The potential benefits of investing in private companies through IRAs
For many, investing in companies is a hallmark of any modern investment strategy. And while the stock market enables most individuals to invest in public companies, it has historically been more difficult to invest in private companies.
Investing in a private company, also known as private equity, can include private stock, warrants, bonds, or membership/partnership interests.
Who qualifies?
Most private company investments are limited to accredited and institutional investors, which often applies to those with a net worth of at least $1 million (not including your private residence) or those with annual incomes of at least $200,000 for the last two years or, as a couple, have earned at least $300,000.
How it works
There are two opportunities to invest in private companies. One, private company employees who have fully vested shares, may sell those shares to enhance their liquidity. Two, the private company management and board looking to raise additional operating capital may offer shares of stock directly through private markets.
Why choose a self-directed IRA (SDIRA)
Self-directed IRAs (SDIRAs) are individual retirement accounts that enable account holders to invest in alternative assets, including private equity. Accredited investors with a SDIRA can invest in private companies either through a direct investment in a specific private company or through funds.
The Benefits
More control
Owners of SDIRAs make their own decisions about which investments to make. They can choose which private equity investments they want to make, depending on what is currently being offered by companies or employees.
Tax-advantaged or tax-deferred earnings
In many cases, investments in private companies only achieve a liquidity event when the company engages in an Initial Public Offering (IPO) or is acquired. Some private companies could take years or decades to exit, which makes them a potentially ideal long-term investment that benefits from tax advantages associated with IRA plans.
Potential diversification
Investors interested in portfolio diversification will find more options in SDIRAs than in standard ones. That’s because private equity is among several other investments not available in standard IRAs.
Potential for higher returns
Private company investments offer the potential for higher returns but with greater risk. Private company exits through IPOs or acquisitions could produce significant gains. However, the company could also close down without an exit and investors may lose their investment. Many Individuals should seek investment advice from a licensed professional before investing.
What you need to know
Since you invest in the private company through your IRA, the IRA owns the private stock. Private company stock is far less liquid than public company stock. IRA investors are responsible for performing due diligence on any company and its management and company valuations before directing an IRA investment.
Prohibited transactions and other regulations
There are several prohibitions that would preclude a SDIRA from investing in a private company. The IRA account owner typically cannot be:
- An owner with 50 percent or more interest
- An owner of 10 percent or more of company stock
- An officer or director of the company
- A highly compensated employee
The IRA account owner also cannot purchase private stock from a direct family member or a fiduciary or service provider to the IRA. For a complete list of prohibited transactions, please refer to IRS rules.
Additional regulations
It is the responsibility of the private company to comply with securities laws and meet certain individual investor requirements. Private companies have additional filing and suitability requirements under FINRA and SEC Regulation D rules.
Get started with Forge Global
We expand access to the private market by providing investors and shareholders with the right tools, data and insights to help drive informed investment decisions.
Liz has been in the individual retirement space supporting clients looking to diversify their portfolios into alternative assets for over 20 years. Before Forge, her roles included IPX retirement and Pacific Premier (formerly Pensco), where her focus was on operational efficiency and client experience.