends because its track record of compliance with IRS and Dept. of Labor rules--as well as the vendor's promise to back up its clients in court. "I like that and comfort as a franchisor," says Sun.

While having an MBA or being a CPA is helpful in understanding the rollover option, it's not necessary. All you need is a qualified retirement plan (401(k), IRA) and the willingness to pay an expert to set up the plan and take you through the process (about $5,000), and then guide you through the necessary steps to ensure compliance over the years (at Benetrends, $120/month).

Exceeding expectations

Chris Ashcraft and his wife Angela operate an Express Employment Professionals franchise in Mobile County, Ala. He drew on his corporate 401(k) plan to buy the franchise in early 2006, well before the economy and stock market nosedived. For Ashcraft, it made sense even then, when lenders were still living up to their name. They funded the company through Benetrends, along with a bank loan.

"My wife thought I was having a midlife crisis. I'd spent 20 years in the paper industry. I was looking for something else to do and started looking at franchises," says Ashcraft. The couple moved back to Mobile from Baton Rouge to start their business. "The family had a home there so we could live inexpensively. We cut expenses to the bone. I was 40, 41," he says.

"I'd owned a business before and probably made most of the mistakes you should make or shouldn't make," he says. "This time I wanted a proven system I would not deviate from and that would grow." Four years later, he says, "It's going better than expectations. Out of 600 franchises, we're number 40 in sales."

Early in the search process, he met with a franchise broker who raised the possibility of him rolling over some of his retirement funds. Ashcraft spoke with Benetrends, "probably before I decided to franchise. They'd figured a way you could take your 401(k) money and change your investment and move it to a company that you basically own," he says.

"It's a complicated process. I'm not sure I have my mind around how it works and how to be sure you're compliant. They formed the corporation for me to be sure it was compliant," he says. "They did all the work. I don't want to spend a lot of time reading IRS documents. I want the comfort of knowing that it's done right."

Plus he likes the control of having his own retirement plan, as opposed to a traditional corporate 401(k) where you choose which investor(s) to use to manage your fund. "I feel like I invested my money into a company that I could control," he says. "I can pretty much guarantee that the money is worth more than it would have been on Wall Street. I avoided all that mess."

Looking forward, he says, "These are uncertain times. You're betting on yourself. You could lose or win. You just have to be prepared for the worst."

Sign him up!

Mike Favoretto operates a Sign-a-Rama franchise in Brighton, Mich., northwest of Detroit. He opened in November 2009, after undergoing several corporate mergers. "It was time to bet on myself. I always wanted to have my own business. I had the skills and knowledge to do it, so if not now, when?"

With his undergraduate degree in graphic arts, Favoretto began by exploring the quick print industry, but found it highly competitive and with slim margins. He decided that signs would be a better fit for his personal and professional goals.

"I worked in corporate America for the majority of my career, so I had an IRS-approved corporate retirement plan and was permitted to borrow money," he says. "Once the money is in, you have the right and privilege to invest those funds in any way you see appropriate. I chose to use that money to invest in my business."

The rollover option, says Favoretto, another Benetrends client, was "an effective and reasonably painless way to fund my business by taking a distribution from my 401(k) without having to pay taxes and penalties. For me that was the best feature of their program."

For example, he says, if you're under age 59½ and need $100,000 to start, after taxes and penalties you'd have to take a $130,000 distribution (income tax and 10 percent early distribution penalty). "You effectively lose the use of that $30,000 for equity growth in your 401(k). I could take out exactly what I needed and keep the rest of my money working."

To supplement the funds he rolled over, Favoretto also took out an SBA obtained through a local bank. "Having just come through a rather torrid, horrible decline in the stock market, I wanted to be cautious about protecting my money in my retirement fund," he says.

Favoretto says he had no idea that the rollover option existed before he started with speaking with the franchisor, United Franchise Group (UFG). "They brought it up to me," says the former industry veteran.

"With the lack of availability of financing, and the fact that people don't have equity in their homes, this has been probably the easiest and best way to open a business," says Tim Phillips, director of finance at UFG.

"The folks at Benetrends--and there are many folks out there--are the forerunners in this program, and through my dealings with them I have found them to be very professional and prompt," he says.

"If they were able to get traditional financing there's always a collateral issue," says Phillips. "There's always a risk involved." And while he acknowledges that any franchisee using their 401(k) to fund their business can lose their retirement funds, he also points out that with traditional financing they could lose their house.

(For a previous story on another rollover plan provider, Guidant Financial Group, as well as other alternative ways to fund franchise growth, see

Building on success

Debra and Barry Holzbach are franchisees of EmbroidMe (another UFG brand) in Webster, Tex., southeast of Houston. She had worked at the store for 8 years when they bought the franchise from the owner in March 2010.

Before becoming a franchisee, he had spent 25 years in the industry. "When I finished with Johnson & Johnson in May 2009, I was still trying to get back into the medical business," says Holzbach. When that didn't pan out, they made the decision to buy the franchise from the owner.

"The good thing about what we did was that we purchased an existing business with almost 10 years of being there," he says. That guaranteed a cash flow, a 3,000-customer database they could mine, and solved the problem of valuing the business, one of the potential red flags the IRS may look for when scrutinizing franchises funded with rollover funds.

