Now that we’ve shed some light on 401(k) Rollover vs. Distribution, let’s continue to delve a little deeper in the subject of small business funding and focus on the cash injection that is needed for most loans.
In our last blog example, John Smith was buying a service-based business for $75,000 and it was determined that his best financial move was indeed to do a 401(k) Rollover as opposed to a Distribution. In fact, doing the 401(k) Rollover was around $10,000 LESS in fees and taxes than a Distribution. So, what if John Smith is buying an asset-based business that requires furniture, fixtures and equipment – is a 401(k) Rollover still the right financial move for him?
Consider this example: John Smith is opening a new asset-based franchise with initial costs and franchising fees totaling $350,000. John is also planning to purchase the real estate where his franchise will operate for another $350,000. John has $75,000 in his personal savings and $325,000 in his 401(k). His plan is to:
- Use $75,000 personal savings, plus
- $225,000 from 401(k) Rollover, plus
- SBA 7(a) Loan for the remaining $400,000 to fund the initial startup and real estate costs
*In this example, John will still have $100,000 remaining in his 401(k).
For an asset-based business up to $2M, a higher initial cash injection (money down or collateral requirement) is necessary. The SBA wants the business owner to have more “skin in the game” which amounts to more borrower responsibility for the loan amount. A 10-year term, SBA 7(a) loan requires up to 30 percent down of the total amount from the borrower and accrues 7 percent interest roughly (fees are related to the dollar amount borrowed).
John plans to use all of his personal savings and part of his 401(k) Rollover funds for the initial 30 percent cash injection needed to secure the loan, but in reality he could choose to keep his $75,000 in savings and use 401(k) Rollover for the entire cash injection if he wanted to.
The SBA 7(a) loan has a 10-year repayment schedule and most franchise agreements have a 10-year contract period as well, so the loan and the franchise contract run congruently. 401(k) Rollover funds are considered a creditor protected asset in the event John’s loan goes into default. Visit this previous blog for the detailed specifics, but just know the remaining $100,000 in John’s 401(k) is not in jeopardy if his business closes and he isn’t able to repay the loan.
Due to the nature of 401(k) Rollover funding and how the new Plan is set up to reinvest – not borrow – qualifying retirement funds in John’s new franchise’s 401(k) Plan, John is starting his business with less debt, on a tax-deferred basis, with less risk and more equity from day one.
To learn more about 401(k) funding, SBA 7(a) Loans and other types of small business funding, keep reading the Tenet Financial Group blog weekly or give us a call to discuss your questions or funding needs – 1-888-901-3335, x. 9.