Purchasing Equity vs Issuing Debt With Your IRA

Private businesses offer many of the same investment opportunities as large public companies, namely stocks (equity) and bonds (debt) in their capital structure. However, smaller companies, particularly growth-oriented businesses that are long on opportunity but short on strong positive cash flow, may prefer issuance of private shares. Alternatively, others, particularly those with a strong record of cash generation, may prefer loans to avoid equity dilution, as well as owner tax advantages through interest deduction.

Here, we take a look at the difference between issuing private loans and purchasing private equity, both of which you can do with your self-directed plan.

Equity Investments

Your IRA, Solo 401(k), or HSA can invest in just about any business of your choosing, and often from an array of platforms. Private stock offerings, subscription agreements, and even crowdfunding platforms provide a range of opportunities.

Regardless of the path, at closing your account will own a slice of the business. If the company thrives there can be no limit on your investment growth. However, purchasing private equity with a tax-advantaged plan may carry additional considerations.

For instance, Unrelated Business Income Tax (UBIT) may apply if your account invests in a pass-through business. Such companies don’t pay taxes at the corporate level, effectively passing tax obligations through to investors. If your IRA invests in such a company, make sure you understand the tax consequences and seek professional guidance as appropriate.

A second consideration is fair market valuations or “FMVs.” Publicly traded stock valuations are reported continuously. On the other hand, private assets often require explicit valuation by a third-party expert. In the case of private equity investments, an applicable company manager can, and often does, provide fair market value information. As an investor, you would forward this information and supporting documentation to New Direction Trust Company for filing requirements.

UBIT and FMVs are just two considerations, well after an investor evaluates the prospects of the business, but are nevertheless important tax reporting requirements.

Debt Investments

Your tax-advantaged account can also lend money to businesses, collecting interest the same way a bank would and enjoying other features of the loan the lender (you) may negotiate. Items such as interest rate, term, collateral, warrants, and other elements as agreed by the principals can all be included in the loan document.

Unlike private equity, a private loan traditionally wouldn’t provide an immediate ownership stake in the business. One of the advantages to issuing private loans with a self-directed account is that you won’t have to worry about UBIT or fair market valuations. Private lending doesn’t fall under the category of UBIT-eligible investments. Furthermore, the fair market value of an account-held loan will always be the remaining balance due.

Combining Equity and Debt as an Investment?

Convertible notes can be the best of both worlds, incorporating debt and equity elements into the same investment. As an example, your account could issue money as a loan and receive repayment in the form of stock instead of cash. In this regard, the debt “converts” to equity. Your account can obtain an ownership stake while the company enjoys a cash infusion without having to pay cash interest and instead substitutes equity issuance.

Contact Us with Your Questions

When it comes to private company investments, the creativity of the capital provider and capital recipient is the only real limitation. That said, stay mindful of reporting requirements inherent with each instrument. Contact New Direction Trust Company at 877-742-1270 or send us a message through the Client Portal if you have questions about your investment options!

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