When it came to financing, the Holzbachs took a 5-year, $120,000 note from the seller, and he rolled over an additional $120,000 from his corporate 401(k) to fund the purchase and to upgrade and expand the business. He says the regional director for UFG made them aware of the rollover option. After calling several franchisees of other brands who had already done this through Benetrends, they moved ahead.

Holzbach says he also looked into an SBA "I spoke with them, but there were a lot of hoops to jump through--and I have impeccable credit. I would rather put all my efforts and attention into making this business strong, not into paperwork."

The rollover and setup process was "pretty smooth," he says, and today the couple are business partners with their own C corporation, their own retirement plan, and a growing business. "I invested in several other people," he says. "We went from a 3-person to 6-person operation." And, according to IRS rules, all the employees are eligible to participate in the profit-sharing plan they set up. He also invested in replacing computers and other equipment, and built in a cushion for additional expenses.

While only she is drawing a salary so far, he hopes to be able to pay himself by summer. Meanwhile, they are paying their monthly fees to Benetrends to be sure they remain compliant every step of the way.

Who's Using Rollovers?

In January 2010, FRANdata released a study that surveyed active Benetrends clients. Here are some of the highlights from the 463 respondents:

  • more than 60% operated a franchise business;
  • 33% of the businesses were in and commercial and residential services;
  • the value of the businesses started ranged from less than $100,000 to more than $2 million; most were estimated to be worth between $100,000 and $250,000;
  • 26% rolled over $100,000 to $150,000; 16% rolled over $150,001 to $250,000;
  • respondents invested a weighted average of 52% of their total retirement assets (37% used 10% to 30%, and 26% used 80% to 100%);
  • 40% covered all their capital needs with rollover funds (i.e., 60% required additional sources);
  • about 75% employ one to three full-time employees; and
  • almost 50% of employees participate or intend to participate in the company retirement plan.

ROBS Probs? Not Really.

In October 2008, the IRS issued a memorandum stating it would be taking a closer look at what it called "ROBS" (rollovers as business start-ups) transactions. The acronym was apt from an agency looking to curb abuses of what many consider a loophole in the ERISA legislation of 1974 that made it possible to tap retirement funds to start a business.

In its memo, the IRS stated: "While ROBS would otherwise serve legitimate tax and business planning needs, they are questionable in that they may serve solely to enable one individual's exchange of tax-deferred assets for currently available funds, by using a qualified plan and its investment in employer stock as a medium. This may avoid distribution taxes otherwise assessable on this exchange."

Many retirement professionals advise strongly against rolling over a retirement plan to fund a business, citing heightened IRS scrutiny and severe penalties and interest for even the slightest signs of noncompliance. However, when these plans are done correctly, there should be no problem.

In its memo, the IRS said as much: "Although we do not believe that the form of all of these transactions may be challenged as non-compliant per se, issues such as those described within this memorandum should be developed on a case-by-case basis."

The memo highlighted two areas of concern: 1) not allowing (or even informing) employees they were eligible to participate in the plan; and 2) valuation of the business (when a business starts, valuation can be near zero).

After a period of uncertainty following the memo, in which one rollover plan provider temporarily suspended its offerings, the situation remains essentially unchanged. This past November, two years after the 2008 memo, the IRS published an article affirming the legitimacy of rollover plans to fund a business, but also echoing its earlier concerns: "ROBS plans, while not considered an abusive tax avoidance transaction, are questionable because they may solely benefit one individual--the individual who rolls over his or her existing retirement funds to the ROBS plan in a tax-free transaction." (Hint: Stay away from expensive "corporate" cars, RVs, and company meetings in Tahiti.)

Bottom line: Properly set up, documented, implemented, and maintained to the letter of the law, rollover plans could be the best use of retirement funds on the market--at least for the foreseeable future.

Too Good To Be True?

Len Fischer co-founded Benetrends with his wife in 1983. The company markets their Rainmaker Plan, which allows the holder of a qualified retirement plan to draw funds from that plan to start or expand a business.

"If a person has money sitting in a 401(k) or other kind of retirement plan, we think the most cost-effective way to expand their number of units is by using their retirement funds," says Fischer. "By using the retirement funds, the government is helping to subsidize the loan, in terms of taxes they didn't have to pay, unless they're over 59½. They get 100 percent of their retirement fund to focus on expansion."

Fischer, who used to speak with all prospective clients himself, says he got the too-good-to-be-true reaction all the time. However, he says, "Everything we do is based on the black letter of the law." He says Benetrends did 1,000 plans in 2009 and more in 2010. "We've done 5,000 and never had one rejected by the IRS."

While the plan itself is straightforward and legal, he says, "This is not a field for amateurs. It looks simple, but there are a lot of thorns." And whether you use his firm or another, he urges anyone considering using their retirement funds to start or expand a business to work with professional firm. "This isn't a one-shot deal. They're setting up a retirement plan and must do it properly to maximize the benefits and operate in full compliance with the laws," he says.

The good news for entrepreneurs is that the proper use of a retirement plan will, he says "become the best planning they ever had." And yes, you can lose your money if the business fails, but only the money you've invested in the business. Liability, he says, is limited to the amount in their stock investment.

Should you consider a rollover plan? Of course, says Fischer. "Regardless of whether they have other funds, they should at least explore if they should use their retirement funds in the mix as they grow their multi-unit franchise."

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