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

SDIRAs offer investors the freedom to invest in non-traditional assets in their tax-advantaged retirement accounts. Investors are typically interested in SDIRAs for several reasons.

The primary reason is that SDIRAs allow account holders to invest in alternative assets — investments beyond traditional stocks, bonds, mutual funds, and exchange-traded funds (ETFs) — that often cannot be held in IRAs from traditional brokerages. Alternative assets have the potential for higher returns than publicly traded stocks or bonds, though they often come with more risk than traditional investments. In addition, alternative assets may offer compelling diversification benefits to an investor’s portfolio, as they aren’t always correlated with public stock and bond markets.

Within the universe of alternative assets, private equity is one of the most popular investment options. According to McKinsey, private equity assets under management totaled $13.1 trillion as of June 30, 2023, and have grown nearly 20% per year since 2018.² While large institutional investors used to be the primary owners of private equity assets, many private equity managers are increasingly offering funds targeted at high net worth individuals.³ And for accredited investors who wish to hold private equity funds in their retirement accounts, SDIRAs may be a compelling option.

What is Private Equity?

Private equity funds buy, manage, and often sell, non-public businesses.⁴ These funds, typically structured as partnerships, are overseen by professional investment managers. Their focus can range from early-stage companies to more mature firms. Private equity funds may either buy stakes (full or partial) in businesses that are already private or complete a buyout of a publicly traded company.

The firms that manage private equity funds raise money from outside investors. Historically, these investors were large institutions or ultra-high net worth individuals. In recent years, however, there’s been a democratization in the private equity world. Accredited investors have greater access than ever before to this growing asset class and are an increasing area of focus for alternative investment managers.⁵

Types of Private Equity Investments You Can Make Through a SDIRA

Under the umbrella term of private equity, there are different investments you can make through SDIRAs. Harvard Business School identifies three main kinds of private equity funds based on their approach:⁶

• Venture Capital (VC) Funds: VC funds invest in early-stage companies (known colloquially as startups), typically with the goal of propelling growth
• Growth Equity: These funds invest in established companies that still require capital to grow
• Buyouts: Buyout funds invest in mature companies, often purchasing publicly traded businesses and taking them private

In all cases, private equity managers seek to add value to the companies they invest in, aiming to generate a multiple on invested capital (“MOIC”).⁷

Other options include:

• Limited Partnership: A business in which Limited Partners (“LPs”) pool assets that are deployed by General Partners (“GPs)
• Limited Liability Company: As its name states, a business structure that offers “limited liability” to shield its owners from the operations of the business
• Hedge Fund: An investment vehicle that may invest in multiple different asset classes like stocks, bonds, and commodities, employing a long position strategy, short position strategy, or a market neutral strategy
• Corporations: A business with shareholders and a board of directors that is not a pass-through tax entity

The Potential Risks and Rewards of Private Equity

As with any investment, private equity comes with both risks and potential rewards. The potential upside to owning a private equity fund is the chance for higher returns than benchmark stock indexes, such as the S&P 500 or Nasdaq-100. If a particular fund owns rapidly growing companies, for instance, it may see its Net Asset Value (or “NAV”) — which represents the value of its holdings⁸ — increase at a similarly fast pace. What’s more, private equity funds may increase in value even if the public stock market declines. When this happens, they can deliver meaningful diversification to their investors in the form of uncorrelated returns.

Private equity investments also come with certain risks. In the same way that a mutual fund will decline in value if its underlying holdings fall, a private equity fund’s returns depend on the performance of its portfolio companies. A fund that owns oil and gas businesses when energy prices are low, for example, may see its value eroded.

Another risk to private equity is that these funds tend to be very illiquid. Investors must typically commit capital for a minimum of five to 10 years. That illiquidity can pose a problem if an individual needs cash but cannot liquidate their investment in short order to access their funds. In contrast, many traditional investments are liquid and can be turned into cash relatively quickly, though not in all cases.

How Investing in Private Equity with a SDIRA Works

Private equity firms usually offer access to these funds via private placements, in which retirement savers may use their SDIRA to purchase a private equity fund as part of a long-term investment strategy. A custodian that offers SDIRAs, such as Forge Trust, can hold private equity funds on behalf of an investor.

Who Can Invest in Private Equity with a SDIRA?

To be eligible to invest in private equity with a SDIRA, you must be an accredited investor. The SEC defines accredited investors as individuals with assets greater than $1 million (excluding their primary residence) or an annual income of $200,000 ($300,000 if their spouse or partner is included).⁹

Conclusion

Please note that private equity funds can be complex investments. We suggest that you consult your financial advisor to determine if a private equity fund fits into your retirement strategy and to learn more about the multiple types of funds that you could invest in using your SDIRA.

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