Definition Or Explanation: A 401(k) is a tax-deferred
savings account that an employer establishes for its employees.
This savings vehicle can be used for almost any kind of investment.
The 401(k) stays intact even if the employee leaves the firm. If
the employee leaves to start a new business, his or her 401(k) can
be used to invest in, or even finance, the new venture.
Appropriate For: Any company at any stage of development.
Since entrepreneurs fund the company with their own retirement
savings, they need only convince themselves that the deal is worth
the risk.
Supply: This option is for entrepreneurs who have been
cut loose from corporate America, with their 401(k) plan. Beyond
simply having a 401(k), the supply is further influenced by how
much of their tax-deferred retirement savings entrepreneurs are
willing to put at risk.
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Best Use: Financing start-ups. When start-up companies
are financed with equity from outside sources, it's the most
expensive avenue of financing because the company is worth so
little. A round of seed financing can cost 30 percent of the
equity. Although 401(k) financing forces a company to surrender
equity, it is surrendered to the firm's founders and, as such,
is not really lost.
Cost: The fees can run high because several professionals
are required to engineer the transaction. However, 401(k) financing
does not cost the founders any equity in their business.
Ease Of Acquisition: Moderately challenging. There are
several legal and accounting issues that must be resolved for this
technique to work properly.
Funds Typically Available: $100,000 and greater.
From Where's the Money? Sure-Fire Financing Solutions for
Your Small Business, by Art Beroff and Dwayne Moyers. (c)
Entrepreneur Press, 1999.