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Many businesses raise capital through public offerings of stocks or bonds. But businesses can also raise money using private placement offerings, which are typically simpler and less expensive than accessing the public markets.

I get a lot of questions about these offerings and how to conduct private placement due diligence when considering investing in a private placement with your self-directed IRA. While we cannot provide advice on how to conduct due diligence, here are some common questions we hear.

What is a private placement offering?

In a private placement, businesses raise capital by selling corporate debt or equity securities to a limited number of investors. Private placement offerings are not required to be registered with the Securities and Exchange Commission (SEC). Businesses typically use private placements as an alternative to selling securities in a public offering. 

Why do companies pursue private placements?

Because private placements are offered to a limited number of sophisticated or accredited investors, they are exempt from registering with the SEC. That is why they are also called unregistered offerings.

Avoiding the need to register with the SEC eliminates the cost and time associated with holding a public offering. Private placements also provide businesses with more flexibility in how to structure their offering. As the name implies, private placements also allow companies to keep the offering confidential.

Are private placements regulated?

Simply because private placements are unregistered does not mean they are unregulated. Private placements are regulated by the SEC under Regulation D (Reg. D), which allows businesses to issue securities based on the type of investors buying them.

If an issuer wants to engage in “general solicitation” and use advertising to drum up interest for its offering, the issuer can only raise money from accredited investors according to Rule 506(c) of Reg. D. Under Rule 506(b) of Reg. D, an issuer can raise funds from accredited investors and 35 non-accredited investors as long as the issuer does not use general solicitation or advertising to market securities. These non-accredited investors must be “sophisticated,” meaning they have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the private placement opportunity.

What type of investors participate in private placements?

Hedge funds, private equity, and venture capital funds represent the lion’s share of the private placement industry. These large investors are often provided with preferred access to private placements, allowing them to purchase stocks or bonds at a reduced cost, and providing them flexibility in terms of what they can do with their investments. Crowdfunding and retail investors represent a smaller fraction of the overall private placement industry.

Can you invest in private placements using a self-directed IRA?

Yes, you can use your self-directed IRA to invest in a private placement. But you’ll need to ensure you follow IRS rules and regulations regarding prohibited transactions and disqualified persons. In general, the IRS does not allow IRAs to conduct transactions that benefit you, your beneficiaries, your business, or other disqualified persons such as spouses or children. This is "self-dealing," and it is prohibited.

If you run afoul of IRS rules and conduct a prohibited transaction, even unintentionally, your IRA could lose its qualified tax-protected IRA status, and you’ll face taxes and potential penalties.

Who conducts private placement due diligence?

If you use your self-directed IRA to invest in a private placement, you are responsible for conducting due diligence. Private placement issuers often give interested investors with a private placement memorandum (PPM) or offering memorandum that provides an overview of the investment opportunity, the securities being offered, and the issuer. However, PPMs are not required, and a regulator does not typically review these documents.

In addition, as an IRA custodian, Pacific Premier Trust reviews offerings for administrative feasibility only. We determine whether an asset can be held in a tax-advantaged retirement account, but we do not review the merits of the offering. We also cannot offer investment advice.

Given this, SEC provides this private placement due diligence checklist that investors can use when vetting an offering before investing:

• What do the financial statements, if provided, tell you about the business? 
• Are the claims and expectations reasonable?
• How reasonable is the issuer’s reliance on a particular technology, customer, product, or natural resources claim?
• Who are the issuer’s competitors?
• What is the experience and background of management?
• How long has the issuer been in business, and has the issuer conducted prior offerings?
• How does the issuer plan to use the money raised?
• If the securities you are investing in have transfer restrictions, when will and how may the restrictions be lifted? 
• Because you may not be able to resell your investment easily, are you comfortable holding it indefinitely?

If an issuer fails to adequately answer these questions, it may be a warning against investing in the deal, according to the SEC. On this topic the SEC also says:

“Private placements may be pitched as a unique opportunity being offered to only a handful of investors, including you.  Be careful.  Don’t be fooled by this high-pressure sales tactic.  Even if the deal is “unique,” it may not be a good investment. It is important for you to obtain all the information that you need to make an informed investment decision. In fact, issuers relying on the Rule 505 and 506(b) exemptions from registration must provide non-accredited investors an opportunity to ask questions and receive answers regarding the investment.  If an issuer fails to adequately answer your questions, consider this a warning against making the investment.

Unlike registered offerings in which certain information is required to be disclosed, investors in private placements are generally on their own in obtaining the information they need to make an informed investment decision.  Investors need to fully understand what they are investing in and fully appreciate what risks are involved.”

If you have questions about using a self-directed IRA to invest in a private placement, please call us at 866.818.4472. Current Pacific Premier Trust clients can reach us at 800.962.4238.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

Pacific Premier Trust (formerly PENSCO Trust Company) performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Pacific Premier Trust is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.

NOT FDIC-INSURED | NO BANK GUARANTEE | MAY LOSE VALUE