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.
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.