Raising Capital with SDIRAs
Trying to raise capital to fund startups, private equity/venture capital funds and real estate funds can be a niche, yet competitive, area. In many cases, only accredited investors are allowed to invest in these types of assets. Even when regulations are more flexible, it can be challenging to find investors with enough capital to deploy.
However, there's an oft-overlooked pool that fund sponsors and issuers can dive into — self-directed individual retirement accounts (SDIRAs).
While SDIRAs remain a relatively specialized area of the retirement market, the 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 So, even small shifts from traditional IRAs into SDIRAs can potentially create significant opportunities to raise capital.
What is a self-directed IRA?
As the name suggests, a SDIRA permits allocation to certain alternative assets within their IRAs, such as:
Note, SDIRAs are still subject to the same specific IRS rules that traditional IRAs are to maintain the tax advantages of these retirement accounts. Plus, certain types of investments like private placements still need to follow securities law, such as requiring investors to be ‘accredited investors.’
Potential advantages of using a self-directed IRA for a capital raise
For fund sponsors and companies seeking capital, tapping into the SDIRA market can provide several potential advantages, such as:
Access to a broader investor base
As mentioned, the trillions in U.S. retirement accounts pose a significant opportunity that is largely untapped by the alternative investment/private market worlds. By positioning your fund or company to raise capital from an SDIRA, you can potentially dip into a large new pool of capital from investors looking to incorporate new assets into their retirement portfolios.
Potential for long-term capital
Many alternative investments are long-term in nature, especially funds that have multi-year lock-up periods. That generally aligns well with the long-term nature of retirement investing. So, rather than having to convince investors to apportion brokerage funds that they might prefer to keep more liquid, funds and startups may benefit from raising capital from long-term SDIRA investors. This may also provide a more stable shareholder base as you build capital for the future.
Opportunity for repeat investment
Using a self-directed IRA to raise capital doesn't have to be a one-time thing. For investors that allocate money to their retirement accounts on a steady basis with each paycheck, that may create an opportunity to keep funds flowing into your fund or company; potentially, even on an automated basis.
Regulations on using self-directed IRAs for a capital raise
While SDIRAs offer potential advantages, including the opportunity to invest in alternative assets such as those found in the private market, ,they are still subject to specific IRS regulations (just like traditional IRAs) to maintain their tax-advantaged status.
In particular, investors and those trying to raise capital from SDIRAs should understand "prohibited transaction" regulations. Essentially, a "prohibited transaction" is one that runs afoul of IRS requirements, which can cause the SDIRA, or any IRA, to lose its tax-advantaged status and potentially incur additional taxes.2
Typically, a "prohibited transaction" involves self-dealing, meaning the account holder or another "disqualified person," such as their spouse or children personally benefit from the transaction made using SDIRA assets.
For example, an SDIRA cannot:
- Lend money to a disqualified person
- Buy or lease property from a disqualified person
- Provide goods or services to a disqualified person
Ultimately, it's up to the investor to ensure that their SDIRA activities are not "prohibited transactions," but it would be beneficial for fund sponsors to be aware of these regulations, such as to avoid soliciting investors for real estate deals that would run afoul of these rules. From a fund sponsor's perspective, it's also important to keep in mind other regulations, such as:
- Ensuring that SDIRA assets are held with a qualified custodian
- Following any securities laws related to private placements (i.e. ensuring that investors are accredited)
- Providing investment disclosures and related documentation to investors, and ensuring that an investor's SDIRA custodian properly manages these documents
Risks of using self-directed IRAs for a capital raise
Despite the possible benefits of using a self-directed IRA to capital raise, fund sponsors and issuers should be aware of the risks associated with SDIRA fundraising, such as:
Compliance complexity
The administrative and compliance requirements for SDIRAs can be complex. That's why partnering with an experienced custodian is important, so documentation is maintained in a compliant manner.
Investor education/due diligence
While it's ultimately up to investors how they allocate their retirement assets and where they open accounts, fund sponsors and private companies might need to engage in more outreach to educate individuals about SDIRA investment opportunities. At the same time, these funds and companies likely want to conduct their own due diligence to ensure that they're accepting capital from investors that are likely to be good fits on their cap tables, rather than onboarding those that have misaligned investment horizons or goals.
Reputational risk
Related to these other challenges, fund sponsors and issuers want to make sure that, while exploring new fund raising opportunities, it does not create reputational issues. For example, a misstep like not keeping up with reporting private company valuations to investors could cause other prospective investors to potentially question the fund.
How Forge Trust can help
Raising capital through self-directed IRAs can be a great way to grow your investor base. You can simplify this process by partnering with a qualified custodian that has the necessary administrative infrastructure and experience working with sponsors and investors to facilitate SDIRA transactions.
Forge Trust has over 40 years of experience in providing custody and administrative services, and we understand the operational complexities of alternative investing. 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 raising capital with SDIRAs
Can I invest my own self-directed IRA into my business or fund?
Generally, you cannot invest your own self-directed IRA into a business or fund that you own 50% or more of, because that makes you a "disqualified person" under IRS rules.3 SDIRA assets must not be used in a way that provides you with a personal benefit beyond the usual retirement investment returns.
How does a self-directed IRA differ from other funding methods?
A SDIRA provides a tax-advantaged vehicle for individual investors to allocate to alternative investments, whereas traditional IRAs typically only allow investments in publicly traded assets like stocks, bonds and mutual funds. Also, SDIRAs differ from funding methods like angel investing or venture capital, because these generally occur outside of the tax-advantaged nature of retirement accounts.
What is a "prohibited transaction"?
A prohibited transaction is an improper use of an IRA, including SDIRAs, by the account holder or another disqualified person, such as the account holder's spouse. Generally, a prohibited transaction in an IRA is any improper use of an IRA account or annuity by the IRA owner, his or her beneficiary or any disqualified person. Disqualified persons include the IRA owner’s fiduciary and members of his or her family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
For example, loaning money to yourself or a family member from your SDIRA would be a prohibited transaction. If an IRA owner engages in a prohibited transaction, the account loses its tax-exempt status, the assets held will be deemed to be distributed, and the IRS may assess a tax penalty.
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.