The stock market is a staple of the investment world, but it’s certainly not the only (or most lucrative) avenue by which to grow your retirement account. Alternative assets, such as private placements, aren’t available on the public market, but they can play a significant and lucrative role in your long-term investment goals.

If investing in private companies is on your radar, there are a few key things to keep in mind, including investing requirements and the role self-directed IRAs play. We’ll also provide some tips on how to complete due diligence when completing a self-directed IRA private equity transaction.

Investing in Private Companies with an IRA

Unlike most stocks and bonds, which are purchased on a public exchange, investing in private companies requires you to invest in a company using a broker, direct exchange, pre-IPO purchase, etc.

Leaving those exchanges aside, the two most common ways you can invest in a private company with an IRA is with private equity or private placements.

Both financial tools are similar; however, private equity involves the sale of equity to investors, while private placements require the sale of debt.

Private placements are technically more specialized and require a greater understanding of this financial instrument before undergoing any transaction.

In either scenario, you’ll need to open a self-directed IRA (SDIRA) to invest in a private company using a retirement account.

Types of Placements Companies to Invest with Your IRA

Once you have an SDIRA, you can use it to invest in several types of private companies, including:

• C Corporations
• Convertible notes
• Equity crowdfunding
• Hedge funds
• Land trusts
• Limited liability companies (LLC)
• Limited Partnerships (LP)
• Pooled investment funds
• Small businesses
• Start-ups
• Real estate investment trusts (REIT)

Pros and Cons of Private Company Investment in an IRA

Pro: Potential for high returns

One of the most attractive reasons to invest in private companies is the potential for higher returns. Businesses that turn to private equity as a means to access capital are often those that have growth potential. The more an entity grows after your investment, the higher your returns.

In addition, specialized private placement opportunities are typically limited to a few investors as opposed to the general public, further maximizing an accredited investor’s earning potential.

Pro: Increased control

When you invest in a publicly traded company, you have very little control over the direction of the company. That’s not true of private company investments. Private company investors frequently have a considerable say in company directives and are often actively involved in the management of the entity.

Con: Not as liquid

Buying and selling public stocks is easy and can often be done with a few quick clicks. But selling private equity or debt doesn’t offer that same flexibility. There is no open public or secondary market, meaning selling your shares can be challenging. Further, private equity or debt purchases may be subject to a locking period—such as 10 years—during which the investor cannot sell their shares.

Con: Limited to accredited investors

While there are a number of alternative assets available to any investor with an SDIRA, private placements are only available to accredited investors. According to the U.S. Securities and Exchange Commission (SEC), accredited investors are individuals who:

• Have a net worth of over $1 million on their own or with a spouse or partner (primary residence is excluded).

OR

• Earn more than $200,000 ($300,000 if including income of spouse or partner) annually for at least two consecutive years.

An individual may also attain accredited status if they have specific professional backgrounds, specifically if they:

• Are holding any of the following licenses in good standing:
  • Series 7: General securities representative license.
  • Series 65: Investment advisor representative license.
  • Series 82: Private securities offering representative licenses.
• Are an employee of a 3(c)(1) or 3(c)(7) private fund issuer of securities and considered a “knowledgeable employee” according to rule 3c-5(a)(4) of the Investment Company Act.

For a full list of accredited investors, see SEC guidance.

Tips to Perform Due Diligence

All SDIRA transactions should be subject to due diligence, especially since custodians will not research nor provide advice on client investment decisions. However, because private company investments often require a large sum of money and are frequently long-term, it’s imperative that you perform due diligence before moving forward.

Here are a few things you can do to improve your chances of success:

1. Complete industry research. By understanding a specific industry, you can identify trends and key players as well as short and long-range forecasts. Doing so will provide a better overview of earning potential in the near and distant future.
2. Survey the company to identify weaknesses and strengths. A promising industry trajectory does not equate to a solid investment. Complete due diligence at the company level by investigating everything from their current and anticipated business model to their product/service, as well as supplier and customer relationships.
3. Dig deeper than the confidential information memorandum (CIM). This document is expansive and provides a great first look into a potential investment, but don’t assume it’s all as rosy as the CIM suggests. Review income, bank and cash flow statements, audits, accounts payable, customer acquisition costs, customer turnover rates, and other metrics that can provide you with a full picture of your potential investment.
4. Seek legal counsel. Unforeseen legal issues can have a swift and significant impact on your investment. Before you invest, it’s wise to speak with a lawyer who can help you determine what, if any, legal red flags exist.

Understanding the Role of Your Custodian

All SDIRAs require a custodian, regardless of what alternative investment you choose. A custodian plays somewhat of a passive role in your investment journey, with responsibilities limited to:

• Executing and receiving trades as requested by the client.
• Ensuring compliance with IRS and industry regulations.
• Completing administrative tasks such as record keeping, transaction processing, and account setup.
• Leveraging industry knowledge to ensure your investments are compliant.

An SDIRA custodian will not provide advice on how to invest or structure your IRA portfolio. However, it’s still important to choose a custodian who is well-versed in private equity (or any other asset you are considering), as their knowledge can ensure that your investments are compliant and eliminate unnecessary or costly hurdles.

Ready to open an SDIRA? Contact Horizon Trust to speak to one of our concierge reps about how to invest in private companies with an SDIRA.

FAQs

What is a private placement?

Private placements are a type of asset that is privately traded and unavailable on the public market. There are multiple types of private placements available to accredited investors, including LLCs, C Corps, hedge funds, and REITs.

You can only invest in a private placement with a self-directed IRA, as standard IRAs are limited to common, publicly sold assets.

Are private placements regulated?

Yes, private placements are regulated under Regulation D of the Securities Act. As part of this act, companies can sell shares or debts to gain capital without having to register their offerings with the SEC. While you can invest in public offerings with a standard IRA account, you must open an SDIRA account with an IRS-approved custodian to invest in private placements. [Learn More: Custodian vs. Depository]