ROBS Plans

[Belgarath]

We don't do these, so I'm not familiar with document details. But it seems to me like a "regular" 401(k) or PS document could be used for a ROBS plan, as long as the document allows essentially unlimited portion of the assets to be invested in the employer (must be a c-corp) stock.

Is that true, or is a special document necessary?

I know these have become more popular in recent years. Years ago, the IRS REALLY didn't like them, but it seems like for plans with no NHC, and a stock that is properly valued by an independent appraisal each year, that FILES 5500 FORMS, that they have dropped some of their previous objections. Anyone work with these?

https://www.irs.gov/retirement-plans/employee-plans-compliance-unit-epcu-completed-projects-project-with-summary-reports-rollovers-as-business-start-ups-robs

[RatherBeGolfing]

I don't do them either but I know some local attorneys who do.  From what I understand, it isn't the plan itself that causes the problems its all the circumstances around the plan.

Also, I think the IRS still REALLY doesn't like them, because most of them are not done right and are pushed by some seriously flawed promoters...  Nothing wrong with them if properly done though.

 

[Kevin C]

We have a client that did this with his plan last year.  He hired one of the big promoters to do the document, testing and reporting, with us just doing recordkeeping on the non-stock 401(k) assets. The promoter claimed to have special language in their document.   In his case, the plan purchased stock in his existing company based on an independent third-party appraisal, so it should work if he follows their instructions.  However, the typical pitch seems geared towards starting a new business using plan assets and I don't see how that works.  When you have an unfunded start-up corporation, how can the fair market value of the stock at the time of purchase possibly be anywhere close to the amount the person wants to invest?  If the plan pays more than fair market value for the stock, it's a PT.

[ESOP Guy]

1 hour ago, Kevin C said:

We have a client that did this with his plan last year.  He hired one of the big promoters to do the document, testing and reporting, with us just doing recordkeeping on the non-stock 401(k) assets. The promoter claimed to have special language in their document.   In his case, the plan purchased stock in his existing company based on an independent third-party appraisal, so it should work if he follows their instructions.  However, the typical pitch seems geared towards starting a new business using plan assets and I don't see how that works.  When you have an unfunded start-up corporation, how can the fair market value of the stock at the time of purchase possibly be anywhere close to the amount the person wants to invest?  If the plan pays more than fair market value for the stock, it's a PT.

As I understand it the logic goes this way regarding the FMV.  I start AB corp and put $1 of capital into the company and issue 1 share.  What is its FMV at that point?  They say the answer is $1 for total enterprise value and $1 per share.  I roll $100k into AB corp's PSP.  The PSP buys 100k of newly issued shares from AB corp for $1 each.  So now AB corp has $100,001 and 100,001 shares issued.  The FMV per share is still $1 with total enterprise value of $100,001.  Now AB corp uses that money to start a franchise (it is this industry that seems to push this idea more then anyone else) and maybe the value drops but that is AFTER the transaction with the PSP. 

Not saying an appraiser would sign off on the above but that is my understanding of the logic.  From what I can tell the IRS doesn't seriously dispute the above logic.  Their problem comes after this point more then this part of the transaction. 

[ESOP Guy]

1 hour ago, Belgarath said:

but it seems like for plans with no NHC, and a stock that is properly valued by an independent appraisal each year, that FILES 5500 FORMS, that they have dropped some of their previous objections.s

Strictly speaking I know people who make the case you don't have to have this stock independently appraised every year.  There is no legal requirement for that to be done which is true.  You would have to answer the question on the Form 5500 saying there was no appraisal.  I worked with a company that wasn't a ROBS but a PSP that owned almost 100% of the company stock.  They did not get an appraisal.  When we got a letter from the IRS about it we explained how the company came up with the value on their own.  The IRS never came back after that. 

I think that was VERY risky.  They had both NHCEs and HCEs and they made distributions based on their value.  I think if they had been challenged over the value and lost they could have owed a lot of people a lot of money. 

[Peter Gulia]

Here’s a question to ponder:

 

If a corporation invites an arm’s-length investor to purchase 100% of the corporation’s original-issue shares before the corporation has any customer, any business activity, any franchise right, any intellectual property, any other property, any money, or any other asset (beyond the corporation’s right to be a corporation), how much should the investor pay for the shares?

