Prospective franchisees often look to their retirement savings to finance a franchise purchase. One increasingly popular method is a Rollover as Business Start-Up, or ROBS. A ROBS lets you invest funds from a 401(k) or other eligible retirement account in a new business without immediately paying income taxes or early withdrawal penalties.
At first glance, the arrangement sounds appealing. You can finance your franchise without a traditional business loan, interest, or monthly payments. But before you put your retirement savings on the line, understand the risks.
How ROBS Financing Works
A ROBS arrangement generally starts with a new C corporation that establishes a qualified retirement plan, typically a 401(k). You roll funds from an existing retirement account into the new plan. The plan uses those funds to purchase stock in the corporation. The corporation then uses the proceeds to acquire and operate the franchise. If you structure and administer the transaction properly, you avoid the immediate taxes and penalties that ordinarily apply to an early withdrawal.
But ROBS is not free money. You are investing your retirement savings directly in your new business. Those funds carry the same risks as any other equity investment.
You Could Lose Your Retirement Savings
The biggest risk is also the most obvious: if the franchise fails, you lose the retirement savings you invested in it. A diversified retirement portfolio spreads your money across hundreds or thousands of companies. A ROBS arrangement concentrates a large share of your retirement assets in a single business.
Even established franchise brands cannot guarantee success. Unexpected construction costs, higher labor expenses, poor sales, and competition can quickly undermine a new franchise. The IRS reviewed ROBS arrangements and found that many of the businesses had failed or were heading toward failure. Some owners lost their businesses and much of their retirement savings with them.
Tax and Compliance Risks
ROBS arrangements are not inherently illegal, but the IRS has raised concerns about how owners structure and administer them. Because the arrangement involves a qualified retirement plan, the business must follow rules on employee eligibility, nondiscrimination, stock valuations, recordkeeping, and annual reporting. Once the franchise begins hiring, you cannot run the plan solely for your own benefit.
If you administer the plan improperly, the IRS can disqualify it. Disqualification can trigger significant taxes and penalties, potentially on the funds you originally rolled over. And an IRS determination letter approving the form of the plan says nothing about whether you are operating it in compliance with the law.
Ongoing Costs and Personal Exposure
Promoters market ROBS as an alternative to debt, but it is not without cost. Setup fees, plan administration, tax reporting, annual stock valuations, and professional compliance services all add up. Those obligations continue even if the business struggles. Before you commit, understand who will administer the plan, what services are included, and what additional expenses may arise.
Using retirement funds also does not eliminate the other financial risks of franchise ownership. A franchisor, landlord, or lender may still require you to personally guarantee certain obligations. If the franchise fails, those guarantees expose your personal assets on top of the retirement funds you already invested.
Before You Commit
Start with due diligence on the franchise itself. Review the Franchise Disclosure Document, particularly Item 7 (estimated initial investment), Item 19 (financial performance representations, if provided), and Item 20 (outlet history). Talk to current and former franchisees. Ask yourself whether you could afford to lose the invested funds and still retire. Build financial projections that account for construction delays, operating losses, and working capital beyond the FDD’s estimates. Consult independent tax and retirement plan professionals who understand ROBS and its ongoing obligations. And compare conventional financing and SBA loans before you decide that retirement savings are the right source of capital.
ROBS can be a legitimate way to fund a franchise acquisition, and for some buyers it is a viable option. But there is a difference between risking money you set aside to invest and risking the savings you accumulated over decades for retirement.
At Marcus & Boxerman, we represent franchisees in reviewing and negotiating franchise agreements and handling the legal issues that come with franchise acquisitions. If you are considering purchasing a franchise, contact us at firm@marcusboxerman.com.