Using ROBS to Buy Your Franchise? Plan to Ask Plenty of Questions First.

When I’m interviewing victims of franchise fraud or misrepresentation, a natural question is: “What’s happening now?” Often, former franchisees are in the midst of a lawsuit or trying to get out of their franchise agreements so they can attempt to put the entire saga behind them.

But in my recent reporting, a handful of people have told me they’ve lost their entire retirement savings because the business failed. So now, it seems, they’ll be working much longer than they expected—instead of spending their well-earned savings in retirement.

Rollovers for business startups, often shortened to ROBS, allow people to use all or some of their retirement account funds to fund a small business or franchise. The program allows users to roll over their 401(k) or IRA funds into a new business 401(k) plan, “which then purchases stock in the company to provide business capital,” according to accounting firm Aprio.

Some people use ROBS to fund a loan down payment, while others use the program to fund the entirety of the initial purchase price. The plans can even be combined with other sources of capital.

Does that sound potentially worrisome? Maybe, but the ROBS program is legal under the Internal Revenue Code and the Employee Retirement Income Security Act, or ERISA, and has been around since 1974. It’s a tax-free transaction because it isn’t a distribution, though the new business plan, called a C corporation, is subject to its own taxation.

Plus, users don’t have to pay anything back, like you would with a loan, which would save business owners money in the short term.

In short, ROBS allows users to “invest in the stock of their own business,” Keith Tracy of Guidant Financial, which specializes in these types of plans, said during one of the company’s webinars. “In simplicity, you’re just shifting the way you invest from the public market you don’t control into private stock of a business you do control.”

So, instead of investing all or some of your retirement into Microsoft, you’re investing in yourself and your business venture. Those considering the purchase of a franchise often come with the mindset that they’d rather bet on themselves.

The process works as follows: You form a C corporation, the corporation implements a 401(k) plan that issues employer stock, you roll over your retirement money into the plan, you buy the newly issues stock, and then you run the business from the C corporation account.

Guidant recommends participants roll over at least $50,000, because “a lesser amount does not make financial sense due to the cost of setting up ROBS.” The main cost associated with the program is the initial set-up fee, plus there’s a monthly administration fee if you’re working with a provider, like Guidant or Benetrends.

Just as with any investment, loan or business venture, there’s risk associated with ROBS plans.

The IRS sets restrictions for ROBS users. For example, an individual can’t own real estate and lease it back to the business under this plan. “If your business needs real estate or major assets, the corporation must own them directly to remain compliant,” according to Guidant’s website.

As a business owner, your salary needs to be considered reasonable, aligning with market rates, so as to not raise red flags with the IRS.

According to the Internal Revenue Service website, “ROBS plans, while not considered an abusive tax avoidance transaction, are questionable because they may solely benefit one individual—the individual who rolls over his or her existing retirement funds to the ROBS plan in a tax-free transaction. The ROBS plan then uses the rollover assets to purchase the stock of the new C Corporation business.”

In 2009, the IRA conducted a study to determine traits of compliant and noncompliant ROBS plans and identify and rectify ROBS plan misuse. That project’s preliminary results found that “most” ROBS businesses were on the road to bankruptcy or failure.

For those failing business owners, “much of the retirement savings invested in their unsuccessful ROBS plan was depleted or ‘lost,’ in many cases even before they had begun to offer their product or service to the public. In some cases, large recurring promoter fees or legal issues were a factor,” the IRS determined.

Granted, that was 17 years ago and conducted just a year after the IRS set up the ROBS Compliance Project, which was meant to

monitor these plans and businesses. (It was also around the time of the Great Recession, which wasn’t exactly a profitable time to be running a business.)

Keith Miller, the director of public affairs for the American Association of Franchisees and Dealers once told me that ROBS was perhaps an appropriate acronym for the program. Keep in mind, the franchisees he’s speaking with aren’t coming to him with positive accounts of their franchise experience—they’re disgruntled at best by the time they reach out to the AAFD.

“These people don’t have enough money to get into the business unless they tap into their retirement. And I’m sorry, I don’t consider franchising that safe of an investment,” Miller said in September.

Rolling over a portion of your retirement savings is one thing. But if a company is encouraging you to roll over more than half, that’s when Miller said it gets dicey.

“If someone’s asking you to roll more than 50 percent of your retirement in, I’ve got a real problem with that because, especially if you’re over 50, 55 years old, you are really risking everything,” he said.

If a franchisor is pushing ROBS, Miller sees it as a potential red flag, especially if that company is new or small. He said a lot of the promotion comes from franchise brokers, who might make a commission. “I think a lot of these brands are pushing it too, because that’s the only way they can get these people qualified,” he said.

It’s easy to get caught up in what a salesperson or broker is selling you—even if it’s not the right path for your business. Take a breath, consider the risks, and don’t be afraid to ask more questions.

Emilee Wentland is managing editor of Franchise Times, and writes the Continental Franchise Review® column in each issue. Send interesting legal and public policy cases to [email protected].