How to invest in AI with a SDIRA?

In the last two years, the potential of artificial intelligence has gone mainstream. But from an investment perspective, most of the focus so far as been on publicly traded stocks—with Nvidia arguably the most prominent. Nvidia’s stock has surged on the back of growing orders for its high-tech chips that play a central role in facilitating AI.

Yet only some of the innovation in AI is being accomplished by companies traded on well-known exchanges. Other, less well-known AI firms are privately held, and they too may develop products and services that benefit from this seismic technological shift. What’s more, given that these companies tend to be smaller and at an earlier stage than the publicly traded behemoths, they may offer a better risk-reward proposition for investors.

One way to participate in the potential success of these AI firms is by investing in Private Equity funds that take direct stakes in them. In this article, we’ll look at how you can use a Self-Directed IRA (SDIRA) to invest in AI.

What is Private Equity?

Private Equity refers to investment funds that acquire, manage, and eventually sell privately owned businesses. These funds are usually organized as partnerships and are managed by professional investors. Their investment targets can range from startups to well-established companies.

Private Equity funds may either invest in privately held businesses by purchasing full or partial ownership or conduct buyouts of publicly traded companies. The firms managing these funds raise capital from external investors, traditionally large institutions, or individuals with ultra-high net worth. However, in recent years, Private Equity has become more accessible, allowing accredited investors broader opportunities to participate in this expanding asset class. As we noted in a previous article, Wall Street giants such as Blackstone, KKR, Apollo and Bain Capital have historically dominated the Private Equity landscape, but there are many other smaller firms as well.

Invest in Private Equity with your SDIRA

Retirement savers, who are accredited investors, may invest in Private Equity funds using a self-directed IRA (SDIRA) as part of a long-term investment strategy. Private Equity firms typically provide access to their funds through what are known as Private Placements. Custodians that offer SDIRAs, such as Forge Trust, can hold Private Equity investments on behalf of the investor.

Who Can Invest in Private Equity with a Self-Directed IRA?

Investing in Private Equity through a self-directed IRA is available to accredited investors.

According to the Securities and Exchange Commission (SEC), an accredited investor is and individual or business with net worth exceeding $1 million (excluding their primary residence) or an annual income of $200,000 ($300,000 if combined with a spouse or partner).

Types of Private Equity Investments You Can Make Through an SDIRA

Private Equity encompasses a variety of investments that can be made through a self-directed IRA. According to the Harvard Business School, there are three primary types of Private Equity funds, broken down according to their strategy:

• Venture Capital (VC) Funds: These funds invest in early-stage startups.
• Growth Equity Funds: These funds target established companies that need additional capital to expand.
• Buyout Funds: These funds acquire mature companies, often purchasing publicly traded firms and taking them private.

Potential Benefits of Investing in AI via Private Equity

An investment in a Private Equity Fund that has exposure to AI firms may offer the potential of meaningful capital appreciation. If a portfolio company develops an innovative technology, the Fund may see its Net Asset Value rise considerably to the benefit of its investors. And oftentimes, the earlier the Fund acquired its stake, the higher the possible magnitude of the gains. When it comes to any profitable investment, getting in on the ground floor is oftentimes preferable to being a latecomer.

However, investing in early stage companies, including those in the AI space, come with increased risk, including the potential loss of your investment, versus later-stage companies or industries, which may offer more stability and less risk. Investors should consult their legal, tax, and investment advisor(s) to determine the suitability of early stage investments.

Risks and Other Considerations

Investing in AI via Private Equity is not without risks. For one thing, there’s no guarantee a Fund’s investment in an AI firm will pay dividends—literally or figuratively. The AI field is crowded, and while the winners should do well, there will also be companies that fail to develop profitable technologies. The value of these firms could fall dramatically and given the hype around AI, the current valuation of some of these companies can be viewed as already quite elevated, which means that a lot has to go right for new investors to turn a profit.

Another consideration for prospective investors in Private Equity is liquidity. With traditional investments, you can typically turn your holdings into cash very quickly. This is not the case with a Private Equity Fund, which often involves a so-called lockup period of anywhere from 5-10 years. The result? Your money is effectively tied up for years—which could be a problem if you have a sudden need for cash.

Conclusion

Artificial intelligence has burst onto the scene and captured the imagination of many investors. For those who seek exposure to this emerging technological shift in a tax-advantaged way, the answer may be to invest in Private Equity with a Self-Directed IRA.