Own tomorrow’s Dow components today! Or we hope, anyway. But you did not have to invest with Steve Jobs while he was still running Apple out of a garage in the 1970s to do well with private equity or private placements in a Self-Directed IRA.
Just invest in solid, well-managed companies with good accounting and controls, who have a viable business that provides a good value and you can do just fine – and even get better returns over the long run, in many cases by taking advantage of the tax benefits of a Self-Directed IRA.
What is private equity?
When a small company wants to raise capital, it can borrow the money, or it can sell off a piece of itself to investors, who are then entitled to a share of all future dividends the company issues. If the company is publicly traded, it can sell shares over the stock market. But if the company is not publicly traded, it will seek out investors anywhere it can, and negotiate a share price privately.
Many companies do not want to go through the time and expense of issuing a publicly-traded security. Just maintaining a listing on boards like Nasdaq or the NYSE can cost tens of thousands of dollars per year. Unless they are getting major investment bank support to help them place their shares, it is just not worth it to these smaller companies.
Many smaller companies with no regular earnings cannot get traditional lender financing, either. Most traditional lenders just are not equipped to serve this market, as borrowers typically do not meet the lending criteria for the banks’ backers. They do not have the regular earnings to support income-based underwriting, and they may not have real estate or other kinds of readily marketable collateral that most banks rely on to justify a loan.
But Self-Directed IRA owners are not limited by these criteria. Moreover, Self-Directed IRA owners also frequently have the long time horizons that companies seeking investment need. For example, if you lend to or invest in a real estate developer, it may be years from the time you provide the financing to the time the real estate developer has a property completely built and sold off so that it has some cash to pay lenders and investors with!
Meanwhile, private equity seekers have to sweeten the deal, to compensate the Real Estate IRA investor for the cost of tying up their money for a long time. That usually means better terms, and better long-run expected returns. That is, private equity seekers (and private debt seekers as well) have to discount their offerings to attract investors.
Qualifying for Private Equity Placements for your Self-Directed IRA
Not just anybody can be a private equity investor and be eligible for direct placements. In order to invest in a direct placement of private equity, you must meet the definition of an accredited investor, according to Rule 105(a) of the SEC’s Regulation D.
Specifically, you must have a net worth of at least $1 million (not including your primary residence), OR;
You must have an income of at least $200,000 in the last two years if single OR;
Have an income of at least $300,000 in the last two years if married.
Reputable brokers or sellers will have you submit proof of your status as an accredited investor before selling you the shares or bonds, if it is a private debt placement.
Because of the substantial returns available in private equity (the potential is virtually unlimited), and the long time horizons involved, private equity placements can make excellent candidates for Self-Directed IRA investment.
Before you invest, though, understand that these investments, like many popular Self-Directed IRA assets, are frequently not registered securities, and are exempt from a number of SEC regulations and reporting requirements.
They also tend to be very early stage companies, subject to substantial economic risks. They may have unproven products, service offerings, inexperienced management teams, difficulty securing follow-on funding, and they could even be fraudsters. It is, therefore important to engage in a thorough due diligence process before you invest in any private placement offering within a Self-Directed IRA.