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Holding a Pre-IPO Company in Your Self-Directed IRA

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  |  By Christopher Orr, SDIP

The media is awash with stories about “unicorns” -- privately-held startups that are valued at $1 billion or more by their investors and are expected at some point to hold massive IPOs.

As the excitement builds around hot tech start-ups like Uber, Airbnb and SnapChat, I am often asked by clients how they can use their retirement dollars to invest in a “pre-IPO” company. At PENSCO, where we custody alternatives assets for our clients’ self-directed IRAs, clients can hold everything from private corporate stock to hedge funds to limited partnerships in their IRA.

While equity crowdfunding is allowing a wider swath of investors to participate in early-stage investing, it is still very difficult to invest in a hot pre-IPO company, especially one of the unicorns.

Given this, I thought this graphic from the Wall Street Journal offered a good illustration of three ways that investors today can get access to a private company’s shares before they are sold to the public.

As the graphic shows, these are three limited ways for qualified investors to obtain these shares aside from the more traditional route of accessing shares through friends and family rounds, angel investment groups or syndication efforts.

In addition, investors typically need to be accredited to access to these deals, meaning they have a net worth of $1 million excluding their primary residence or they have $200,000 in salary or $300,000 for a married couple.

For investors who are offered the opportunity to invest in a company that may eventually one day go public, it’s important to be aware not only of the potential rewards of owning these companies but also the risks.

For starters, investors should not expect overnight success stories or profits, if any, to come quickly. Investors in technology startups are likely to have to hold their positions in any one investment for an average of 7 years. However, that timing could work well for investors who own these private company stakes in their self-directed IRAs, because retirement investments tend to naturally have a longer time horizon.

Investors also need to understand they won't have control over when to cash out of these investments. While the exit strategy for many unicorns is expected to be an IPO, recent stock market volatility makes it harder for companies to hold initial public offerings. Between Aug. 12 and Sept. 15 there were no new U.S. listing, according to this article in the Wall Street Journal.

If the IPO market turns south, it means investors could end up holding their stakes longer than expected and it could also force companies could pursue a different exit strategy -- such as a merger or acquisition.

There is no doubt that investing in a pre-IPO unicorn has the potential to reap substantial returns for an investor, especially when these investments are held in a tax-advantaged self-directed IRA.

But before our clients go chasing unicorns, we want to make sure they understand the potential risks that come along if they happen to catch one.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.