A former executive starts a new chapter in her life and wants to buy a franchise operation and work there. A long-time consultant tires of working for others and wants to start and manage a new stand-alone business for himself. Where can they access money to fund these new operations? From their credit cards? Off their home equity lines? From a new kick-start campaign online?

Some advisors refer to financing a new company with funds from a 401(k) plan, 403(b) plan, or traditional IRA as a “ROBS” transaction: rollovers as business start-ups. It’s an unfortunate acronym, one the IRS coined, in large part due to the agency’s skepticism and suspicions about using retirement savings to capitalize a business. See Michael D. Julianelle, Director of Employee Plans – IRS Employee Plan Memorandum, October 1, 2008, “Guidelines Regarding Rollovers as Business Start-ups (https://www.irs.gov/pub/irs-tege/robs_guidelines.pdf). As there is company stock (“qualified employer securities”) involved, a less pejorative term used in the business community and ERISA industry is a “QES” funding strategy.

Under a QES transaction, the budding entrepreneur from above sets up a C corporation (and for reasons that include ERISA’s complex fiduciary and the Internal Revenue Code’s disqualified person prohibited transaction rules, it cannot be an S corporation or limited liability corporation) with authorized, but still unissued stock. The C corporation then sponsors a tax-qualified 401(k) plan that permits a rollover of funds from a former employer’s plan. The 401(k) plan also permits participants to invest in employer stock. With a plan that offers that type of design structure, the entrepreneur requests a tax-free distribution from the former plan, and that money goes right into the new 401(k) plan. The entrepreneur, now a participant in the plan, chooses to invest in all the company stock, using all the money that was rolled over. So long as the entrepreneur purchases the stock for adequate consideration and no commission, there is no prohibited transaction and no related excise tax. See DOL Advisory Opinion 96-08A (June 26, 1996) (http://www.dol.gov/ebsa/programs/ori/advisory96/96-08a.htm).

And, voila! Where the entrepreneur had initially thought to tap a credit card or home equity line, the new start-up now has funds in its company coffers to hire workers (including the entrepreneur), pay salaries, and start running a new business (such a franchise operation).

A budding entrepreneur should be cautious with the promoters out there, as there are the opportunists who will offer to set up the financing strategy for a somewhat large fee, but then will walk away from guiding such entrepreneur on the ERISA compliance rules (proper 401(k) plan administration, allowing other employees into the plan, 5500 filings, annual business valuation) that a QES transaction requires. The lack of ERISA attention, along with the IRS’s retirement plan concern that people are possibly throwing their career-long savings away to a businesses that fails (really no different from mortgaging a home even more, which entrepreneurs have done), appear to make these QES transactions somewhat risky. It should be noted however that, while the IRS has expressed concern over the QES financings as recently as late 2015, the agency does not find the transaction as non-compliant (“we do not believe that the form of all of these transactions may be challenged as non-compliant per se”) (https://www.irs.gov/Retirement-Plans/Employee-Plans-Compliance-Unit-(EPCU)-Completed-Projects-Project-with-Summary-Reports-%E2%80%93-Rollovers-as-Business-Start-Ups-(ROBS)).

One very attractive incentive goal of the QES transaction is that it can offer a home run: when in the future an unrelated third party offers to buy 100 percent of the company stock, it is the entrepreneur’s 401(k) account that will receive the proceeds, with no income tax upon the sale of the stock. Instead, ordinary income tax is deferred until distribution.

Even better and if designed properly, the QES transaction can offer a grand slam: if the company plan allowed Roth 401(k) rollovers (on which the entrepreneur has already paid income tax), when an unrelated third party buys 100 percent of the company stock, the gain to the entrepreneur’s account is forever income-tax free!

With proper counseling, a QES transaction is an appropriate financing tool, so long as the entrepreneur understands the risk, armed with the right team of advisors in place. This is self-serving, of course, but an entrepreneur needs, at a minimum, an ERISA attorney who quarterbacks these transactions (and is conversant with DOL fiduciary and IRS tax rules), a sophisticated CPA, and 401(k) service providers who can handle the ongoing administration of the plan.