Using a Self-Directed IRA to Fund Your Venture Investments

Main Take-Aways

• The IRA was created in the 1970s in response to a decline in defined-benefit pension plans and has become one of the most popular ways to invest for retirement.
• With both traditional IRAs (to which you make tax-deductible contributions) and Roth IRAs (from which you take tax-free distributions), you can invest in conventional financial assets like stocks, bonds, and mutual funds.
• You can invest in a much wider range of investments through a self-directed IRA (SD-IRA) that provides the benefits of IRAs, including the potential of tax deferral and tax-free gain. Popular choices for SD-IRAs include real estate and precious metals. Venture capital is also becoming an increasingly popular option.
• Venture capital (VC) can be a good match for SD-IRAs for many reasons. Venture investments typically have a 10-year term — compatible with the typically longer timeframe of a retirement vehicle. VC has also been less affected by adverse economic conditions than assets such stocks, bonds, and mutual funds.
• Investing in venture via a qualified retirement account is a strategy that over a third of AV investors employ to diversify their retirement portfolios. AV works with STRATA Trust Company, which sets up an IRA on the behalf of AV investors and manages all administration.

Building a Retirement Security Net

The IRA has proven to be a valuable tool in the retirement savings game. It was created in the 1970s in response to a decline in defined-benefit pension plans and has become one of the most popular ways to invest for retirement. Over 60 million taxpayers now own individual retirement accounts (IRAs), which offer individuals an opportunity to save for retirement in a tax-advantaged account. Taxpayers may either contribute to IRAs annually or roll over balances from employer-sponsored plans.

With both traditional IRAs (to which you make tax-deductible contributions) and Roth IRAs (from which you take tax-free distributions), you can invest in conventional financial assets like stocks, bonds, and mutual funds, provided by brokers such as Charles Schwab, Fidelity Investments, or Vanguard.

Advantages of a Self-Directed IRA

While regular IRAs are a popular choice for retirement accounts, they do have their limits. The custodian — usually a bank or a brokerage firm — typically restricts your investment options to approved securities like stocks, bonds, and mutual funds.

A self-directed IRA, on the other hand, offers much greater options. While participants must follow the same eligibility requirements and contribution limits, the term “self-directed” refers to the fact that the investor, not a custodian, chooses investment options.

And you can invest in just about anything, unless it’s prohibited by the IRS. Choices range from real estate and precious metals to dairy cows and Broadway shows. Such investments are growing in popularity. A recent study showed that ultra-high-net-worth investors (net worth of at least $30 million) committed 50% of their assets to alternative investments in 2020.

Here are some commonly cited benefits of having an SD-IRA:

• Individuals can align publicly traded investments and alternative assets with their passions, knowledge, or experience.
• The potential for tax-free growth, with the benefits of IRAs, as well as tax deferral and tax-free gains.
• Available as either traditional or Roth IRAs.
• Increasing portfolio diversification can lower risk by spreading money across and within different asset classes.

Choosing Venture for Your SD-IRA?

Venture capital (VC) is a form of private equity and a type of financing that investors provide to startups that are believed to have long-term growth potential. While venture is a high-risk asset class, the rewards can also be attractive for winning investments. Indeed, VC was among the fastest-growing alternative investment asset classes tracked by Pensions & Investments’ annual U.S. retirement plan survey — increasing 85% to $83.9 billion in the 12 months ending Sept. 30, 2021.

As with other types of SD-IRA investments, the potential benefit of investing in venture capital funds is the possibility of gaining tax-advantages, such as tax-deferral or tax-free growth on income or gains the investment generates.

There are many reasons that VC and SD-IRAs can be an appealing pairing. Venture investments typically have a 10-year term — compatible with the typically longer timeframe of a retirement vehicle. Therefore, many investors see retirement accounts (which they may not plan to access for many years) as an attractive vehicle for VC investing.

Investors also like the performance and resilience of VC-backed companies. According to Q1 2022 PitchBook-NVCA Venture Monitor: “U.S. VC remains strong while navigating market of uncertainty. … Venture-backed companies attracted nearly $71 billion during Q1. Even though the figure was off pace from every quarter in 2021, it still exceeded pre-2021 quarterly totals.”

In addition, the ability of VC and other private equity assets to withstand, adapt, and prosper in volatile market conditions is demonstrated in studies by AngelList Venture and Cambridge Associates. In fact, some of the most iconic companies — from Microsoft to Airbnb — launched in the midst of harsh economic headwinds.

Other VC advantages were cited at the May 2021 Fiduciary Investors Symposium (FIS) by a panel of experts that included Todd Ruppert. His 40 years of experience in the financial services industry included service as CEO and president of T. Rowe Price Global Investment Services. Ruppert recommends investors tap the VC asset class — in part, because many companies are waiting longer to go public, when they may already be past some of their highest-growth years.

How to Invest in a Self-Directed IRA

While enrolling in traditional IRAs is relatively straightforward, SD-IRAs can be somewhat complicated to set up and manage.

An SD-IRA is not an account you manage completely on your own, says Brian Stivers, president and founder of Stivers Financial Services. “Self-directed IRAs require you to utilize the services of a third party, often referred to as a custodian or trustee.”

Opening an SD-IRA requires the following steps:

1. Identifying a custodian or trustee for your account.
2. Vetting and choosing the investments you want.
3. Finding a broker to purchase the investment and funding an account.
4. Directing the custodian or trustee of the account to make the transaction you want.

Enrolling in a Self-Directed IRA Through Alumni Ventures

Investing in venture via a qualified retirement account is a strategy that over a third of Alumni Venture investors employ to diversify their retirement portfolios.

While Alumni Ventures is open to working with other custodians who accept AV fund investments, we also make it very easy to create an SD-IRA for your AV portfolio through STRATA Trust Company. STRATA sets up an IRA on your behalf and manages all administration. Monies can be transferred without penalty or jeopardizing tax-deferred status.

AV chose STRATA as its independent third-party provider for several reasons:

• Excellent customer service, including AV-dedicated service team
• Low flat annual fee of $225; no transaction fees or higher fees based on holdings
• Undirected cash held in interest-bearing FDIC insured account
• Clients can also invest in stocks and mutual funds
• Strong back-end systems
• Excellent track record: 50,000+ clients, $4 billion+ in assets
• Trade public securities through TradeStation partnership

Although the process to enroll in an SD-IRA through Alumni Ventures is fairly straightforward, you are encouraged to contact [email protected] to begin.

• First, you need to demonstrate you’re an Accredited Investor.
• Next, you set up an account online with STRATA and complete a transfer form.
• Then, you return to the AV portal to sign our Subscription Agreement.
• STRATA funds your AV investment as soon as your transferred funds settle.

Interested in learning more? STRATA has an AV-dedicated page on their website: stratatrust.com/av. AV investors can receive assistance setting up their account, funding their investment, or any post-investing questions.

All AV Fund investments described above are for illustration purposes only. These investments are not intended to suggest any level of investment returns; not necessarily indicative of investments invested by any one fund or investor. Many returns in investments result in the loss of capital invested. These investments are not available to future fund investors except potentially in certain follow-on investment options. To see the performance of each exited investment for all Alumni Ventures funds over the last twelve months and our historical performance since 2014, click here.