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How To Invest In Private Equity With a SDIRA

How To Invest In Private Equity With a SDIRA

Estimated reading time: 4 minutes

What do Uber, Airbnb, and Dropbox all have in common? They’re all businesses that started their journey with a little help from private investors. What if you had the power to invest in companies like these in their earliest days? What if you could do so in a manner that was not only tax advantaged, but also helped you prepare for retirement?

With a self-directed IRA (SDIRA), all of this is possible. Utilizing your SDIRA funds can amplify your investing power by unlocking access to the retirement funds you’ve already got. If done right, it can ultimately save you thousands of dollars on taxes while simultaneously allowing you to build wealth that could potentially carry over for generations.

Private equity is a term that refers to investing in privately held entities such as companies or small businesses not (yet) listed on a public exchange. Access to PE was once restricted to accredited investors and high net worth individuals only. Now, thanks to relaxed regulations, the popularity of crowdfunding platforms and alternative investments in general, it’s becoming increasingly available to private investors. 

Why invest in private equity?

Private equity operates independently from the public market, potentially insulating your portfolio from market fluctuations. It gives you the opportunity to get in on the ground floor of the next big thing. With PE, you can invest using your expertise to find the people, projects, and causes you believe in.

What can you invest in?

    • Limited liability companies (LLCs): This business structure is a combination of a corporation and a partnership or sole proprietorship. In an LLC, the owners are not personally responsible for the LLC’s debts.
    • Limited partnerships (LPs): When two or more partners whose responsibility for the partnership’s debts are limited to the amount they invested.
    • C corporations: Any corporation that is taxed separately from its owners. A C corporation is distinguished from an S corporation, which is generally not taxed separately.
    • Private placements: These are shares or bonds sold to selected investors rather than on the open market.
    • Private hedge funds: These are open-ended alternative investment funds that use pooled money to earn returns for their investors.
    • Real Estate Investment Trusts: Also known as REITs, these own or finance income-producing real estate. While many REITs are listed on public exchanges, others raise capital privately and on crowdfunding platforms.
    • Startups: These young companies are at their earliest stage of development. They used to be characterized by having to rely on their founder’s credit cards, family, friends for their initial funding. Today, you can bet on their future success by investing from the start.
    • Small businesses: Sometimes called the backbone of the US economy, small businesses are often looking for investors so that they can scale to the next level.

Who can invest in private equity?

Though access to PE has been greatly democratized in recent years, some companies do still restrict their offerings to accredited investors. This type of investor came into existence after the Security & Exchange Commission (SEC) made moves to protect the economy after the 1929 stock market crash. To obtain this status, you have to demonstrate a certain degree of financial sophistication and wealth:

  • A net worth, not including your primary residence, of a least $1 million; or
  • Income exceeding $200,000 in each of the two most recent years; or 
  • Joint income with a spouse exceeding $300,000 for those years, and a reasonable expectation for the same income level in the current year. 

If you are considering investing in a company, it can be helpful to find out from the start if they restrict their offerings to accredited investors only. 

One other strategy that is becoming increasingly popular for accredited and non accredited investors alike is online crowdfunding. These digital platforms allow businesses to raise capital from a large pool of private investors. There are nearly 1,500 crowdfunding organizations in the US alone and the global market approached $30 billion in 2019.

What’s the process for investing in PE with a SDIRA?

Investing in private equity is a popular option for SDIRA holders. When done correctly, it can have significant positive impacts on the size and value of your IRA.

Looking for a practical example of how it works? Check out this quick case study about a SDIRA holder named Tai. Her friend Julie created a mobile app to help people minimize their plastic waste. After watching the app’s subscriber count grow Julie’s business, Tai was excited to learn that Julie was looking for investors to raise capital for her startup. Doing so felt like a great opportunity to build her savings while also making a positive impact in her local community and on the environment at large.

Before you invest: conducting due diligence for PE

One of the first steps that Tai had to take before investing in Julie’s app was carrying out her own due diligence. PE investments are usually exempt from Securities and Exchange Commission (SEC) registration, so investors don’t have access to the regulatory documents usually filed by the investment issuers. Some ways to do so include:

  • Research the background of the principals of the LLC, LP, REIT, or startup. 
  • Get copies of any available reports or other written materials.
  • Understand your options for liquidating the investment.
  • Find out if the investment is conditional or if it has a return policy. 

In Tai’s case in particular, this meant studying Julie’s business plan, reading media coverage of the app, and doing some general research into plastic waste.

Opening and funding your SDIRA

Opening your SDIRA is easy, but there are a few decisions you have to make along the way. This includes choosing what type of account you’d prefer: Traditional IRA, Roth IRA, SEP, SIMPLE, etc. Each has its own distinct tax advantages, contribution limits, and eligibility requirements, so there’s an account type to fit every need. You can learn more about the different account types here.

Once you’ve decided what type of account you’d like to open, you’ll need to decide how you’d like to fund it. You can do so via a contribution, a transfer, or a rollover. A contribution is exactly what it sounds like; where you make cash contributions (up to the limit allowed by the IRS) and grow your account year after year. Transfers and rollovers both involve moving existing funds from another account, like an old 401(k) or IRA, to your new SDIRA. Learn about the differences between transfers and rollovers here.

In Tai’s case, she had an existing IRA that she decided to transferan> to an Entrust SDIRA, giving her access to funds that had previously been tied up in the traditional stock market. She decided to go with a Roth IRA, which would allow her returns to grow tax free; providing that certain conditions were met.

Time to invest

Once Tai’s funds were available in her new SDIRA, it was time to invest in Julie’s app. She gathered any necessary documents. In her case, she needed a purchase agreement which she then submitted to Entrust along with a purchase order, also called a Buy Direction Letter at Entrust. She made sure the documents were titled in the name of the IRA since her SDIRA owns the shares, not her personally:

Example: The Entrust Group Inc FBO [Tai’s Account #123456] [Tai Smith ]

Upon completion of the transaction, the shares in Julie’s startup then belonged to Tai’s SDIRA. Over time Julie’s app continued to become more and more popular and generated profits helping Tai’s SDIRA to grow in value. Fast forward 30 years and Tai is ready to retire. Because she chose a Roth IRA, she was able to liquidate her shares and take distributions tax free.

How can you invest in PE?

Investing in PE with a self-directed IRA can be a rewarding way to build wealth. Retirement is about the pursuit of lifelong passions. Making the right investments in unique people, deals, and companies can be a very fulfilling part of the process.

At Entrust, we empower our clients to take control of their financial future. One of the ways we do so is via our online marketplace, Entrust Connect. Our platform allows you to connect with investment offerings that other Entrust clients have already invested in. Curious about how it works? Learn more about Entrust Connect.

Got questions about SDIRAs and how to use them to invest in PE and beyond ? Set up your free consultation with one of our experts today.

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