Finance Your Own Business. Garrett Sutton
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P & Ls)
• What is your collateral?
If you don’t meet the criteria, then seek out help from a local entrepreneurial training provider. Not only will they help a business obtain a loan, but they will help locally grown small and micro-businesses become successful.
Finally, be prepared to give the lender what they ask for. Entrepreneurial training organizations often can help you with loan packaging, such as putting your documents in order and making sure the lender has all the information that they need to consider your loan application.
Credit Union Loans
Credit unions may not be the first place you think of when you think of small business loans, but don’t overlook them. Many credit unions make loans to small businesses in their community, and during the economic downturn, some were making loans to businesses that were being turned down by other financial institutions. In addition, some credit unions offer smaller loans than some banks, and usually have very close ties to the communities in which they live and work. Some strive to lend to underserved or overlooked businesses. That makes credit unions one of the first places you may want to consider for a loan for your business.
Find out which credit unions you may be able to join at www.ASmarterChoice.org.
How to impress the lender and get the loan
A lot of borrowers are unaware of what it takes to get a business loan. They think that if they have been a regular customer of that bank, the bank should give them a loan; or if they show up with a passion about their business, the bankers will share that enthusiasm.
You will make a great impression if you know what the lender wants. We covered some of these points in the previous section on bank loans, but they are crucial so they bear repeating. Commonly, a lender is looking for the following:
• Cash Flow and Profits: Business tax returns that show two years of profitable operating history, or enough historical profits to cover your personal expenses and make a loan payment.
• Bank Accounts: Bank statements that show well-managed personal and business checking accounts—that is, no overdraft, transfers between accounts that follow sound business practices and healthy balances for business operations and household expenses.
• Credit History: Good credit history with no defaults or bankruptcies.
• Collateral: Equity in real estate, large equipment or vehicles.
• Equity: Business owner has 25% of total project costs in cash or direct investment to contribute to the project.
• Uses of funds: Funds needed to expand or evolve an already successful business.
• Industry Experience, Planning and Research: A solid business plan based on industry standards.
• Supporting Documentation: Location, job creation potential, type of business and any information that enhances the business’s chances for success.
If a borrower has all of the above, they will be considered low risk and have more loan options. When one or more of the above is shaky, such as a history of overdrafts, unexplained deposits and transfers in the bank accounts, the funds are needed for business start-up or refinancing, or the business owner has little or no industry experience, then the loan application is considered to have more risk.
In the end, microlenders will go beyond what traditional banks would do in terms of risk and will be more flexible in the loan criteria. But they still have criteria. They still want to see cash flow, good management on checking accounts, some type of collateral and proof that you know your industry and how to generate revenue.
Now let’s consider whether it is a good idea to use your retirement monies…
Chapter 6
Retirement Financing
Don really wanted to buy an existing franchise business. His wife Mary was less enthusiastic. Don said they needed $300,000 to get it going. The couple had explored obtaining an SBA loan but they didn’t have the 25 percent down payment required. And their credit was not stellar.
The only source of money they really had was Don’s 401(k) plan. He had managed to accumulate $350,000 for retirement. Mary said their financial planner warned they shouldn’t take their money out for something as risky as starting a business; they would need it to help them pay expenses in their later years.
But Don felt their financial planner just wanted to hold onto their account. Of course he wouldn’t suggest using the money for starting a business. He would lose out on financial planning fees.
So Don went on the internet and found all sorts of promoters claiming that one could easily tap into their 401(k) for business financing. The promoters touted that there were provisions within the Employee Retirement Income Security Act (“ERISA”) and the IRS tax code allowing people to invest retirement savings in a business if they were active employees. (Those seeking passive income through absentee ownership didn’t meet the requirements.)
On the internet it seemed so easy. There were five basic steps to follow:
1. Set up a C corporation. An S corporation, limited liability company or other structure wouldn’t work. You had to set up a double tax C corporation before you created or bought your business.
2. Have the C corporation set up a 401(k) plan. The new plan must specifically provide for the acquisition and holding of qualified employer securities (meaning stock in the business).
3. Roll your existing 401(k) plan into the new plan. So your old plan gets rolled into the plan you just set up for the new C corporation.
4. Have the new 401(k) invest in the new C corporation. The new plan (which is specifically authorized to do so) then invests directly into the business. The plan is now a shareholder of the new C corporation.
5. The 401(k) money is now in the corporation. With cash in the corporate bank account you can now start doing business.
Don reported all this back to Mary. He said the unique strategy was called Rollover as Business Start-Ups or ‘ROBS.’ Mary was not convinced, noting that all she saw was a risky business that ‘robs’ their retirement monies.
Don said the promoter offered all sorts of benefits to this strategy. A key, he said, was that there was no debt service on the business like there would be with an SBA or bank loan. Their house and other assets were not exposed. While Mary acknowledged this as true, she noted that their most valuable and asset protected entity—their 401(k) plan—was now completely exposed. If the business failed their retirement monies were gone. Did Don have enough years left to ever accumulate another $300,000?
Don was confident of their future success. He noted another benefit was that all the profits went into their 401(k) plan tax free. And it would be there accumulating tax free until they needed it. Mary didn’t have an answer for this and said she would talk to their CPA about it.
Several days later, Mary reported back. Their CPA was very concerned that any profits made by the C corporation were subject to taxes of between 15% and 34%.
But even worse, Mary said, were the numbers when the business was sold. Because of the double tax C corporation (the corporation being a requirement for a ROBS transaction) a great deal more in tax was paid at the time of sale.
The C corporation paid another 15% to 34% tax on the gain before money went into the 401(k) after a sale and then another hefty 10% to 39.6% personal income tax was paid when the 401(k) distributed the money out to Don. Their ROBS required a double tax scenario which robbed them of any real gains. Don thought about it all. He asked Mary what their CPA thought about ROBS plans. She said he wasn’t a big fan of them. The IRS had never fully endorsed them and the Tax Court was cracking down on them. The recent case of Ellis v. Commissioner (TC Memo 2013-245) questioned the ability of taking a salary from your ROBS entity. The CPA had asked why you would set up such a convoluted structure and then not be able to take a salary from it? All in all, the CPA felt that they operated in a grey area of the IRS