Raise Money Using a Self-Directed IRA This clever twist on retirement fund investing could draw the patient investors business owners love.

By Asheesh Advani

Opinions expressed by Entrepreneur contributors are their own.

If you believe in your business and think it has the potential to be a long-term success, why not make an investment in it using your retirement plan? Can it be done? You bet it can, using a so-called "self-directed IRA."

To be clear, this isn't the same as borrowing from your 401(k) or your spouse's retirement savings. In previous columns, I have cautioned entrepreneurs against borrowing heavily from retirement assets. Instead, raising money by using a self-directed IRA is the opposite; it involves putting your company's stock into a retirement plan to protect its capital gains. In my opinion, self-directed IRAs are an underappreciated tool for allowing entrepreneurs--and their friends--to invest retirement funds into a startup.

As always, take care to do it right and to not cross the IRS. But investing funds from your self-directed IRA into your business is a viable and potentially wise alternative you should consider. In fact, your siblings, friends and business associates can also invest in your business from their retirement funds and ensure their capital gains get favorable tax treatment. This could make an otherwise break-even investment proposition seem more attractive.

In addition, it could make your investors more patient by extending their investment horizon to their retirement years, which is a huge benefit from your perspective. Experienced entrepreneurs will tell you that patient investors are a hard-to-find treasure. By suggesting self-directed IRAs to potential investors that you're in discussions with, you can increase the chances that they close and that they become your long-term financial partners.

Here's how it works. Move your IRA funds into a self-directed IRA. Pensco Trust Company is one firm that does this. (I've mentioned more at the end of the article.) Then, direct your IRA to make an equity investment in your business.

Pensco has a success story of a young entrepreneur who put $1,800 into a self-directed IRA and, along with some friends who also invested their modestly funded IRAs, formed a company. The company grew rapidly, was acquired three times and finally went public, returning $38 million to the founder's IRA--not a shabby nest egg to have sitting in a tax-free IRA.

The trick is that the IRS is serious about IRAs being used to build funds for retirement and is on the lookout for schemes to use IRAs to enrich your life now. So take note of these complicated and important rules:

  • Don't investment in S corporations or in a general partnership . This is simply because of the tax definitions of these legal structures.
  • Respect the list of "prohibited transactions." While friends, business associates and siblings may invest in your business via a self-directed IRA, your parents, children or a spouse may not.
  • You can't be the key employee and key investor in the business. You can't own more than 50 percent of the business in which you invest, and you can't have a controlling interest in the company. Basically, someone else has to have the right to hire or fire you. The IRS wants to make sure you aren't "self-dealing," or moving retirement funds in a way that might benefit you in the present through a salary or other immediate payments.

If you're not the startup type, you can also buy a business with your IRA. The business is then subject to a tax called the unrelated business income tax, since IRAs are otherwise tax-free. But your equity position still appreciates in your IRA tax-free.

However you do it, putting some of your retirement funds into a business that you already plan to pour your time and effort into is yet another way your sweat equity can pay off in the long run.

There are fairly detailed tax and securities law involved with this, so consult with trusted experts in the field. For example, Tomer Tal at New Venture Attorneys and Pensco offer free information and webinars on this topic. Keep in mind that you must use a special custodian to manage your self-directed IRA. A handful of companies specialize in this and maintain websites with educational resources, webinars and blogs to get you the latest information on the topic. They include:

For my company, I successfully raised money from a handful of early investors who purchased stock using self-directed IRAs. I found that these investors had a long-term investment view and were cooperative and patient. This tool has helped me raise money, and I hope it can do the same for you.

Wavy Line

Asheesh Advani is CEO of Covestor, an online marketplace for investors. He founded CircleLending, which was acquired by Virgin.

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