Yes, you can convert your retirement account into equity for a small business loan

You’ve found the right space for your restaurant or the equipment that would let your business expand, but there’s a problem. The SBA requires a down payment—called an equity injection—for its loans, and your savings just don’t cover it. 

Your retirement funds, however, have been growing for years, and there’s enough there to meet the equity requirements. You wonder if you can put that money to work for your business.

The answer is yes, but with some strings attached. Below, we’ll cover what an equity injection is, the two main ways to tap retirement funds to meet it, and when this move helps versus when it’s smarter to leave those funds right where they are.

What is an "equity injection"?

Lenders want to see borrowers invest their own money first before they provide financing. This is called an equity injection. It’s “skin in the game” that shows lenders you’re committed to making your business work and shifts some of the risk off their shoulders. SBA loans typically ask you to contribute 10% to 20% before you can qualify for funding.

But what happens when you don’t have cash on-hand to cover it? In some cases, reaching into your retirement funds provides the best solution.

Two ways to tap your retirement funds

There are two ways to use retirement funds as equity, and they come with different benefits and considerations.

Early withdrawal

Early withdrawal means taking money directly from your IRA or 401(k) account before you reach retirement age. It’s the most straightforward option, but this convenience comes at a cost. You’ll owe income tax on whatever you withdraw, and if you’re under 59 and a half years old, you’ll also be hit with a 10% withdrawal penalty. It can still make sense in some situations, but the costs add up fast.

Rollover for Business Startups (ROBS)

A Rollover for Business Startups (ROBS) is a more complex option, but it sidesteps early withdrawal penalties by investing your retirement funds directly into the new business. Most IRA types qualify, with the exception of Roth IRAs. ROBS is not an SBA program, but rather an IRS-recognized retirement funding strategy that some borrowers use to cover their equity injection requirement.

The ROBS structure works like this: You form a C-Corporation and give it a retirement plan of its own. Your retirement savings roll into that plan, which then invests the money into your corporation by buying stock. The cash earned from the stock sale becomes your equity injection.

While a ROBS is typically used for new business ventures, with the right planning and structure, you may be able to use it to provide the equity injection for an SBA loan for your existing business, to purchase an existing business, or to buy a franchise. 

This is an IRS-recognized strategy, but it isn’t a do-it-yourself project. In a ROBS scenario, the right guidance makes all the difference in making the best decisions for your current goals and future plans. Because a ROBS is a complex transaction, borrowers should work with experienced tax, legal, and retirement plan professionals to establish and administer the structure to ensure it remains compliant.

When using retirement funds for equity makes sense 

Using retirement funds for equity can be a reasonable path forward if you have a strong business opportunity and expect the return on your business investment to outweigh what the retirement funds would earn if they stayed in an investment account. This is especially true if using part of your savings still leaves you with plenty for retirement.

Ultimately, if the opportunity is strong, you're comfortable with the risk that success isn't guaranteed, and you have the right support in place, this strategy can provide equity injection funds. Working with a qualified financial advisor or CPA who has reviewed your full picture can help you decide if this is the right strategy.

When to think twice about using retirement funds for equity

Before you decide to invest your retirement funds in your business, it’s worth pausing to look at a few of the risks, especially if your retirement savings are your primary or only financial safety net. 

Starting a business is inherently risky, and if it fails, you may lose all or a significant portion of your retirement savings. The risk level goes up if the business is a startup with no revenue history. There can also be ongoing IRS compliance concerns if the plan doesn’t meet reporting obligations or isn’t administered properly.

If you’re able to cover the funds needed with other sources, like savings or family contributions, that’s often the best path forward.

How to get started

When you’re ready to explore using retirement funds for an equity injection, here’s what you need to do:

1. Talk to a CPA or financial advisor before moving any money to get a clear picture of the pros, cons, and tax implications.
2. If you decide to move forward with a ROBS, bring in a ROBS specialist  — a third-party administrator who sets up the structure and keeps it compliant with IRS requirements.
3. Connect with your SBA lender early. They’ll tell you what documentation they need and confirm your retirement funds will qualify as equity.

Partner with RBAC for guidance and support

RBAC is here to discuss your business plan, path to financing and your future. When we sit down with you, we’ll map out your goals and listen to your vision. Then we’ll help you understand what an equity injection is and come up with a plan to explore all options for meeting your equity injection requirement, which may include converting your retirement savings. Give us a call, so we can start working together today.