Self-Directed IRAs vs. Other Funding Methods for Capital Raises
Most fund sponsors know the routine when it comes to raising capital: pitch angels, court venture capitalists (VCs) and maybe approach some family offices or high-net-worth individuals. In this paradigm, virtually everyone is fishing in the same pond, which creates fierce competition and challenging success rates. But there's a noteworthy pool of capital that most sponsors completely overlook: self-directed IRAs (SDIRAs).
With over $45.8 trillion in U.S. retirement assets, including nearly $18 trillion in IRAs, according to the Investment Company Institute (ICI), capturing even a small fraction of that market may potentially transform your fundraising results.2 Like any funding method, there are pros and cons to SDIRA capital raising. But in general, it has the potential to provide another source of fundraising.
What is a self-directed IRA?
As the name suggests, a self-directed IRA (SDIRA) 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 permits allocation to certain alternative investments within their IRAs, such as:
This asset flexibility creates opportunities for fund sponsors and private companies to use SDIRAs for capital raising. Rather than being limited to traditional funding methods for alternative investments, like courting angel and VC investing pools, tapping into SDIRAs can expand your potential investor base.
SDIRA vs. angel investing
Angel investors typically write checks from their personal accounts or investment portfolios, but also want to stay involved in their investments. For example, many angels expect board seats, advisory roles, and/or at least regular updates on company progress.
SDIRA investors often operate differently because they are using retirement funds, which means, which generally, are more focused on long-term returns than day-to-day involvement. Due to the potential tax advantages of associated with SDIRAs, and the generally long-term nature of these accounts, investors may be willing to lock up capital for longer periods.
While the specifics vary by investor, in general, angel investing is more about bringing on select high-net-worth individuals with expertise and heavy involvement in the early formation of startups. SDIRA investing still might involve high-net-worth individuals, but it might be possible to draw from a larger pool of investors, thereby letting each take smaller slices than angel investors. And SDIRA investors might be more focused on long-term diversification of their retirement portfolio, rather than looking to hit short-term home runs.
SDIRA vs. venture capital
Venture capital (VC) also tends to come with strings attached, similar to angel investing. VCs often want significant equity stakes, board representation, and tend to push for rapid growth and exits after a few years. These investors also tend to be more institutional and/or professional.
In comparison, SDIRA investors are individuals that typically do not bring the same expectations into private market investing. While the specifics depend on the investor, using a SDIRA means the investor is using retirement funds, so that often corresponds with long time horizons, rather than just a few years. Also, it may be possible to solicit from a broader range of smaller investors to potentially create a large enough capital stake in a fund or startup, versus trying to solicit a few VC funds to take significant equity stakes.
That said, VCs often bring institutional expertise and extensive networks, which could be an advantage for some startups. But, if you want to maintain more control and get long-term buy-in from a varied investor base, soliciting SDIRA investors might help.
SDIRA vs. crowdfunding
Crowdfunding platforms have opened up capital raising to smaller investors, but they come with limitations. Most platforms take fees,3 and success depends heavily on marketing and social media presence rather than investing fundamentals.4
SDIRA funding works through direct relationships with investors and custodians. That helps avoid platform fees eating into your capital and fund sponsors not competing for attention with thousands of other campaigns.
Plus, SDIRA investors are using retirement funds, so that may help build a long-term investor base, whereas crowdfunding investors might have shorter time horizons. That said, crowdfunding campaigns might be easier to market at times, such as if a crowdfunding platform already has a sizeable audience that organically comes the fund-raising opportunity.
SDIRA vs. bank loans
Debt financing, such as from bank loans, often carries strict qualification requirements and repayment terms. In contrast, SDIRA fundraising is typically equity-based, which means the funding may have more flexibility. Nonetheless, it's possible for a SDIRA to engage in private lending, although the terms still might be more flexible than they would be with bank loans.
Granted, a bank loan might be easier for those looking to raise a large chunk of funds at once. And for those that do not want to give up equity, debt financing might be preferable, but it can be hard for a startup to take cash flow out of the business to repay loans.
As such, raising funds from SDIRA investors, particularly via private market equity investments, might be preferable for those looking to build a capital base of long-term investors. SDIRA investors also might be good candidates for follow-on investment, given that they might contribute to these retirement accounts on a regular basis and may want to deploy more of their capital.
How Forge Trust can help
Raising capital through self-directed IRAs may provide potential advantages over other funding methods, particularly by growing a diversified base of long-term investors. A fund sponsor can simplify this process of bringing on SDIRA investors with a qualified custodian that has the administrative infrastructure and experience to facilitate investments in the private market.
Forge Trust has extensive experience facilitating alternative investments and is here to help make the custody, safekeeping, and administration aspects of SDIRAs smoother. If you’d like to learn more about how SDIRAs-focused 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 funding methods for capital raises
What other ways do fund sponsors and companies raise capital besides SDIRAs?
Fund sponsors and companies often raise capital through angel investors, venture capital, bank loans, crowdfunding and other resources. Each fund raising resource and method has different characteristics related to investor expectations and involvement.
Why would an investor choose SDIRA funding opportunities over other investment options?
SDIRA funding potentially offers tax advantages that regular investments don't have, which can open a potential capital source for fund sponsors. The generally long-term nature of these accounts can also align well with many startups looking to grow a stable investor base, whereas other funding methods might require quicker returns.
Can SDIRA funding work alongside other funding methods?
Yes. Many sponsors use SDIRA capital as part of a broader fundraising strategy. It doesn't have to be an either/or scenario. Instead, SDIRA capital often provides a stable base, while other fundraising methods might fill specific needs like for expertise or networking.
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.