Investing Your 401(k) in a New Business Venture

Question

The presentation Creative Models for Raising Capital mentioned using a 401(k) to fund a start-up.  Could you point me in the direction of more in-depth resources for researching this issue?

Answer

These types of plans are called ERSOPs, or Entrepreneur Retirement Stock Option Plan and they do carry some risks.  A short summary of how the process of funding your new business with your 401(k) is as follows:

Step 1: Form a C Corporation (no other type of corporation will work)

Step 2: Your new corporation Sponsors a 401(k) Plan - Your new plan needs to be designed to allow for investment into your corporation and you need a favorable determination letter from the IRS.

Step 3: Rollover to your new 401(k) Plan - At this point, you move your retirement funds from your previous employer or IRA into your new 401(k) Plan.  You need to have already separated from your employer is your plan was with an employer.

Step 4: Your 401(k) Plan Invests in your Corporation – Your new 401(k) Plan purchases stock in your new corporation, resulting in a capitalized business that is debt-free and cash-rich from the sale of the stock, ready for you to launch or acquire a business.

Step 5: Your 401(k) Plan will require administration, allocations, trust accounting and federal government reporting every year.

I would definitely recommend using a company that is an expert at providing this service.  You should expect to pay between $4,000 - $5,000 for this service up-front to get everything set up and then between $800 - $1,000 per year to maintain.  Since this a complicated procedure, I would highly recommend that you use an expert to help guide you through the process to avoid any potential run-ins with the IRS.  Even if you do get an IRS determination letter, the IRS could change their mind on the issue, since there is no formal ruling and limited case law that bolsters the case for the use of ERSOPs.  At issue seems to be whether or not the value of the C corporation you formed was substantial enough to warrant the value of the investment made in the plan rollover.

Listed below are two companies and a link to their website describing their service:

Guidant Financial

SD Cooper Company

NVL members who want to engage in this type of transaction need to hire expert counsel to advise them of the rules.  Do not rely solely on the advice of the above firms that promote this type of transaction.


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