August 20, 2021

Investing In a Private Placement With a Self Directed IRA

One of the distinct advantages of a Self Directed IRA is its ability to invest in non-market offerings. Wall Street is limited to companies of a certain size and revenue, and does not allow for smaller (yet equally profitable) ventures. One of the most popular alternative investments is the private placement. Here we will discuss how a private placement works, which private placements are the most popular, and how can you invest in one with a Self Directed IRA. 

What is a private placement? 

A private placement is simply an investment in a private company. The company is not public (i.e. not listed on the stock market,) and hence its investment opportunities are considered private. They are generally not offered to the public at large and instead target a specific group of investors. The type of companies that utilize private placements can range from a small real estate investment to a large company which eventually plans on going public. 

Why is a private placement a good fit for a Self Directed IRA? 

One of the main drawbacks for most private placements is the lack of liquidity. Many have a 3-5 year holding period before an investor can cash out. This is usually not attractive for active investors, but it works fine for a Self Directed IRA. In a retirement account, the account holder anyways doesn’t have personal access to the funds until they reach retirement age. Thus, putting those funds in a long-term investment doesn’t cause any undue financial hardship.  

Additionally, the types of assets that private placements focus on can at times only be accessed via a Self Directed IRA. If a retirement investor has a company sponsored 401(k) or an IRA with a big brokerage, they can’t use those platforms to invest in a private placement. Brokerages typically only give access to market products like stocks or mutual funds. If an investor finds a safe and potentially profitable private investment, the only way to get into it with retirement funds is via a Self Directed IRA. 

What are the types of private placements available? 

Investments in any of the following can be structured as a private placement: 

  • Hedge fund 
  • Private equity fund 
  • Small business 
  • Startup 
  • Real estate 
  • Crowdfunding venture 

Are there any limitations on who can invest in a private placement? 

It very much depends on the nature of the offering. The SEC breaks down investors into three main categories: 

  • Accredited investors - This designation can apply both to entities (e.g. an employee benefit plan) or to an individual. The SEC defines accredited individuals as having a net worth of at least $1 million or an annual income exceeding $200,000. 
  • Sophisticated but non-accredited investors – These are knowledgeable individuals (e.g. those who possess a professional license which demonstrates relevant professional knowledge) but who do not meet the net worth requirements. 
  • Non-accredited investors – Investors who meet neither of the above standards. 

Depending on the nature of the offering, the SEC will sometimes limit it to accredited investors, sometimes to accredited or sophisticated investors, and sometimes there will be no limitations at all. You can find out more about investor limitations here

How does a Self Directed IRA invest in a private placement? 

The first step is to open a Self Directed IRA account. There are different kinds of accounts available with differing fee schedules and functionality. For the standard private placement, a custodian-based Self Directed IRA would be your ideal account. It has a fast economic setup and you’ll receive live support as you send funds to the private placement. If you’re looking to invest in other assets as well, then schedule a call with a Madison specialist. For high-transaction accounts, a Self Directed IRA LLC or IRA Trust may be more appropriate. 

Once your Self Directed IRA is established, it’s time to invest in the private placement. This is accomplished by sending Madison an Investment Authorization form which details where you would like your funds sent. In addition, your fund sponsor will have given you Articles of Organization, Operating Agreement, and a Certificate of Good Standing (if the entity has existed for more than 12 months.) You will send copies of these to Madison as well. 

How to research a private placement 

Due diligence is very important when investing a Self Directed IRA in a private placement. Since the offering has not received the same SEC scrutiny as a public offering, it is incumbent upon the investor to conduct their own research. This process starts with the documentation provided by the fund sponsor. The documentation should include the nature of the investment, expected returns, company structure, and any notable risk factors. 

Once you have read through this literature, you can now start asking the important questions: 

  • Who are the investment sponsors? - Are they recognized names in the specific industry? Has their previous investment experience been profitable? Have they been associated with any scandals? Obviously, it’s usually better to stick with well-known financiers who have experience in this niche. 
  • When do you expect to be able to cash in your shares? - It’s important that a company or venture have a timetable which will allow for a responsible return of invested funds. Even if there are no official regulations against an investor cashing out, sometimes it can be functionally impossible if the asset hasn’t matured or if the company hasn’t gone public.  
  • Are there multiple share classes? - A standard trend in private placements is to give great deals to the fund founders and favored investors, but to give just average or sub-average deals to everybody else. Make sure you understand how the profits will be distributed and what that will mean for the success of your investment. 
  • Does the investment make sense? - Just because it has a well-known sponsor at the helm doesn’t necessarily mean that the idea is a good one. Speak with industry professionals and get their take on the viability of this private placement, and whether or not it would be a good fit for your Self Directed IRA. 

Moving Forward With a Private Placement 

The first step is to get educated. Schedule a call here with a Madison specialist. You'll get the answers to your questions and find out whether this is a viable plan for your Self Directed IRA. 

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Speak with a Self-Directed IRA Specialist.
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