Show Me the Money: Financing a New Business in Today’s Economy
Ask any startup business owner these days what the greatest challenge he/she faces is access to capital. Even in a good economy, startup businesses struggle to find any sort of bank financing, be it traditional or some type of SBA loan. In the current credit crisis, bank financing for startups is almost nonexistent.
The lack of bank financing leaves the startup business owner with few options, but one in particular appears to have risen to the top: use of a self-directed 401(k) or IRA account.
A self-directed IRA requires the account owner to make investment decisions and investments on behalf of the retirement plan. IRS regulations require that either a qualified trustee, or custodian hold the IRA assets on behalf of the IRA owner. Generally the trustee/custodian will maintain the assets and all transaction and other records pertaining to them, file required IRS reports, issue client statements, assist in helping clients understand the rules and regulations pertaining to certain prohibited transactions, and perform other administrative duties on behalf of the Self-directed IRA owner for the life of the IRA account. Self-directed IRA accounts are typically not limited to a select group of asset types (e.g., stocks, bonds, and mutual funds), and most truly self-directed IRA custodians will permit their clients to engage in investments in most, if not all, of the IRS permitted investment types (an almost unlimited array of possibilities including foreign real estate). Some of the additional investment options permitted under the regulations include, but are not limited to, real estate, stocks, mortgages, franchises, partnerships, private equity and tax liens.
One of the common investments for a self-directed IRA account is a new business venture. Here’s how it works: the prospective business owner establishes a self-directed IRA account through a company which offers them. At the same time, the owner then forms a C corporation or limited liability company (LLC). Then, the owner invests in the new business through his/her self-directed IRA.
Use of a self-directed IRA to, in essence, finance your new business requires strict compliance with IRS regulations in order to avoid penalties for withdrawals and/or distributions from the IRA. It also requires a team of comptetent advisors who know how to structure your account within the IRS’ confines. When I work with clients using this funding mechanism, I work with a full complement of advisors. Entrust Midwest works with the client to create the account, I draft the entity documents, and we have a sharp CPA (Pam Ricker, Ricker & Associates) and an equally sharp financial advisor (Todd Terhorst, Diversified Wealth Management) available to give guidance as to what is and what is not permitted in this type of transaction.
Especially in the current economy, for some new business owners, the only way they can get their business idea off the ground is by investing in their own business through their self-directed IRA.
NOTE: THE INFORMATION CONTAINED IN THIS ENTRY DOES NOT CONSTITUTE LEGAL ADVICE OR TAX ADVICE. FOR APPROPRIATE ADVICE REGARDING THIS SUBJECT MATTER, PLEASE CONTACT YOUR ADVISOR(S).