One of the more frequent inquiries we hear at New Direction
regards the transacting of business between an IRA and a private company. For
us to perform our jobs successfully for your IRA, we will often need a
discussion with the account holder to discern whether the participation in the
private company is a loan or a private stock (or equity) purchase. Both
investments involve sending IRA money to the company with the expectation of a
return, but the supporting documentation for the two types of investment are
different.
A) “A
loan”?
As you probably know, it is permissible for your IRA to loan
money to a private individual, so long as that individual is not disqualified
by virtue of IRS regulations. But an IRA can also lend moneys to a business –
and this will also constitute the same sort of Private Lending. Companies will
often need infusions of capital to “start-up” or fund their growth and
development, and they may solicit potential capital infusions by offering
attractive interest rates to Lenders (which could include an IRA).
The parties draw up a Promissory Note, spelling out the
amount of funds to be loaned, and the terms of that Loan, and an inked
signature of the Borrower on it — which the New Direction IRA client furnishes
to us along with the Promissory Note Buy Direction Letter form.
The characteristic that most often indicates that the IRA’s
asset is a loan (and not private stock) is that the return on the investment is
agreed upon and fixed in the transaction documents. Remember, just as in the
case of lending to an individual, lending to a company would only be prohibited
if, for example, the IRA holder or other disqualified person is a majority
owner or controlling officer of that company.
B)
“Buying stock”?
Very often, smaller or growing companies elicit investment
capital not only through acceptance of loans, but also by offering stock. In
other words, though they’re still private, a company may sell stock shares to
investors, giving those investors the opportunity to acquire equity in their
enterprise. Since these companies are not publicly traded on stock exchanges,
the only means to acquire a stock investment is through what is typically
called a Purchase or Subscription Agreement, or Private Placement.
The company draws up their Agreement or Private Placement
document, spelling out the number of shares to be purchased and price, which
the IRA holder furnishes to us along with the Private Stock Buy Direction
Letter and Disclaimer & Indemnity Agreement forms.
The characteristic that most often indicates that the IRA’s
asset is private stock or private equity (and not a loan) is that the return on
the investment is largely based on the performance of the company which is a
variable.
C)
“Convertible Notes”? (a kind of combo or hybrid)
It’s not uncommon for companies to also offer an investment
opportunity which incorporates both the element of a Loan with that of Equity —
by offering a Convertible Note. This is a kind of Loan, transacted as in the
first example above, using a Promissory Note. The difference here is that the
Note may provide an option at some point for the Lender to convert their
creditor status for an actual ownership share (purchase of stock in the
company), at some point in the future.
Once again, it is easy to see that there are a myriad of
ways to exercise the freedom of your self directed IRA. However, because the
supporting documentation for these types of investment are a little different,
it is a good idea to decide the nature of the investment before beginning the
acquisition process.
