You’re probably familiar with traditional stock terms like “IPO.” Most traditional retirement plans allow you to invest in stocks and IPOs using public exchanges, like the NASDAQ or Dow Jones.
But what if you want to invest in a company that is newly formed or hasn’t otherwise registered with the SEC?
Unfortunately, these opportunities, also known as private placements, aren’t available to standard retirement account holders.
Only self-directed IRAs allow you to invest in private placements using your retirement funds.
So what exactly is a private placement, and what rules should you be aware of if you want to purchase one with your SDIRA?
What Are Private Placements?
A private placement, or non-public offering, represents an opportunity to invest in unregistered securities or assets offered by a company not registered with the SEC.
These private investment opportunities are typically offered under Regulation D, which provides registration requirement exemptions to certain securities. Asset options are often stocks or shares of the company, but private placement offerings can also include promissory notes or warrants.
One question investors have is why a company would offer private placements. One advantage of private placements is that they allow companies to raise capital without going public. In turn, companies get to remain private and are subject to less burdensome regulations.
Investors benefit from private placements by retaining exclusive equity within a company that is seen as highly desirable. As a result, private placements can yield higher returns in the future once the company goes public.
What Private Placement Investments Are Eligible in My SDIRA?
There are a variety of private placements that you can invest in if you have a self-directed IRA. Options include:
- Limited Liability Companies (LLCs) and Limited Partnerships (LPs)
- C corporations
- Convertible notes
- Land trusts
- Hedge funds
- Pooled investment funds
- Equity crowdfunding
- Start-ups and small businesses
While private placement investments may seem like a no-brainer, there are some things you should be aware of.
Private Placement Investment Advice
Private placements have the potential for significant earnings, but investing in them can also incur significant risk.
Here are some things to keep in mind if you’re considering adding a private placement to your retirement portfolio.
Private placement investment is limited to “accredited investors.” Generally, to be considered an accredited investor and have access to private placements, you must meet the following SEC requirements
- Have a network of at least $1 million, either on your own or with a spouse or partner. Your primary residence is not included in your net wealth.
- Ability to show a primary income of at least $200,000 ($300,000 with a spouse or partner) for the last two years.
- Be an investment professional with a Series 7, Series 65, or Series 2 license or, investing in a fund, be a knowledgeable employee of the fund.
Because private placements don’t carry the same protections as registered assets, there is considerably more risk and even the potential for fraud. That makes due diligence so important when participating in placement opportunities.
When you perform due diligence, you examine each part of the security and company you’re about to invest in, including the offering document, product or service offering, market and financial overview, corporate documents (including any subsidiaries), and government filings, among other things. Ensure that everything in the documentation is complete and accurate and that the issuer can answer any questions you may have and provide transparency (you may need to sign an NDA).
It’s also helpful to investigate the key individuals and to be on the lookout for any criminal backgrounds, bankruptcies, judgments, outstanding liens, etc.
Finding additional funding
Private placements can require considerable equity. If you don’t have enough funds in your IRA, or if you’re not comfortable putting it all on the line, does that mean you have to pass up the opportunity?
Not necessarily. In some cases, like real estate investments, you could consider taking out a non-recourse loan, but what if that’s not an option?
If you want to invest in private placements but need additional funds, consider investing alongside your spouse or partner, tapping into their IRAs as well.
You can also consider partnering with another IRA or funding your IRA by rolling over from a qualified account. Remember that you cannot combine IRA funds with personal funds, as that would be considered a prohibited transaction. And if funding your IRA from another source, you must adhere to IRS contribution limits, though rollovers do not count towards that limit. (*note: direct rollovers have no li it but you can only do one indirect rollover within a 12-month time span)
When you have the option to invest in a private placement, the company, or“issuer,” will create a securities disclosure document, also known as a Private Placement Memorandum (PPM), offering document, or offering memorandum.
The document will include:
- Summary of the offer terms that indicate the capitalization of the company as well as other relevant information types, such as conversion rights, liquidation preferences, voting rights, and anti-dilution provisions.
- Investment risks, as identified by the issuer. The information in this section typically includes general risks associated with the industry or asset type as well as risks specific to the entity or terms of the offering.
- Company description, which discloses the company’s history, the product or service it provides, market strategies, any intellectual property information, customer and competition descriptions, and any other information that may be relevant to an investor. It will also include a list and description of management, such as their background and skill sets.
- Use of proceeds, which will inform investors on how capital will be used.
- Securities descriptions, a description of the class of securities and associated rights and restrictions.
- Investment instructions, also known as “subscription procedures.”
- Supplemental information, or “exhibits,” as necessary to assist investors in making a decision. This may include financial statements, relevant contracts, licenses, organizational documents, etc.
This PPM, which is held to anti-fraud provisions, will provide valuable insights about the investment, all of which can be used as part of your due diligence. If you’re considering the opportunity, reviewing this document alongside a legal or financial professional may be helpful.
Although your SDIRA custodian cannot provide investment advice, an experienced custodian like Horizon Trust can help you navigate the complexities of a private placement investment. Contact us today to speak with a financial professional who can help.