Unlocking the Power of Retirement Funds

Finding innovative financing strategies can be worthwhile, especially if they lead to multi-unit franchise ownership. One method you may want to look into involves the use of retirement funds to invest in some of the nation's most attractive franchises.

Cooper and his partner Karen Franklin, CPA, have been utilizing this strategy for some time with individuals who have large sums of money in their pension accounts. Cooper is president and Franklin, vice president and chief financial officer of SDCooper Company in Huntington Beach, California.

Cooper, Franklin and a staff of experts have developed a way to move money locked in retirement accounts as an equity investment directly into new or established corporations without incurring early distribution penalties, income taxes, or loans. Cooper says once the funds are freed up they may be used to purchase franchises, property, equipment, or as working capital.

The company has completed 350 ERSOP Profit Sharing 401(k) plans for clients and nearly 50 percent own franchises. These include such well-known franchise companies as AAMCO, Ace Hardware, Signs by Tomorrow, Molly Maids, and Quiznos.

The details of the plan

Here's how "ERSOPs" (entrepreneur rollover stock ownership plans) work: SDCooper Company asks investors to incorporate as regular corporations and have the new corporation adopt a new profit sharing 401(k) plan that it designs with the enabling language.

Once this is accomplished, the investor rolls over funds from a 401(k) plan or an IRA (or rollover IRA, SEP, Keogh, etc) into the new profit sharing 401(k) plan. In order to be eligible for a rollover from an employer's retirement or 401(k) plan, the investor must have terminated employment with his or her employer.

The investor is essentially investing the funds into the stock of the new corporation. Afterwards, the C corporation can use the money to purchase a new or existing franchise.

Cooper says this ERSOP strategy encompasses several assumptions. "First, we assume that in five to ten years the investor will want to sell the franchise in a tax efficient manner." Another important assumption is "that the next buyer will probably prefer to purchase assets of the company and not stock," he explains.

Under current tax law, the corporation will probably need to elect S corporation status within the first two to five years to prepare for a tax efficient exit strategy. By switching to the S corporation, the investor is not hit with an excessive federal tax bill. This would be the scenario if the company remained a regular corporation. Most of the gain will flow through as capital gains.

To prepare for the switch to S corporation status, the corporation should accumulate retained earnings over the first two to four years. With that accumulated cash plus some borrowing (if necessary), the corporation then repurchases the stock from the plan rollover account. Says Cooper: "With the stock retired, the corporation may elect S corporation status with minimal adverse tax consequences."

The stock sale also requires the franchisor to get a formal valuation of the franchise. "We need third-party valuation to satisfy the IRS that the corporation paid fair market value for the shares," says Cooper. In addition, switching to S corporation status freezes the built-in gains as required under Section 1374 of the Internal Revenue Code.

Cooper says the corporation generally retires its stock within two to five years after starting this program. With the cash back in their profit sharing 401(k) plan rollover account, many decide the best investment of the funds is to put them into unit number two or another franchise. In this way the investor is on his or her way to becoming a multi-unit franchise owner.

One of SDCooper Company's clients has purchased three existing franchise units in the first stage of his investing and is now working on unit five. Most of the company's clients have large retirement accounts and "if they were to pull that money out of their retirement accounts, it would be a tax disaster," he says.

Although the plan is pre-approved (with the appropriate language) with a favorable determination letter, SDCooper Company requests an individual "favorable determination letter" from the IRS for each plan. Cooper says the IRS has issued a favorable determination letter for each one of the 350 plans the company has successfully completed.

The company charges a flat fee for setting up the plan and then the investor's corporation pays an annual fee that covers administration of the plan, preparation of benefit statements, and annual returns to the IRS. "This is true retirement planning by pension professionals who understand and appreciate franchises," he maintains.

If you are interested in finding out more about this type of financing, you can contact Steve Cooper or CPA Karen Franklin at 866-693-7767.

A note on the SBA 7(a) program

The Small Business Administration's 7(a) program was temporarily suspended for about a week recently because the agency ran out of funding. The 7(a) program provides small businesses including franchise owners, with loans from SBA-approved banks. Under the program, the lender receives a federal guarantee of up to 95 percent of the loan.

The SBA recently announced that it has started accepting applications for loan guarantees under Section 7(a) again. The maximum loan size will be $750,000 during fiscal 2004 until further notice.

The SBA is reopening with an additional $470 million in lending authority under a continuing resolution. Once the SBA receives its full year's appropriation, it expects to be able to keep the program running without interruption.

Published: February 15th, 2004

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