There was a question on Quora that asked something along the lines of “what is the most overlooked factor in starting a business?”.
This applies equally to an online or offline business … and, I was surprised that none of the responses mentioned it:
Risk
.
In order to launch a business, you need to be able to overlook risk.
Even though risk can be managed, if you sat down to think about all the possible things that could go wrong with your proposed business, well, you would never start it.
So, I think you need to be able to overlook risk – and, move well out of your comfort zone (unless you are already into extreme sports and other forms of death wish!) – if you are to think about starting a business that consumes considerable time and/or money (no ‘hobby businesses’ here).
Hopefully, this now paves the way for a sensible discussion around a rather controversial Wisebread article sharing Darwin’s thoughts on How to Start a Business With Your 401(k).
Darwin’s view is that, rather than taking on expensive debt, it may be better to start your business by withdrawing all or part of your 401k using “a little known, but increasingly popular provision in the tax code referred to as the Rollover as Business Startup (ROBS). It allows someone to start up a new business venture with funds from an old 401(k) account without incurring the dreaded early withdrawal penalties meant to deter people from using their 401(k) accounts like piggy banks.”
A sensible – negative – response is offered by one reader:
To avoid going into debt is a pretty bad reason to raid your 401(k). If your business fails you can always declare bankruptcy – bankruptcy can’t touch most 401(k)’s – you’ll still have your retirement savings…roll it over into the business instead, have it fail…and you’ll have nothing.
And, I agree – to a point: your 401(k), although woefully inadequate for its intended purpose (i.e. ensuring your retirement) is useful as an insurance policy when all else in your financial life goes wrong.
Cashing in your insurance policies because you need money is the last thing that you should do!
But, this viewpoint ignores some basic realities:
1. Going into business, for a true entrepreneur (the type that can build a $7m7y business) is a “must do”.
Starting my own business was all I could think of for 4 years (yes, I was slow to act), and risking everything (career, etc.) was simply par for the course. I’m not saying this is ‘right’, just that it’s how an entrepreneur thinks.
2. Raising significant debt finance is almost impossible for a new business.
Sure, you can (and should) tap out your sources of traditional finance: refinancing your house (if you’re not already upside down on your mortgage); max’ing out your credit cards; trying for a personal loan (fat chance once the bank manager finds out what it’s for).
I do not think cost of the debt is an issue (if it’s available TAKE IT because it’s deductible and you’ll pay it off if your business is successful). I do think access to debt is … I think you’ll find it’s just not available; at least, not in the amounts required if your business requires access to substantial capital (e.g. for shop fit-outs, software builds, stock purchases, etc.)
3. Equity Capital can be equally difficult
The first place you should go for funds for your new venture is the 4 F’s: Founders (see above), Family, Friends … and, Fools. These days, Fools are very hard to find (they’ve already had their pockets emptied in the crash!) and Family and Friends are less likely to dig into their pockets than ever before.
So, that may leave your 401(k).
If that’s the only source of funds for your new venture, what will you do?
I’m facing this delimma right now.
The problem with the ROBS is that it requires a costly business valuation and for you to offer the same deal of buying stock in the business to all future employees. And the IRS is not very lenient on the rules.
I’m applying for an SBA loan of $75k as we speak, and have a good chance of getting it, plus a $25k revolving line of credit.
If I can get both of these, I won’t have to tap my 401k, but I still have to come up with at least 10% cash injection.
AJC, you interested in investing in a retail startup? ๐
@ Chris – Taking out loans, such as SBA, is far preferred to ‘last resort’ measures like killing a relative for the insurance payout (hint: make sure you’re listed as a beneficiary, first) or tapping your 401k (I think there’s more than one way to tap into a 401k).
Good luck with the venture … we’d love to read about your exploits here and on your blog!
” 4 Fโs: Founders (see above), Family, Friends โฆ and, Fools”
So that’s 5 F’s now. Adding the “Four O One K”
๐
Reasonably thought out, as you have said, risk can be managed. If this was the only source of cash I had to get my hands on, I’d take the chance and use it to start that business.
@ Steve – I guess it’s all about need …
Hmmm. So I can withdraw 85k from my 401k buy a fourplex in say las vegas cash. Rent each out for 550 a month. After bills and other expenses take home of about 1500 per month. With a conservative payback time frame of 10 years. In ten years I have a foueplex plus my original 85k. The question would be where would my 85k be if I do nothing?
I might just do this. Saludos, Luis
@ Luis – taking into account that I didn’t mention the words: “las vegas”, “payback time” or “fourplex”, I’m wishing you luck! ๐
I rather say “oh well than “what if”
So I will have no problem with cashing out a 401k
@ Marie – Spoken like a true entrepreneur! Although, I hope that you are never forced to have to make that decision ๐
Luis,
I’m not sure how tight credit control around Vegas is. But instead of sitting on the 4plex for ten years:
Why not, as soon as you’ve had an income from the 4 for long enough to be able to get a mortgage, take the maximum from the 4plex that you can, and take that money to buy another 4plex (or duplex if you can’t get enough for a 4plex – or even just one more lettable property).
I’m not saying overextend. But sticking cash into a mortgage-able asset seems like simply moving your cash from one low-risk (401k) low income instrument, to another low risk low income instrument (paid off property).
You might be able to repeat this process 2 – 3 times in the ten years – and then your 85k might be 170 or 240k. I doubt if your 401 k can move from 85 to 170 in ten years.
And that is not considering the likely increase in property value. (It’s unlikely that America will have another property crash within the next 10 years, I think?)