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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 self-directed IRA funds amplifies your investing power by unlocking access to your existing retirement funds. You can invest in any asset the IRS allows, including private equity (PE) opportunities.
By investing in PE, you may acquire substantial equity in emerging technology firms. Budding innovations like artificial intelligence, cryptocurrency, and biotechnology hold transformative potential. If you conduct thorough due diligence, you could secure significant returns for your portfolio while substantially reducing your tax liability.
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KEY TAKEAWAYS
Private equity investments offer unique advantages, including portfolio diversification, local and mission-driven opportunities, and high growth potential.
However, PE investment also brings risks, such as illiquidity and longer investment horizons. Conducting due diligence can help to mitigate these risks and align your objectives with the private equity investment vehicle's lock-up period.
Various investment options are available within the private equity space, including limited liability companies (LLCs), limited partnerships (LPs), startups, and small businesses. Each option offers distinct opportunities for investment and growth.
Some offerings only allow investment from accredited investors, which may include industry expertise or meeting financial thresholds. However, the rise of online crowdfunding platforms has made private equity investing more accessible and efficient for a broader range of investors.
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Private equity (PE) refers to investments 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 wealthy individuals only. Now, thanks to relaxed regulations, the rise of crowdfunding platforms, and the viability of alternative investments, this potentially lucrative asset class has become accessible to individual investors.
Here are some common investment vehicles and opportunities within the private equity space:
Private equity investments can be rewarding but also come with risks. It's important to conduct thorough due diligence, assess the investment's potential, and consult with financial advisors before making investment decisions in the private equity space.
Private equity offers unique advantages that make it an attractive investment option for many investors. Here are some reasons why investing in private equity can be beneficial:
Private equity allows investors to get in on the ground floor of promising companies and projects. By investing early, you have the opportunity to participate in the growth and success of innovative businesses and industries. If you attain high equity, capital appreciation could prove quite lucrative. These gains become even more astonishing when paired with the tax benefits of an IRA.
Famously, Silicon Valley entrepreneur Peter Thiel contributed $2000 to a Roth IRA in 1999. Today, the account is worth over $5 billion. In a taxable account, Thiel would have to pay about $1 billion in capital gains tax upon distribution. If he waits to withdraw until he’s 59 ½, he may not have to pay a dime. That’s the power of private stock held in tax-advantaged accounts.
Many investors find the use of their 401(k) retirement savings uninspiring, held in conservative, faceless funds. They want to not only secure their financial future but also make an impact on their town. By investing in PE through a self-directed IRA, you can invest in local businesses to improve your community and build wealth at the same.
You can mobilize your existing retirement funds to invest in nearby startups and enterprises that contribute to the growth and development of your neighborhood. By supporting local initiatives, you not only have the potential for financial returns but also the satisfaction of playing an active role in the economic landscape of your region.
Moreover, private equity investments with an SDIRA allow you to explore mission-driven opportunities. These are investments in companies that have a strong social or environmental focus. Whether it's renewable energy, sustainable agriculture, healthcare, or education, you can choose to support businesses that align with your values and have a positive impact on society.
Private equity investments operate independently from the public market, providing potential insulation from market fluctuations. This can help diversify your investment portfolio and reduce correlation with traditional asset classes.
This is also true of many alternative assets, such as real estate and precious metals.
No investment is without its downsides, and private equity is no exception. Here are a couple of the key considerations you should have in mind before investing in PE:
Unlike publicly traded stocks that can be bought or sold on a daily basis, private equity investments typically have longer holding periods. You may not be able to exit for many years, so these investments require patience.
It's crucial to align your investment objectives and time horizon with the lock-up period of the private equity fund or investment vehicle you choose. You may have limited access to your invested capital until the investment matures or an exit opportunity arises.
Private equity is often seen as a high-risk, high-reward investment.
Unlike more established companies, there is a relatively small chance that a budding startup or small business will experience growth. Breakdown is quite common among these companies — about 90% completely fail, with many dissolving within the first year.
Of course, startups are one of the higher-risk options available with PE, though the overall trend is clear. Only a handful of PE investments make significant returns. An even smaller percentage eventually establish themselves as true market heavyweights.
Yet, many of the most intelligent and respected venture capital investors funnel over $200 billion into PE each year. Why?
The answer lies in expected returns.
Imagine spreading $1,000,000 across ten different PE investments. Seven die off within the first few years, and $700,000 evaporates. Two of the firms manage to steady the ship, though they only return modest gains.
The final investment delivers a truly innovative product and reshapes the market in the process. In this case, you won’t just make back your initial investment. You may reap returns of 10x, 100x, or even more, allowing you to totally forget about the seven failures.
This is the definition of expected returns. A high failure rate can be justified by the immense gains that come with a single win.
Though access to PE has been greatly democratized in recent years, some companies do still restrict their offerings to accredited investors.
In 1982, the SEC introduced the concept of an accredited investor to determine eligibility for participation in private offerings. Initially, the definition included institutions and high-net-worth individuals. The purpose was to ensure that only investors with sufficient resources and financial sophistication could participate in riskier investment opportunities.
Over time, the SEC expanded the definition of accredited investors to include factors beyond wealth. This includes professional certifications and expertise, allowing more individuals to qualify as accredited investors.
While it is possible to be an accredited investor without a high net worth, here are some financial criteria to qualify as an accredited investor:
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.
Another private equity investment strategy that has skyrocketed in popularity recently is online crowdfunding.
Crowdfunding platforms typically operate as online marketplaces, connecting investors with private companies or investment funds seeking capital. They leverage technology and instant communication to streamline the investment process, making it more accessible and efficient for both investors and issuers.
Crowdfunding platforms generate over $17 billion of funding annually, with the market expected to reach $26 billion by 2026.
Crowdfunding allows self-directed IRA investors to own a share of a business venture in exchange for small cash investments. Equity crowdfunding empowers ordinary investors with access to early-stage ventures that were previously limited to accredited investors.
This form of PE investment supports small and medium-sized businesses, stimulating the economy through new ventures and job opportunities. While blue-chip companies are primarily responsible for driving the stock market forward, small businesses are responsible for the majority of job creation, accounting for two out of every three new jobs.
Investing in private equity with an SDIRA requires a systematic approach to ensure informed decision-making. Here are the key steps to consider when investing in private equity with your retirement account funds:
By following these steps, investors can navigate the process of investing in private equity with a self-directed IRA more effectively. Taking a proactive and informed approach will contribute to maximizing the potential benefits of private equity investments while managing the associated risks.
If you're looking for insights and actionable tips, watch a replay of our recent webinar, Private Equity Investing: Insights from an Industry Expert. We invited Paul Karrlsson-Willis, CEO at Justly, to instruct viewers on:
Got questions about self-directed IRAs and how to mobilize your retirement funds to invest in PE? Set up your free consultation with one of our experts today.