As it becomes more and more difficult to get a business loan from traditional lenders, many entrepreneurs are looking to non-traditional sources for business financing. While some people consider their 401K or IRA investments a “sacred cow”, others see it no differently than a convenient self-funded bank. If you approach buying a business with your 401K in the same way as a bank loan, complete with interest payments, it really can be a reliable source of financing. The only problem is the risk that your business could fail, and then you would need to continue repaying your loan with interest.
Another way of buying a business with your 401K is to take a distribution, with penalties of course. While there is an immediate tax impact for taking a distribution, there is not an obligation to repay the debt. Again, any time a 401K or IRA is used to fund a new venture, it is very important to minimize the risk wherever possible. This means choosing a business that is almost fail-proof, if that is even possible, or taking over a business from someone who is already has an established client base.
Before you consider buying a business with 401K money, it is important to assess your risk tolerance. Even in the most successful business transactions, there is always a chance something could get in the way of your success. Take the extra steps necessary to ensure your family’s financial future by purchasing an enough term life insurance to get you through the riskiest start-up period, especially if you still have young children or an expensive mortgage.
Another point to consider is your current state of employment. For example, if you’re planning to take a loan against your 401K funds and you are still employed; your company’s 401K administrator may require the loan to be repaid within 60 days of your departure from the company. Be sure to read the fine print and consult with a lawyer or tax advisor before signing the loan documents.
If you decide that your risk tolerance is too low, or your spouse won’t agree with your plans to use retirement savings for such a venture, then a business broker may be helpful. Business brokers are often aware of many alternative sources of low-interest financing, with the most common one being seller-assisted financing. In a buyer’s market, it is more likely a seller will be motivated to work with you on financing, and a business broker will help negotiate the terms.
For more information about finding a business and buying a business with your 401K, read the blog posts about this topic on BizSale.com.