Self-directed IRAs offer a few more investment options than typical IRAs, one of these options being private placements. Private placements are investments in privately owned companies, rather than public companies that are registered with the Securities and Exchange Commission. A few examples of private placement investment opportunities include those with:
- Limited Liability Companies (LLC)
- C corporations
- Small businesses
- Limited Partnerships (LP)
- Hedge Funds
- Land Trusts
- Secured (deeds of trust) and unsecured (not backed by collateral) notes
These types of investments rely on individual investments to raise funds since many banks restrict loans to these businesses. Investors have the potential to earn much more on their investment than with “safer” stocks, bonds, and mutual funds. Private placements can also help diversify an investor’s portfolio, which may or may not be advantageous depending on how close the investor is to retirement. Generally, the closer an investor is to retirement, the riskier investments should decrease while the safer investments increase to ensure they have enough funds for retirement.
What are the Restrictions on Private Placements?
Not everyone can invest in a private placement. There are certain criteria that must be met before investing to help manage the risks involved. A few of these criteria are explained below.
- Investor cannot work for the business that their IRA funds.
- IRA owner cannot own 50% or more of the business if it is an existing entity.
- Accredited investors must have a net worth of $1 million.
- Accredited investor must show an income more than $200,000 ($300,000 with a spouse) from the past two years and be expected to earn at least that much in the next year.
- If investor doesn’t meet accredited investor criteria, they can still invest as a non-accredited investor.
What to Know Before Investing in Private Placement
Just because private placement investments inherently carry more risk, it doesn’t automatically mean they are all “bad” investments. There are, however, a few best practices you should exercise to protect yourself from dangerous, or even fraudulent, private placement investments.
First, conduct thorough research on the company offering the investment opportunity. Understand their industry and the competition, and evaluate the reasonableness of their claims and expectations. Obtain a copy of how the company plans on using the funds raised. Carefully review any offering documents and familiarize yourself with the terms of the investment. Pay special attention to transfer restrictions, when proceeds will be paid back to the investors, and the difficulty of selling or reselling your investment. Some private placements take years before investors can sell or resell, so you will want to make sure the timeframe is in-line with your retirement goals. Lastly, discuss the investment with your broker to see if it makes sense to add this type of investment to your portfolio. They will also provide their expertise on the riskiness of the investment, and may also conduct deeper research into the business itself on your behalf.
Private placement investments may not be beneficial for every investor, but they can reap higher returns than other standard IRA investments. Private Placements are investments worth investigating, especially for investors who are far away from retirement or who need to balance their portfolio with a higher-return investment.