How SDIRA Capital Raises Work
As fund sponsors compete with other funds and companies for capital, a large pool of assets may be overlooked. Self-directed IRAs (SDIRAs) provide a tax-advantaged way for investors to allocate to alternative investments like private equity funds, yet these accounts are sometimes overlooked by both investors and those raising capital.
Here, we'll take a closer look at how SDIRA capital raises work and how they can benefit fund sponsors and their investors.
What is a self-directed IRA?
As the name suggests, a self-directed IRA is a type of individual retirement account (IRA) that enables the account holder to take greater control over their investment decisions. Unlike a typical IRA that typically only allows account holders to invest in traditional, publicly traded assets like stocks and bonds, a SDIRA gives investors the opportunity to allocate to alternative assets within their IRAs, such as:
There are still certain regulatory restrictions, such as requiring a SDIRA investor to be an accredited investor to invest in most private placements. But in general, SDIRAs may open -up the possibilities for how retirement funds can be well-tailored for individual goals.
Why fund sponsors embrace SDIRA capital
The depth of the private market provides plenty of exciting investment opportunities, but that also means that companies and funds are competing for assets. Existing pools of capital, like pension funds and high-net-worth investors' brokerage accounts, only go so far. By tapping into capital within retirement accounts, fund sponsors can appeal to a broader range of investors and may be able to expand their potential investor base.
The total value of U.S. retirement assets is over $45.8 trillion, including nearly $18 trillion in IRAs, according to the Investment Company Institute (ICI).1
SDIRA capital raises can be win-win as well, because investors gain the benefit of keeping these funds within tax-advantaged retirement accounts, while fund sponsors or issuers gain the benefit of accessing this capital.
The SDIRA capital raising process: 5 key steps
For fund sponsors or issuers considering SDIRA capital raises, there are typically five key steps to go from finding investors to managing those funds:
1. Access to untapped capital pools
With self-directed IRAs, investors are choosing their own investments, so it's not as if one can get on a fund menu the same way as one could within a 401(k), for instance. But similar to other types of fund marketing, one can be proactive to attract investors, such as by including clear, SDIRA-friendly language in pitch decks, on a website, and in any other investor communications, letting investors know the fund is ready to accept SDIRA capital. Keep in mind that for private placements, one typically still need accredited investors.
2. Long-term capital alignment
Most financial services companies that offer IRAs do not provide custody services for SDIRAs. These accounts require qualified custodians to hold and administer these assets. While it's ultimately up to the individual investor which custodian they choose to open an SDIRA through, a fund sponsor can inform investors about the benefits of working with a reputable custodian, so that processes are in place for efficiently opening and funding a new account.
3. Tax advantages
Depending on the type of investment, fund sponsors will need to submit specific investment documents to the investor's account custodian. For example, private equity funds would likely need to submit a Private Placement Memorandum (PPM) and a signed investment authorization form so that the custodian can determine the administrative feasibility of custodying assets. Custodians do not provide investment advice, but an investor might be more comfortable investing via a SDIRA with a custodian that has a strong track record of safe recordkeeping and administering complicated assets.
4. Streamlined due diligence process
Once the custodian completes its document review, the custodian then transfers funds from the investor's account into a fund.
5. Participate in ongoing administration
While the custodian often handles account administration or partners with a third-party administrator, a fund sponsor's job isn't quite over once it raises SDIRA capital. Not only does the fund then manage the actual investment, but it will likely have to work with the custodian on some ongoing compliance or administrative tasks, like when it comes to reporting annual valuations.
How Forge Trust can help
Integrating SDIRA capital raises into a fundraising strategy can potentially be a timely benefit for a fund or private company. Forge Trust has a deep expertise in alternative investments and is here to help make the custody, compliance, and administration aspects of SDIRAs smoother.
If you’d like to learn more about how SDIRA capital raises work, please visit Forge Trust’s Resources page, and if you’d like to get started with a SDIRA, open an account today.
Frequently asked questions about SDIRA capital raises
What is a self-directed IRA (SDIRA)?
A self-directed IRA is a retirement account that gives investors more flexibility in what they can invest in. Unlike a typical IRA, which usually only holds public stocks, bonds, and mutual funds, an SDIRA can include assets like real estate, private company shares, precious metals, etc.
What are the tax implications for using a self-directed IRA for a capital raise?
From the fund sponsor's perspective, the capital from an SDIRA is essentially the same as it would be from any other source. But from the investor's perspective, an SDIRA provides potential tax advantages. Like a traditional IRA, a traditional SDIRA generally enables investors to deduct contributions, while a Roth SDIRA enables investors to make tax-free withdrawals later on. Granted, there are specific IRS rules for investors to follow, but using an SDIRA could make investing in alternatives more tax advantageous than investing directly. Refer to IRS Publication 590 for information regarding the deductibility and taxation of IRAs.
How does a self-directed IRA compare to other funding methods for a capital raise?
A self-directed IRA provides a different type of capital pool than what's typically accessed via funding methods like angel investing or venture capital. While an investor might still need to be accredited, depending on the type of investment, raising the capital from self-directed IRAs provides a tax-advantaged vehicle for individual investors. That could help convince more investors to participate, and these investors might be more willing to take a passive stake, in contrast with angel investors or VC investors that often take a more active role in shaping companies.
Zander is a seasoned product leader with a 12-year history in financial technology, specializing in private market investments. His tenure includes roles at LTSE, Alto, and IHS Markit, where he focused on product management and strategy. Zander holds an MBA from Vanderbilt University, focusing on International Business, and a B.A. in Economics from Colby College.