Rollover into a Business Startup (ROBS)

I was recently contacted by a potential client that asked about using a rollover into business startup (ROBS) to fund his new business. I had heard of a ROBS, but I didn’t know much about how it worked so I decided to do some research.

A ROBS account (a very unfortunate acronym, in my opinion) allows a new business owner to use his or her retirement funds to start their new business. That means that they can use money from their 401(k) or traditional IRA without paying taxes or penalties so long as the money is used correctly for the new business.

How a ROBS Works

First, the entrepreneur must form a C-corp. Unfortunately, a C-corp is the only permitted business entity. C-corps tend to be more complicated to maintain, and an S-corp or an LLC would generally have tax benefits to the owner.

The entrepreneur then sets up a retirement account for the new business. This could be a traditional 401(k) plan or a profit-sharing plan. Then the owner transfer funds from his or her personal retirement account to the business retirement account. There are no penalties or taxes paid for this transfer. That’s the point of the ROBS. Using those funds, the company retirement account buys shares from the company. Those funds are then available as cash for the company.

Requirements to form a ROBS

The business owner must have an eligible retirement account. Most accounts are eligible except for Roth IRA’s and Roth 401(k)’s. The owner must also have at least $50,000 in retirement funds. This is not technically a rule, but the costs of forming and funding a ROBS can be steep and anything less than $50,000 won’t make sense.

Lastly, the business owner must be a legitimate employee of the business. This usually means that they must work at least 1,000 hours a year. Owners must be careful not to overpay themselves because that would get them into trouble with the IRS and Department of Labor (DOL).

The funds must be used for the business. They cannot be used in any way for personal use. This makes sense because if the owner could use the money for personal gain, he or she would essentially be taking the money out of the retirement accounts without paying taxes or penalties. Obviously, the IRS and DOL would prohibit that kind of use.

ROBS Costs

There is usually a high upfront fee required by providers. The fee is usually around $5,000. The ongoing costs can be as high as $150 per month to maintain the ROBS.

There are some other costs associated with a ROBS. Employees are allowed to invest in the exact same way that the owner does, meaning they can invest in the retirement plan and use those funds to buy shares of the company. The owner is obligated to educate his or her employees about these options.

(“Rollover for Business Startups (ROBS): The Ultimate Guide”, Dennis Shirshikov, “Rollovers as Business Startups (ROBS): What You Need to Know”, Steve Nicastro)

ROBS: good idea or bad?

I think whether a ROBS works for an individual is based greatly on who that individual is and what they plan to do with the money.

The main benefit of a ROBS is that you can fund your startup with your own money. Therefore, you have no investors and no debt costs. If your business does well, your retirement funds can increase greatly.

The main problem is the risk of losing your retirement funds. If you’re comfortable with risk, then you might feel fine putting your funds on the line. If you have a lot of retirement funds, you may not be risking your entire retirement, and if you’re young, you have plenty of time to build up your retirement accounts before you actually retire.

The nature of the business matters, too. If you’re investing in a franchise or something with a proven model, the risk is a lot lower than starting a brand-new business. Most new businesses fail or aren’t very profitable. Picking an industry, you know and a business model with a good track record will help mitigate that risk.

The last risk is the fact that you have to make the retirement plan available to your employees. For most small businesses this is not a problem, but I could see a situation where the ownership shares could get a bit diluted. The owner would need to keep an eye on this in certain circumstances.

Bottom line is that the ROBS may work for the right person in the right business. Rules need to be followed, but if you handle everything correctly, this could be a low-cost way to fund a new startup.

Conducting Trials via Zoom

Many courts have opted to use Zoom or other video conferencing platforms to conduct their courtrooms since the pandemic hit in March. For most status dates and procedural issues, these conferencing platforms work fine. In my experience, they are a bit slower than in-person court, but they generally get the job done.

However, I do not think they should be used for trials, especially jury trials. There are numerous reports of Zoom fatigue and the inability to develop trust via video conferencing. Trials are already marathons for the attorneys, judges, and jurors. Considering what we know about Zoom fatigue I can’t imagine how everyone is going to manage an entire trial via conferencing software, let alone how effective the trial will be at doing justice. It’s hard enough to convince people while arguing in-person, arguing via Zoom will make our jobs that much harder.

Zoom Fatigue

Zoom fatigue is real. Participating in a video conference takes more energy and is more taxing than an in-person conversation. The primary reason for this is that we rely on nonverbal cues constantly during an interaction, and video conferencing simply does not convey all of those cues.

When we don’t get the cues we are used to, our brains have to work harder to figure out what’s going on. We don’t necessarily notice the extra work happening, but it takes a toll on us in the way of fatigue. When your brain is working overtime, it’s hard to relax into the conversation.

