Venturing into private equity investments

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 views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of SVB Private or other members of Silicon Valley Bank and SVB Financial Group. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein