Before You Use Retirement Funds for Your Startup

(page 2 of 2)

Private investors. Consider raising money from angel investors—wealthy individuals who look for business investment opportunities, often in fields where they have some expertise. The Angel Capital Assn. publishes a directory of its 165-plus members. Financing marketplaces and communities such as Prosper and RaiseCapital,com allow entrepreneurs to post their business ventures online, accompanied by business plans, photos, and contact information for would-be investors. "We have facilitated successful marriages in the form of equity plays or traditional loans," says Rick Singer, CEO and founder of RaiseCapital.com. The site charges a $99 fee but does not oversee deals or take a percentage of any transactions that result.

Continue looking for employment while you research your business venture. If you don't find anything and none of the funding alternatives we've discussed pans out, you're better off with an ERSOP than with cashing out your IRA funds outright, Dienes says.

"If you simply withdraw the money from your IRA, you will have to pay both income taxes on that money and a penalty for withdrawing your money early [assuming you are younger than 59.5]. By setting up an ERSOP, you set up a new company, create a profit-sharing trust for that new company, rollover your IRA, and use your retirement funds to purchase stock in your new company, without incurring taxes," he says.

The catch with ERSOPs is that they are a funding vehicle that is not officially sanctioned by the U.S. Internal Revenue Service. "The tax treatment of ERSOPs has not been conclusively resolved," Dienes says.

They also are costly to set up and maintain, says Lawrence Sprung, a certified financial planner with Mitlin Financial in Hauppauge, N.Y. "If you go that route, hire an independent tax adviser or business attorney to look out for your interests. Don't rely on the third-party companies that sell ERSOPs to advise you," he says.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.

Business Exchange

Track and share business topics across the Web.