401(k) Investments a Potential Alternative to Small-Business Loans, Study Finds

Small Business
401(k) Investments a Potential Alternative to Small-Business Loans, Study Finds

The small-business loans landscape since the 2008 recession has been characterized by hesitant banks, unregulated online lenders and a limited pool of venture capital. But a recent study suggests the potential for a new source of small-business funding: retirement investments.

A Washington, D.C.-based research group wants to make it possible for individuals to invest up to 10% of their 401(k) money in small businesses through intrastate crowdfunding websites.

In a June 2015 policy study, R Street Institute, which promotes free markets and limited government, proposed a change to federal labor regulations to allow such investment of retirement savings. Sound like a risky venture for retirement funds? To lessen the risk, the group proposed that securities purchased through the crowdfunding sites could be easily resold on secondary markets, making it easier for the investor to cash out.

MORE: NerdWallet’s Small-Business Guide

The proposal aims to give small businesses a way to raise equity capital from ordinary investors in their local communities. It imagines a world where state crowdfunding platforms are “vibrant marketplaces where small companies can raise capital from their own communities,” author Oren Litwin writes.

Hurdles to small-business funding plan

Although Litwin’s plan is viable, it’s pretty far out, says Anthony Zeoli, a Chicago-based finance attorney at Ginsberg Jacobs LLC. Zeoli also runs CrowdfundingLegalHub.com, where he tracks states’ crowdfunding laws.

Several things would have to happen before the plan the study proposes could work, Zeoli says. First, states would have to build out their crowdfunding markets. Although some sites such as CraftFund in Wisconsin and truCrowd Texas have emerged, few states have intrastate crowdfunding platforms, even though it’s now legal in many places. Eighteen states and Washington, D.C., have enacted laws permitting intrastate crowdfunding, and eight more have passed laws soon to be effective, according to the North American Securities Administrators Association.

The proposal aims to give small businesses a way to raise equity capital from ordinary investors in their local communities.

States would also have to build secondary markets, or avenues for reselling the securities purchased on state crowdfunding platforms. Michigan is the only state with a secondary market, according to Litwin’s study. The ability to resell is crucial to Litwin’s proposal, because it makes the investment less risky.

Finally, 401(k) plan administrators would have to get on board for people to be able to use a portion of their retirement funds to contribute to local businesses through intrastate crowdfunding sites. 401(k)s are employee-sponsored retirement plans that typically allow people to invest in a curated selection of mutual funds. It would be up to the plan administrators to decide what crowdfunding investment options to make available and how to structure the investments, according to Litwin’s proposal.

A risky investment?

If Litwin’s proposal became a reality, small businesses would have access to a huge pool of capital; there was an estimated $4.4 trillion in 401(k) accounts as of June 2014, according to the Investment Company Institute.

But small businesses are notorious for their high failure rates; only about half survive five years, according to the U.S. Small Business Administration. To lessen the investment risk, Litwin proposes that the investments be state-regulated and liquid, or easy for investors to cash out, but he also says he recognizes that some people might be wary of investing their retirement funds in a new venture.

“The risks involved are definitely different,” he told NerdWallet. “What I’m hoping to do is provide more options.”

For more information about how to start and run a business, visit NerdWallet’s Small Business Guide. For free, personalized answers to questions about starting and financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page.

Teddy Nykiel is a staff writer at NerdWallet, a personal finance website. Email: teddy@nerdwallet.com. Twitter: @teddynykiel


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