Everyone dreams about discovering the “next Microsoft” or “next Amazon” and investing in the company before it goes public or during the initial public offering (IPO). The numbers are mind-boggling: Buying just one share of Microsoft at its IPO price of $154.53 in 1986 would now result in your having more than $44,000 if you had held onto the investment. If you like getting in prior to a company going public, then look no farther than the Amazon investor who made a $50,000 angel investment in June 1996. That $50,000 gained the investor just over a 1-percent share in Amazon, which equated to about $29 million in Amazon stock when the individual left the board of directors in 2019. The decision to help the company “bootstrap” its way to success with a relatively small angel investment while “The Everything Store” was still private led to huge dividends.
Of course, not everyone has $50,000 in their checking account with which to invest in an up-and-coming company. However, many self-directed investors have this much capital (and far more) in retirement accounts. One of the best things about self-directed retirement accounts is their flexibility; while a “traditional” IRA usually precludes investing in these types of investments, self-directed account holders are able to use their experience, insight, and research to place their capital with companies they believe have the potential to produce huge returns. Of course, there are a few things to consider prior to making this type of investment.
An IPO, or initial public offering, is the point at which a private company makes their shares public by issuing stock. At the point of the IPO, the stock becomes a publicly-traded asset and is valued accordingly. Many investors confuse IPO and pre-IPO investing as being essentially the same thing, but they are not. Pre-IPO investing involves buying into the company directly before shares are available on the stock exchange, while IPO investing involves buying shares when the stock first goes public. Both types of investment can be risky because it is difficult to evaluate risk in startup companies.
Investing in startups pre-IPO and at the IPO stage requires some planning if you intend to use a self-directed retirement account. If you already have a self-directed account, then you will need to notify your IRA custodian that you want to purchase shares using capital in your self-directed account. The IRA custodian will need to review the asset and supporting documentation, which can take up to several days. Keep your custodian informed about your investment strategy so that they can let you know how your timeline is likely to work out.
Smart self-directed investors know they cannot invest in companies or assets owned by disqualified persons, including:
However, many do not realize that this extends to private investments in which the disqualified person may have a partial interest. If any disqualified person has a 50 percent or more ownership stake in the company in which you are investing, you are prohibited from making that investment.
It would be wonderful to have the opportunity to invest like a visionary. We would all love to reap the financial and psychological rewards of having spotted a “diamond in the rough” before anyone else. However, it is extremely important to remember when investing in private businesses, pre-IPO businesses, or IPOs that most startups do not succeed and even when they do, they do not succeed wildly. While allocating a certain part of your investment capital toward this type of investment can help protect you from volatility in other markets and, in some cases, result in huge returns, remember not to put all of your eggs in one basket. After all, even a small investment in Amazon would have generated massive, nearly unimaginable returns. You can afford to diversify your strategies and also protect some of your capital with more traditional, secure self-directed investments like real estate, real estate-related assets, private placements, REITS, or more traditional exchange-traded securities.
Please note: Not all alternative investments require Accredited Investor status. Please review the private placement memorandum, subscription agreement, or prospectus for purchase.
Always take the time to consult with trusted, professional advisors to ensure you understand tax, legal, and investment issues related to the use of IRA funds in LLCs.