Further, when we don’t have all of the information we are used to, we become more insecure about our place in the conversation. For example, delays in response from people we are communicating with can shape our opinion of those people in a negative way. A 2014 study showed that even a delay of 1.2 seconds over conferencing systems made people perceive the responder as less friendly or focused.

There is also the added pressure of having a camera, and potentially 12 other people, staring at you the entire time. During a normal meeting or trial, the spotlight isn’t on one person the entire day. That’s not to say that people don’t pay attention to you, but you’re not as aware of their gaze. Having everyone see you all the time forces you to perform constantly, which can be exhausting. (“The Reason Zoom Calls Drain Your Energy”, Manyu Jiang)

Science Supports my Position

A study was conducted in 2011 where researchers compared how trust was developed via telephone, video conferencing, and face-to-face interactions. They discovered, unsurprisingly, that trust was built much faster via in-person communication as compared to the other two forms.

Face-to-face > video conferencing > telephone

The reason face-to-face was better at building trust had to do with the information we get by communicating in-person. Specifically, researchers tied trust to eye contact and other body language. Video conferencing does not allow for eye contact, which can reduce participants’ trust levels significantly.

However, that’s not the end of the story. The researchers found that groups communicating via video conferencing could reach the same levels of cooperation as the face-to-face groups, but that it took several more rounds of the experiment to accomplish. They found that deception was high in early meetings, not because of a lack of desire to cooperate, but due to a lack of knowledge of the other participants’ intentions. We read intentions via physical clues like mutual gaze and posture, which can’t be experienced over a conferencing platform. (“Video Conferencing and Trust”, VSee; “Being There versus Seeing There: Trust via Video”, University of Michigan)

Zoom Trials are a Bad Idea

Convincing people to do anything requires trust. As attorneys, we develop trust with a judge or a jury over specific amounts of time that have been established over hundreds of years. I might see a judge a couple of times a week on various cases so I can develop trust with him or her over time. But juries are different. Our relationship is heavily regulated by the court. My concern is that the above studies show that we will need more time to build trust with a jury via video conferencing than we would have in-person. However, I doubt that any changes will be made to courtroom procedure to take this lack of trust from the jury into consideration.

That, coupled with the fatigue that naturally occurs via video conferencing, will make jury trials extremely challenging. There is doubt that our world will adapt to our changing times, especially as more research is done into the use of video conferencing software. But until then, I don’t want my clients to be the test cases for this new form of lawyering.

Personally, I am recommending to all of my clients that we don’t conduct any trials via Zoom until we understand how to better argue our cases via this new medium.

Data Use in Complex Civil Litigation

Data is the next frontier in just about everything. Every tech company claims to be a data company (or an AI company, which is basically the same thing these days), and for good reason. Data has become extremely powerful thanks to artificial intelligence’s ability to comb through huge amounts of information. That information contains our spending habits, our driving behavior, our responses to brands, and so much more.

It’s no surprise that data aggregation and interpretation has come to the legal market. The truth is that it has been here for years. Insurance companies have been sharing lawsuit data for at least a decade. Now that same data is being mined for more useful information. We don’t only consider how much cases are worth but also information on individual lawyers and judges. There is no doubt that this information will be used by all law firms in the near future.

Data Available to Law Firms Today

There are three areas where data is being used today: case results, attorney profiles, and judge profiles.

The compilation of case results has been happening for decades, but with help from artificial intelligence more cases can be collected and nuanced data can be teased out of the information. No longer are we only concerned with the final amount paid to a plaintiff, now we can identify specifics about the case such as location, medical damages, and the nature of the injury. We can separate a soft tissue case in Kane County from a broken ankle in Cook County.

Some companies claim to be able to rate attorneys based on past performance. Premonition claims to be able to compare attorneys based on win rates, hourly cost, and the average length of time a case is open. Based on those metrics, Premonition ranks lawyers from best to worst. This is primarily offered to insurance companies and in-house counsel, both of which are in the business of hiring defense attorneys.

Premonition also claims to have profiles for judges. This is not unique to Premonition; many companies claim to have data on judges. The theory is that with enough data you can predict what a judge will do on a specific motion. This data is largely limited to federal judges, where the case details are more available. I have yet to see a company offer similar information on state court judges.

How Useful is this Data?

Information on the valuation of cases is very useful, and my guess is that virtually every insurance company uses that form of data on a regular basis. The data is limited somewhat, however, by the availability of information. For example, much more data is available in large urban areas than in rural areas, and the data doesn’t always apply across geographical regions. Chicago juries award more money than suburban juries, and there are perhaps 100 times more cases in Chicago than Aurora (Aurora is the second biggest city in Illinois but has 1/10th the population of Chicago). The information gained by analyzing Chicago juries will not be applicable to a case in Aurora.

