Tapping Investors' Retirement Cash to Fund Small Businesses
Posted by: John Tozzi on April 09, 2009
Would you put your retirement money into a start-up or other small private company? More people may be doing just that, as other retirement investments like stocks and bonds have lost a lot of value recently. Entrepreneurs raising capital might want to ask investors to consider putting in a share of their retirement funds.
Self-directed retirement accounts let people invest in and actively manage a wider range of assets than traditional IRAs. Anyone can open these accounts, and investors can use them to put retirement money into private companies (as well as other alternative investments like real estate). One company that offers self-directed IRAs, the Entrust Group, says it has seen more interest in investing in private companies recently.
Entrust has about 50,000 accounts with $4 billion in assets. The share of those assets that people have invested in private companies has grown from 21.6 percent in 2006 to 31 percent in 2008.
(One caveat: it’s possible that increase is the result of other assets like stocks losing value over that period. Anecdotally, Entrust reports more interest in investing in private companies and other alternatives like precious metals.)
Often the people making these investments from their IRAs are also putting other money into the same companies, says Hugh Bromma, CEO of Entrust Group. I asked him if it wasn’t a little risky to put some retirement money into start-ups or other small businesses. His response:
“The individuals who invest in private placements really tend to do their due diligence on what those investments are, much more so than they do so in [public] equities… They may engage in what other people consider risky behaviors, but if you speak with self-directed investors you’ll find they’re really wholly engaged in the kind of investments they make.”
Bromma says these tend to be long-term, passive investments but in some cases investors can take a voting share of a private company. Also, they’re prohibited from investing in their own firms or companies belonging to family members — that would cause them to lose the tax-deferment from the IRS.
I asked Case Western economist Scott Shane, expert on angel investing (among other things), about this. While he hadn’t heard of the trend, Shane noted that private company performance is uncorrelated from a lot of other asset classes, meaning that a stake in private firms may hold up even when stocks and bonds drop in value — which could make private company investing particularly attractive now.
(He also mentioned the investment strategy brought up in The Black Swan. I haven’t read the book, but Shane characterized it like this: Put most of your money in risk-free assets like Treasury bills and put a very small percent in risky investments that have the potential for big payoffs, like start-ups. Shane notes that if you had most of your money in cash and small private companies, you would have been pretty well insulated from last year’s crash.)
That said, we’re not here to give investment advice. But entrepreneurs raising money should know that they can ask people with self-directed IRAs. Bromma suggests going to investment clubs or forums online — I’d imagine angel groups are another good bet.
“If they advertise that they’re interested in having self-directed IRA money, there are people who are looking to place their money into private placements who have cash,” Bromma says.