 

If your answer is anything more than $0.00, why?

[ESOP Guy]

1 hour ago, Fiduciary Guidance Counsel said:

Here’s a question to ponder:

 

If a corporation invites an arm’s-length investor to purchase 100% of the corporation’s original-issue shares before the corporation has any customer, any business activity, any franchise right, any intellectual property, any other property, any money, or any other asset (beyond the corporation’s right to be a corporation), how much should the investor pay for the shares?

 

If your answer is anything more than $0.00, why?

I think that is why the defenders of this say you first sell one share for some nominal amount be it $1, or $1,000 before the qualified plan does any transaction then your question is n/a It has some assets and nothing else. 

[david rigby]

1 hour ago, Fiduciary Guidance Counsel said:

Here’s a question to ponder:

If a corporation invites an arm’s-length investor to purchase 100% of the corporation’s original-issue shares before the corporation has any customer, any business activity, any franchise right, any intellectual property, any other property, any money, or any other asset (beyond the corporation’s right to be a corporation), how much should the investor pay for the shares?

If your answer is anything more than $0.00, why?

I might be willing to invest $1.  Risk vs. reward. 

[Kevin C]

5 hours ago, ESOP Guy said:

I think that is why the defenders of this say you first sell one share for some nominal amount be it $1, or $1,000 before the qualified plan does any transaction then your question is n/a It has some assets and nothing else. 

The issue isn't whether the company has any assets at the time the stock is purchased, it's  whether the stock is purchased for no more than fair market value.  If the stock isn't worth the purchase price until after the proceeds have been received, it was purchased for more than fair market value.  What Peter described is the definition of fair market value.  

 

[A Shot in the Dark]

I am not a advocate of ROBS, but our practice does have a few clients using these vehicles.

The valuation issue for a start up C corp is as follows:  The appraised value of the stock of the corporation is completed simultaneously with the infusion of the rollover of cash used to acquire the stock.  You make the number of shares issued equal to the amount of cash used to acquire the stock. For example, $200,000 rollover -200,000 shares of stock issued, one dollar per share.

$200,000 of cash in corp.  200,000 share issued.  How can one argue that value of the company can be less than the cash on hand if that is sole asset of the corporation.

 

[Peter Gulia]

Wouldn’t a rational investor pay no more than fair-market value based on what a share’s value is when the investor makes the purchase (rather than what the value becomes after the investor made her purchase)?

[RatherBeGolfing]

44 minutes ago, Fiduciary Guidance Counsel said:

Wouldn’t a rational investor pay no more than fair-market value based on what a share’s value is when the investor makes the purchase (rather than what the value becomes after the investor made her purchase)?

I agree with your point, but are investors necessarily rational?

[Mike Preston]

Doesn't the inclusion/exclusion of the cash tendered depend on who is selling the stock?  If the stock is being sold by the company (i.e., treasury stock) the amount paid will end up on the balance sheet of the company and to ignore it when it is material to the value of the company seems ludicrous to me.

What is far more likely to me is that the purchase of the stock would include a premium of some sort.  The company may not have hard assets before the transaction, but it should have, at the least, a business plan.  If that plan has merit then the stock price should reflect that value.  Let's assume that said value is $50,000.  Somebody wants to purchase 99% of the company.  What should the amount of cash be that changes hands? It depends on the price per share after the transaction that the buyer thinks is fair.

 Before the transation there was 1 share, valued at $49,999/share.  After a $200,000 cash infusion the company would be valued at $250,000.  If 199999 shares were issued by the company in this transaction then the fair-market value of each share after the transaction would be $250,000/200,000 = $1.25. Now, if I were the owner of that 1 share valued at $49,999 I would think there would have to be compelling reasons for me to go along with the scheme to issue treasury stock such that the value of my share would decrease by $49,998.  Unless I were issued some sort of preference I would think the better course of action would be to liquidate the company.  This can get very complicated.

Mathematically, it is not hard to go through the above with a pre-transaction value of $1 for the one share of stock.

[ESOP Guy]

22 hours ago, Kevin C said:

The issue isn't whether the company has any assets at the time the stock is purchased, it's  whether the stock is purchased for no more than fair market value.  If the stock isn't worth the purchase price until after the proceeds have been received, it was purchased for more than fair market value.  What Peter described is the definition of fair market value.  

