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Venturing into Private Equity Investments

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A clear example of investing in venture capital and startups using a self-directed IRA

Last month we looked at alternative-asset IRAs and whether it would be right for you based on three scenarios. We continue the conversation with one of our most common questions from clients: How can I invest in a venture capital fund investment via an IRA or Roth IRA? Before deciding to use a self-directed IRA, there are several considerations for every investor:

  • Do not consider putting a risky asset into an IRA simply because this is where your excess cash is located.  A self-directed IRA is better utilized for an investment that an individual is planning on making, but likes the tax benefits offered by placing the investment here. 
  • If the investment(s) being made offers potential significant upside (2x or more), it may be appropriate to consider converting an existing IRA into a Roth, pay taxes (preferably outside of the Roth itself) and invest in a tax-free Roth IRA.  Remember you don't get to utilize long-term capital gains treatment within an IRA.

Rules of Thumb

We are commonly asked by clients who are considering investing in a Venture Capital Fund, how to use assets currently held in a previous employer's 401(k) plan. Let's assume:

  1. Our investor is eligible to open the Self-Directed Roth IRA with a trust company such as Pensco Trust or Millennium Trust. 
     
  2. Plenty of liquidity.  Our investor likes the idea of putting the fund into a tax-free vehicle and does not anticipate having to access these funds in the near term, possibly never, and hopes to achieve a 2x or 3x return on the investment. 
     
  3. Approval by the fund to use an IRA or Roth IRA.  Not all funds allow use of retirement accounts for investments. The process of approval can take several weeks.


Opening an account with the trust company seems simple, but the investment needs to be approved by both the fund and the trust company. Also, many investments are not eligible (such as GP Carry).  If the investment is eligible, the fund's counsel may reserve the right to alter the language in the authorization form, and the back and forth between legal counsels can take some time.  Additionally, there is a long list of documents needed for approval, which may include: Certificate of Good Standing, Certification of Partnership, articles of organization, limited partnership agreement, subscription agreement and an offering memorandum (if applicable).  These documents are similar for LLC investments, Hedge Funds, REITS and offshore investments. 

Setting up the account with the appropriate titling and tax identification information is required to avoid an inadvertent distribution from the retirement funds. As always, it is important to consult with wealth and tax advisors before entering into (and during) a transaction like this to make sure that you have a comprehensive understanding of the risk and liquidity constraints this type of investment puts upon a portfolio. Additionally, you will want to make sure you understand the benefits of putting such an asset into a retirement vehicle.


Funding Your Account

Finally, our investor needs to fund the account; and this can be the last step as the initial capital is often called after the closing of the fund. There are a couple of choices:

  1. Work with the trust company to do a direct rollover from the 401(k) into the trust company, or

  2. Establish a traditional rollover account, and separately convert only the amount of the commitment to the trust company holding the Roth IRA. 
     

Good for Angel Investing too

This process is similar for individuals wishing to utilize their IRAs for angel investing. It is important to understand the number of documents you will have to collect from the private company and the time it may take to get approval.  If the timing of an investment is very near-term, it may not be physically possible to get an approval made to do the investment in a Self-Directed IRA.  We are often asked to make the investment outside of the retirement account and have it transferred into the Self-Directed IRA, but this is not possible; qualifying investments need to be made directly from the IRA. Clients sometimes utilize this option by buying preferred shares of company stock (where they work); however, similar to a GP's inability to commit to carry via the alternative-asset IRA, the IRA cannot be used to purchase shares from an employee stock option grant.


What are the Takeaways?

  1. Plan ahead, this can be a long process.  Given the documentation requirements and the rules surrounding retirement fund transfers for funds held in retirement accounts, it is important to allow enough time to make investments using a Self-Directed IRA.

  2. Get the right advice from both a financial and tax advisor. Be thoughtful in determining whether or not retirement funds are the correct place for the investment. 
     
  3. Have a strategy that is well rationalized with your overall personal balance sheet.   


We are happy to work alongside your tax planner to determine if alternative-asset IRAs make sense for your situation.

The Fine Print

This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice, nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice, before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. Past performance is not a guide to future performance. Opinions and estimates are as of a certain date and subject to change without notice. 

All material presented, unless specifically indicated otherwise, is under copyright to SVB Wealth Advisory, Inc. and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SVB Wealth Advisory, Inc. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities. 

©2016 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. (NASDAQ: SIVB) SVB>, SVB Financial Group, Silicon Valley Bank Make Next Happen Now, are registered trademarks, used under license. SVB Wealth Advisory, Inc. is a registered investment advisor and non-bank affiliate of Silicon Valley Bank and a member of SVB Financial Group.

Products offered by SVB Wealth Advisory, Inc.:

 

Are Not insured by the FDIC or any other federal government agency Are Not deposits of or guaranteed by a Bank May Lose Value

Neither SVB Wealth Advisory, Inc., Silicon Valley Bank, nor its affiliates provide tax or legal advice. Estate planning requires legal assistance. Please consult your tax or legal advisors for such guidance. Banking services are provided by Silicon Valley Bank, and wealth advisory services are provided by SVB Wealth Advisory, Inc (0616-016) P-16-14992 06/16  

About the Author

Ann Lucchesi is Head of Founder Advisory Services for SVB Wealth Advisory, serving as a trusted advisor of client relationships and their investment needs, putting together strategies regarding equity compensation, educating clients on the tax nuances surrounding their ownership and helping them plan around their concentrated positions.

Prior to joining SVB, Ann served as an independent consultant in the equity compensation field specializing in helping companies with their unique issues surrounding equity plans. Ann’s previous experience includes many years in investment banking focused on technology and life science companies helping develop liquidity plans and manage the wealth creation process. She has extensive experience in working with affiliates of publicly held companies and the various issues that affect them during and after the IPO process. While working in Corporate Services, she worked extensively with clients on 10b5-1 selling plans, selling restricted securities, guiding companies on their equity plans and executing corporate buyback plans.

Ann currently holds an MBA from Haas School of Business and has a CFP® and CEP (Certified Equity Professional) certifications. Ann grew up in Oregon, receiving a B.S and B.A from Oregon State University before moving to the Bay Area and launching a career in the Financial Services Industry.

The individual named here is both a representative of Silicon Valley Bank as well as an investment advisory representative of SVB Wealth Advisory, a registered investment advisor and non-bank affiliate of Silicon Valley Bank, member FDIC . Bank products are offered by SVB Private Bank, a division of Silicon Valley Bank. Products offered by SVB Wealth Advisory, Inc. are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value.
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