The decision to buy a business is the easy part of a business acquisition.
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The more difficult part is securing the funding and financing that is necessary to turn your dream into a reality. And in the current economic climate, financing a small business purchase is not an easy proposition.
Yet many mid-life entrepreneurs already have a source of capital they can tap into for a small business purchase: Retirement savings. The funds you have invested in an IRA, 401k or other vehicles can be leveraged to purchase an existing business.
But buying a business using an IRA isn't a decision that should be taken lightly. Individuals who are depending on IRAs and other investments for retirement income can lose the value of their investment and end up working well into their golden years. If buying a business using an IRA sounds like something you might be interested in, here are a few things to consider.
- Risk. It can't be stressed enough that business ownership is a substantially riskier activity than investing in a low-risk IRA. Although you may be excited about the possibility of owning your own company, you can't let your enthusiasm blind you to the reality that you could exit your business with less money than you started. Assess the risks and make an informed decision before you cash in your IRA for a business acquisition.
- Penalties. The money invested in your IRA or 401k is yours. But be prepared to pay for the privilege of using it finance the purchase of a business. Until you reach the age of 59 ½, withdrawals are subject to penalties and taxes. Early withdrawals can also push you into a higher bracket for the current tax year. This can significantly reduce the amount of capital you have at your disposal, so be sure to base your decision on the net amount of your withdrawal after taxes and penalties.
- Borrowing. In theory, it's possible to borrow against the money you have in an IRA or 401k. But in the real world, borrowing against an IRA is not a realistic strategy for financing a business purchase. In addition to limitations regarding the use of borrowed funds, repayment periods are typically short and not suitable for a business purchase.
- Income analysis. It's important to carefully analyze the amount of income you can realistically generate from the business versus the amount of income your funds are earning as a retirement investment. There's a good chance you can justify a withdrawal based on annual profits and the appreciation value of the business. Just avoid making any rash decisions until you run the numbers.