 

Actually whether the company has any assets at the time of the purchase IS KEY to the question I was answering.  Allow me to quote part of it again. 

 

If a corporation invites an arm’s-length investor to purchase 100% of the corporation’s original-issue shares before the corporation has any customer, any business activity, any franchise right, any intellectual property, any other property, any money, or any other asset (beyond the corporation’s right to be a corporation), how much should the investor pay for the shares?

 

If your answer is anything more than $0.00, why?

 

Emphasis is mine

 

The question clearly states the value of the corporation is zero before the qualified plan has any assets would have a value of zero.  As I point out I have never seen one of these transactions done when the company has not assets at all.  They always set up a corporation and have it receive a nominal amount of cash.  So it has assets so the value has to be something greater then zero. 

 

So the answer to the question given is the question has a fatal flaw in assuming the corporation has no assets. 

 

I don't see how anyone disputes the idea if a corporation has $1,000 in cash and not other assets or liabilities can be worth less then $1,000?  You might make a case there are some transaction costs in shutting it down but as long as it is a going concern that doesn't seem to apply. 

 

So read my example again  I don't say the stock has a value AFTER the transaction.  I clearly say the stock has the SAME value BEFORE and AFTER the transaction with the plan.  No one has given a valid reason addressing the facts I gave why that isn't true.  The one attempt to do so make a false statement the corporation had no assets before the transaction when I clear said it had assets before the transaction with the qualified plan. 

 

[ESOP Guy]

4 hours ago, Mike Preston said:

Doesn't the inclusion/exclusion of the cash tendered depend on who is selling the stock?  If the stock is being sold by the company (i.e., treasury stock) the amount paid will end up on the balance sheet of the company and to ignore it when it is material to the value of the company seems ludicrous to me.

What is far more likely to me is that the purchase of the stock would include a premium of some sort.  The company may not have hard assets before the transaction, but it should have, at the least, a business plan.  If that plan has merit then the stock price should reflect that value.  Let's assume that said value is $50,000.  Somebody wants to purchase 99% of the company.  What should the amount of cash be that changes hands? It depends on the price per share after the transaction that the buyer thinks is fair.

 Before the transation there was 1 share, valued at $49,999/share.  After a $200,000 cash infusion the company would be valued at $250,000.  If 199999 shares were issued by the company in this transaction then the fair-market value of each share after the transaction would be $250,000/200,000 = $1.25. Now, if I were the owner of that 1 share valued at $49,999 I would think there would have to be compelling reasons for me to go along with the scheme to issue treasury stock such that the value of my share would decrease by $49,998.  Unless I were issued some sort of preference I would think the better course of action would be to liquidate the company.  This can get very complicated.

Mathematically, it is not hard to go through the above with a pre-transaction value of $1 for the one share of stock.

Once again I know of no one that advocates ROBS that sets up the process the way you describe. If they issue 1 share for the original $50,000 investment then for the next $200,000 investment they would issue 4 share to the qualified plan. 

So at the end the corporation would have $250,000 in assets and that would be seen as the value of the corporation.  There would be 5 shares outstanding so the value of each share is worth $50,000.  There has been no dilution of the original investor. 

[Peter Gulia]

The not-so-hypothetical situation I described yesterday is based on a real situation I worked on.

 

Unlike ESOP Guy’s illustration of a different fact pattern, there was no investor before the retirement plan’s purchase of all the corporation’s original-issue shares.

 

Rather, the retirement plan paid the corporation an amount for 100% of the corporation’s original-issue shares.

 

The appraiser’s report said the corporation’s value was identical, to the penny, to the amount the retirement plan paid in for the shares.

 

So if, as the appraiser’s report concluded, the corporation had no value beyond its money (which it didn’t have before the only investor put it in), why would an investor part with money with no expectation of a return?

 

RatherBeGolfing is right that investors generally, and investors in these businesses particularly, might not be coldly rational.  But meeting ERISA and Internal Revenue Code rules for doing transactions at fair-market value calls for a valuation grounded on what such a hypothetical arm’s-length investor would do.

 

There can be proper ways to value the fair-market price of a share of a start-up business.  But that isn’t what was done in the appraisal I saw.