The information supposedly gathered on attorneys is even less useful, in my opinion. They claim to rank lawyers based on win rate, hourly fees, and length of time a case is open. The lawyer has virtually no control over any of those factors. I’m not even sure how a win rate is calculated. Civil cases are never won or lost. Usually, a win is any verdict higher than you were expecting (or lower if you are defense counsel). There are very few cases that return a $0 verdict. Frankly, I think there are plenty of cases where both lawyers win.

Lawyers also have little control over the facts of the case, which are hugely determinative of the end result. Did the defendant rear-end the plaintiff? Pretty hard for the defense attorney to win that case. Maybe he or she can reduce the award, but a complete win is out of the question.

Also, difficult clients frequently dictate whether a case even goes to trial. I will give an example from my career. I handled a divorce case many years ago that had maybe 10 issues for trial. Our client was slated to lose on virtually all of them. The guardian ad litem was completely against her, and the odds of success (however you define it) looked grim. The trial went extremely well. We actually won on 9 of the 10 issues. To the judge and every lawyer in the room, it was a resounding victory. However, my client considered it a loss because we did not win on the one issue (btw, that issue was ranked at “not important” by our client prior to trial). So was that a win or a loss?

Similarly, an attorney has little control over hourly fees. Our market generally defines fees. If you charged drastically less than the competition, clients would be suspect of your abilities. And fees tend to follow experience. A brand-new attorney will have a lower rate than a seasoned litigator (and perhaps a better win rate, too, given the small number of cases). If you rank attorneys by the rate they charge, you will likely hire attorneys from smaller towns with less experience. Those are odd criteria with which to make a decision.

Lastly, lawyers have very little control over the length of time a case is open. There can be delays for all sorts of reasons: difficult clients, service issues, troublesome witnesses, complicated issues, etc. Some lawyers are slow, don’t get me wrong, and they are a headache to deal with, but to rank attorneys by the length of case misses the nuances of handling complex litigation. The lawyer is merely one factor in the length of time a case requires.

Judge profiles are potentially more useful but probably not for specific motions. Does this judge grant a lot of motions for summary judgment? A foundational question must be how many motions for summary judgment does he or she hear in a year. The higher the number of cases, the more useful the data for sure. This data will be more useful for judges in large counties, who handle many cases. A judge in a rural county might only hear 10 motions for summary judgment a year. With a data set that small, outliers are more likely to impact the data, making the information less useful.

The Data Will Become More Useful

We are just at the beginning of this trend in data use. As AI gets more sophisticated and courts store more data online, the information gains will be great. It’s not hard to imagine a world where every decision of a judge is recorded somewhere – in fact, that is already happening. The question is when will our data mining be effective enough to catalog everything. Advances in optical character recognition and natural language processing will usher in a new era of data gathering because machines will be able to understand the handwritten orders found in most courts. More importantly, the data will be organized in a way that is more useful to law firms and insurance companies.

What are the Implications of Better Data Sets?

I had a negotiations professor in law school that had an interesting experiment. He sent half of the class outside and then asked the remaining students two questions:

  1. Is the population of Pakistan greater or less than 90 million?
  2. What is the population of Pakistan?

Then he asked the second set of students, whom he had sent into the hall, two different questions:

  1. Is the population of Pakistan greater or less than 170 million?
  2. What is the population of Pakistan?

The first group of students predictably guessed that the population of Pakistan was around 90 million, and the second group put the number around 170 million. The population of Pakistan is 212 million according to the World Bank, but that was not the point of the exercise. The professor’s point was that the first mover in a negotiation frequently dictates the general area of the negotiation.

But this applies to big data sets, as well. If two attorneys have access to that same data which puts the value of their case between $30,000 and $50,000, the case will invariably settle around those numbers. This is especially true if the data set is large and trustworthy. There is nothing wrong with this, but isn’t the data influencing the settlement rather than the settlement influencing the data? Won’t the data become even more standardized? Isn’t this the tail wagging the dog?

Believe it or not, this already happens in workers’ compensation law. Every settlement or decision is recorded and the attorneys spend their time arguing whether the current case is worse or better than comparative injuries from other cases. This will start to become the norm in civil cases, as well.

In fact, the only arguments made by counsel might be to move the case from one data set to another. For example, I might argue that the case should be considered a broken leg rather than a broken ankle because a broken leg is worth more according to the data.

These issues will occur. The only question is when they will become mainstream. The other natural issue will become: what is the role of attorneys in this data-driven process? That’s the question that should make every civil litigation attorney sit bolt upright in the middle of the night.