Private Equity and Start up investing is an exciting way to place your Solo 401k capital.
Private equity and start-up investments are a form of financing that invests money or capital into a company. A limited number of shareholders own these private companies. Open stock exchanges do not trade these shares.
Government organizations, like the Securities Exchange Commission, heavily regulate publicly traded companies on stock exchanges. Public companies disclose regulated information about their performance, making it easy to see their financials, revenue, etc.
Private companies do not answer to public shareholders, so they have lighter regulation standards. They do not have to disclose earnings reports or submit financial statements for auditing. This makes it hard for outsiders to find reliable and up-to-date information about them. Privately held companies are not required to disclose details about their operations that could potentially benefit competitors.
Typically, investments in private equity and start-ups are limited to accredited investors.
What it Means to Be an Accredited Investor
One government regulation still limiting some investment opportunities is SEC Rule 144A. The rule prevents some investors from participating in private placements. Individuals allowed to participate in these private placements are known as “accredited investors.”
Until recently, the accredited investor requirement severely limited the people who qualified to invest in private placements. Previously, these two wealth thresholds defined an “accredited investor” –
Earned income of more than $200,000 ($300,000 together with a spouse) in each of the last two years and reasonably expects to earn the same for the current year, or;
Has a net worth over $1 million, either individually or together with a spouse (excluding the value of a primary residence).
Changes to “Accredited Investor” Thresholds
The SEC made two significant changes. One change broadened the application of wealth calculation. The wealth calculation now includes the term “spousal equivalent,” which means that if one spouse qualifies as an accredited investor, that person’s spouse does also. The other change provides a path to accreditation that is no longer solely based on already accumulated wealth.
Your Solo 401k can play a key role in this qualification. Generally, if you are the trustee of your Solo 401k and your combined assets (Solo 401k plus personal assets) meet the $1 million threshold, both you and the Solo 401k should qualify as accredited investors.
A non-wealth change is that there are now other ways to become an accredited investor. Individuals can now qualify as accredited investors based on certain professional credentials or certifications. As of now, it includes people who have obtained Series 7, Series 65, or Series 82 investment securities licenses. State or SEC-registered investment advisors also qualify. Expect the list of qualifying licenses to expand sometime in the future.
There is no certified exam or piece of paper issued that states a person is an accredited investor (other than for the securities licenses). The process and duty are for the companies issuing unregistered securities to determine a potential investor’s status by conducting due diligence prior to the sale of shares. Each time an investor purchases unregistered securities, the purchasing company conducts the due diligence at that time. After you go through the process once, you’ll know what will be required in the future.
Common documents included in a Private Placement or Start-up Investment
Depending on the structure of the investment entity (e.g. C-corporation, Limited Partnership, LLC, etc), the offering documents may include the following:
Private Placement Memorandum
Limited Partnership Agreement
Subscription Agreement (may also be a Stock Purchase Agreement)
Investor Deck
Accredited Investor letter (typically your attorney and/or CPA will need to verify your assets proving you meet accredited investor status)
Certificate of Good Standing from the Secretary of State where the entity was formed
Investor Questionnaire – this is typically to fulfill anti-money laundering and Know Your Customer banking and SEC regulations to ensure your money is truly yours and that you’re able to spend it as you see fit
How to Invest with a Solo 401k
Identify the private placement or startup investment and complete your thorough due diligence
Complete the investment paperwork in the name of the 401k trust and use the 401k trust EIN. Do not use your personal or business information (name or SSN). Your 401k trust is the investor.
Complete IRS form W9, if required. See our guide here on how to complete a W9 for your Solo 401k
Wire funds from your 401k trust bank or brokerage account to the investment
Where are dividends paid out?
Once the investment starts paying dividends, or if there is an exit (in the case of a startup), have the fund or investment sponsor wire funds back to the Solo 401k trust bank or brokerage account.
Do not receive any dividends or payouts to your personal or business bank account. All investment income must go right to the Solo 401k.
Private Placement Investment Fast Facts
The Solo 401k trust is the investor, not you as the trustee
The Solo 401k trust EIN should be listed on all investor subscription documents
You as the 401k trustee may sign the investor documents on behalf of the 401k trust (e.g. John Smith, Trustee of Smith Consulting Trust
Once your investor documents have been approved, wire the funds to complete the investment from your Solo 401k trust bank account
Collect any dividends or disbursements into your Solo 401k trust bank account (not your personal or business bank account)
As the Solo 401k trustee, you are the fiduciary of the trust. The words fiduciary and trustee may be used interchangeably with respect to completing the investment
Reporting Requirements for a 401k Trust in a Private Placement
The fund is required to issue certain forms to investors to satisfy their reporting. These forms may include a 1099-R or K-1 (depending on the structure of the investment)
Your Solo 401k trust is a tax-deferred entity and doesn’t need to file a tax return. If the investment was made correctly in the name of the Solo 401k trust, using the 401k trust tax ID number, the IRS would be able to identify the trust as a tax-deferred entity, and no reporting of the forms is required.
Ensure you provide a copy of IRS form W9 as part of your investment, to ensure proper tax filing and reporting.
Disclaimer: Investing inherently involves risk. Nabers Group and its affiliates, subsidiaries, or partners are not investment advisors, and we do not offer investment advice. Always complete your due diligence before executing any investment and check with your CPA, legal counsel, or tax advisor before executing investments using retirement funds.