[Belgarath]

I wonder if the fiduciaries (the "owners" but not really owners) in these plans are getting the ERISA bond - I don't think the IRS project necessarily addressed this. I'll bet lots of them don't...

[BG5150]

3 hours ago, Belgarath said:

I wonder if the fiduciaries (the "owners" but not really owners) in these plans are getting the ERISA bond - I don't think the IRS project necessarily addressed this. I'll bet lots of them don't...

Won't a lot of these plans be 1-participant plans, and thus no bond needed?

[MoJo]

3 hours ago, BG5150 said:

Won't a lot of these plans be 1-participant plans, and thus no bond needed?

Most of the ones I've seen start off as 1 person plans (or husband and wife) but ultimately may add employees.  Then things can get interesting....

[Belgarath]

Not as I understand it. The problem is that the PLAN is the owner of 100% of the stock, rather than "Mr. and/or Mrs. Jones" which moves it out of the definition of a "one participant plan" for 5500 purposes. Other thoughts? Am I misinterpreting something?

[BG5150]

How is it any different that a "regular" plan.  In those, the plan still owns the assets, though they are earmarked as benefits for Mr. & Mrs. Jones later.  What if the sole investment is 1200 shares of the ABC fund?  Who is the owner of those shares?

[ESOP Guy]

10 minutes ago, BG5150 said:

How is it any different that a "regular" plan.  In those, the plan still owns the assets, though they are earmarked as benefits for Mr. & Mrs. Jones later.  What if the sole investment is 1200 shares of the ABC fund?  Who is the owner of those shares?

In an ESOP at least the shares in the plan the law is clear the trust owns the shares.  So if Mr. Smith has over 5% of the shares in his account that does NOT count for HCE purposes because he doesn't own the shares.

I believe that is true here where it is a PSP plan trust that owns the shares.  So if 100% of the shares are owned by the trust then no human owns any shares.

Although most ROBS I have seen (as noted above) the plan doesn't own 100% of the shares more like 99% of the shares. 

I have seen PSPs that own 100% of the shares however. 

[Belgarath]

BG - as I understand it, who owns the ASSETS is immaterial - and I agree that the assets are owned by the plan regardless of whether it is a ROBS plan or not. The exemption is based on who owns the CORPORATION. So if my wife and I are the sole owners and employees of corporation A, then we qualify for the exemption. However, if the PLAN owns the corporation, then this requirement is failed, and we have to get the bond. Again, I'm just curious if folks agree or disagree, and if they disagree, what justification would you use to say no bond is required? Thanks again.

P.S. - for my reasoning on this, see DOL 2510.3-3.

[Peter Gulia]

Here’s the text of 29 C.F.R. § 2510.3-3(a)-(c):

 

(a)   General.  This section clarifies the definition in section 3(3) of the term “employee benefit plan” for purposes of title I of the Act and this chapter.  It states a general principle which can be applied to a large class of plans to determine whether they constitute employee benefit plans within the meaning of section 3(3) of the Act.  Under section 4(a) of the Act, only employee benefit plans within the meaning of section 3(3) are subject to title I.

 

(b)   Plans without employees.  For purposes of title I of the Act and this chapter, the term “employee benefit plan” shall not include any plan, fund or program, other than an apprenticeship or other training program, under which no employees are participants covered under the plan, as defined in paragraph (d) of this section. For example, a so-called “Keogh” or “H.R. 10” plan under which only partners or only a sole proprietor are participants covered under the plan will not be covered under title I.  However, a Keogh plan under which one or more common law employees, in addition to the self-employed individuals, are participants covered under the plan, will be covered under title I.  Similarly, partnership buyout agreements described in section 736 of the Internal Revenue Code of 1954 will not be subject to title I.

 

(c)   Employees.  For purposes of this section:

(1)   An individual and his or her spouse shall not be deemed to be employees with respect to a trade or business, whether incorporated or unincorporated, which is wholly owned by the individual or by the individual and his or her spouse, and

(2)   A partner in a partnership and his or her spouse shall not be deemed to be employees with respect to the partnership.

 

 https://www.ecfr.gov/cgi-bin/text-idx?SID=93795492ebbf6ce09dc6217cdaace5aa&mc=true&node=se29.9.2510_13_63&rgn=div8