How To Invest in a Startup with a Self Directed IRA

Posted on: September 29, 2020   |   Category: How To
Boy in a suit with wings and a pilot hat on, dreaming about the future

There are millions of startup companies in the world. Many have the high hopes of being the next Facebook, SpaceX, or Airbnb. Unfortunately, most startups are not as successful as these companies. The reality is that most startups do not have enough funds to finance their company. Many founders turn to family and friends, venture capitalists, and angel investors to keep their business afloat. However, those sources often come up short.  

That’s where Self Directed retirement accounts enter the picture. They can provide crucial coverage for the financial gap. Investing in a startup with a Self Directed IRA is a two-way street. Investors have the opportunity to diversify their portfolio and engage in a potentially profitable investment, while startup founders are able to access an untapped source of funding.    

The Role of a Self Directed IRA in Startup Investing 

Most IRAs and 401(k)s are set up at brokerage firms who solely focus on investing in publicly traded companies through stocks, bonds, and mutual funds. However, what if you want to invest in a company that is privately held? This is where the Self Directed IRA is needed.  

A Self Directed IRA is the vehicle that allows investors to purchase alternative assets outside of the stock market. Investing in an alternative, such as a startup, benefits the investor by diversifying their retirement portfolio and providing more stable returns.  

Once an investor has an idea about what startup they are looking to invest in, they should speak with a Self Directed IRA Specialist to see if it fits their investment needs.  

What Types of Startups Can You Invest In? 

A Self Directed IRA can invest in almost any startup. From a local coffee shop, to your friend’s healthcare startup, to a small company that may have the latest and greatest product idea – the possibilities are endless!  

The only limiting factor is engaging in Prohibited Transactions. The general rule is that the investor cannot be the owner of the company. The startup’s owner also cannot be a disqualified person (which is an immediate family member such as a child, spouse, parent, or grandparent). You also cannot directly benefit from the investment. For example, if you invest in a company and your son gets hired by that company because of your investment, this will be a problem in the eyes of the IRS. Ideally, you would not be involved in the business in any way, other than being an investor.  

High Risk / High Reward Investment  

Investing in a startup or small business may be considered risky, but it has the potential to result in high rewards if the business begins to boom. It is a good strategy to invest in a startup if you have time on your side and expect this to be a long-term investment. Startups require time to grow, so investors often see more returns in the long-run than in the near future. However, due to the risky nature of startups, investors should not dedicate all of their funds to them. It is highly recommended that investors do their due diligence and talk to a financial advisor before placing an investment.  

Set-Up Process  

After weighing the pros and cons and deciding to invest in a startup, the setup process is very simple. 

Step 1: Create an Account with a Self Directed IRA Custodian  

Step 2: Transfer Funds into the Self Directed IRA  

  • Funds may be transferred from your current IRA and deposited into your new Madison IRA. 
  • Funds may be rolled over from a former employer’s plan, like a 401(k) or 403(b) . 

Step 3: Invest in the Startup of Your Choice  

It’s that easy! Now you are helping a startup grow and are diversifying your retirement account with a profitable startup.