How to Fund Your Start-Up with Self-Directed IRA Investors

There are 25 trillion dollars in retirement plans in the United States. Do you know that these funds can be invested into your business? Yes, it’s true, IRAs and 401(k)s can be used to invest in start-ups, private companies, real estate, and small businesses. Unfortunately, most entrepreneurs and retirement account owners didn’t even know that retirement accounts can invest in private companies but you’ve been able to do it for over 30 years.

Think of who owns these funds: It’s everyday Americans, it’s your cousin, friend, running partner, neighbor…it’s you. In fact, for many Americans, their retirement account is their largest concentration of invest-able funds. Yet, you’ve never asked anyone to invest in your business with their retirement account. Why not? How much do you think they have in their IRA or old employer 401(k)? How attached do you think they are to those investments? These are the questions that have unlocked hundreds of millions of dollars to be invested in private companies and start-ups.

How Many People Are Doing This?

Recent industry surveys revealed that there are one million retirement accounts that are self-directed into private companies, real estate, venture capital, private equity, hedge funds, start-ups, and other so-called “alternative” investments.  It is a sliver of the overall retirement account market, but it’s growing in popularity.

So, how does it work? How can these funds be properly invested into your business? If you ask your CPA or lawyer, the typical response is, “It’s possible, but very complicated, so we don’t recommend it.” In other words, they’ve heard of it, but they don’t know how it works, and they don’t want to look bad guessing. If you ask a financial adviser, particularly your own, they’ll talk about how it’s such a bad idea while thinking about how much fees they’ll lose when you stop buying mutual funds, annuities, and stocks that they make commissions or other fees from. Well, not all financial advisers, but unfortunately too many do.

Now, there are some legal and tax issues that need to be complied with, but that’s what good lawyers and accounts are for, right? And yes, there is greater risk in private company or start-up investments so self-directed IRA investors need to conduct adequate due diligence and they shouldn’t invest all of their account into one private company investment. So how does it work?

What is a Self-Directed IRA?

In order to invest into a private company, start-up, or small business, the retirement account holder must have a self-directed IRA? So, what is a self-directed IRA? A self-directed IRA is a retirement account that can be invested into any investment allowed by law. If your account is with a typical IRA or 401(k) company, such as Fidelity, Vanguard, TD Ameritrade, Merrill Lynch, Charles Schwab, then you can only invest in investments allowed under their platform, and these companies deem private company investments as “administratively unfeasible” to hold so they won’t allow your IRA or 401(k) to invest in them (some make exceptions for ultra-high net-worth clients, $50M plus accounts). As a result, the first step when investing in a private company with retirement account funds is to rollover or transfer the funds, without tax consequence, to a self-directed custodian who will allow your IRA, Roth IRA, SEP IRA, HSA, or Solo 401(k) to be invested into a private company. There are over 30 companies who provide self-directed IRAs. For a detailed list of the companies that provide these types of accounts, check out the Retirement Industry Trust Association’s website and membership list. RITA is the national association for the self-directed retirement plan industry, and most major companies who provide these accounts are members of RITA.

Legal Tip: If an investor’s retirement account is with their current employer’s retirement plan (e.g. 401(k)), they won’t be able to change their custodian until they leave that employer or until they reach retirement age (59.5 years old). So, for now, they’re 401(k) is usually limited to buying mutual funds they don’t understand and don’t want.

Sell Corporation Stock or LLC Units to Self-Directed IRAs

Are you seeking capital for your business in exchange for stock or other equity? If so, you should consider offering shares or units in your company to retirement account owners. You don’t need to wait until your company is publicly traded to sell ownership to retirement accounts. Here are a few well-known companies who had individuals with self-directed IRAs invest in them before they were publicly traded: Facebook, Staples, Sealy, PayPal, Domino’s, and Yelp, just to name a few.

You can also raise capital for real estate purchases or equipment whereby a promissory note is offered to the IRA investor who acts as lender, and the funds are usually secured by the real estate or equipment being purchased. There are many investment variations available, but the most common is an equity investment purchasing shares or units where the IRA becomes a shareholder or note investment whereby the IRA becomes a lender. Keep in mind, you need to comply with state and federal securities laws when raising money from any investor.

Need to Know #1: Prohibited Transactions

There are two key rules to understand when other people invest their retirement account into your business. First, the tax code restricts an IRA or 401(k) from transacting with the account owner personally or with certain family (e.g. parents, spouse, kids, etc.). This restriction is known as the prohibited transaction rule. See IRC 4975 and IRS Pub 590A. Consequently, if you own a business personally you can’t have your own IRA or your parents IRA invest into your company to buy your stock or LLC units. However, more distant family members such as siblings, cousins, aunts and uncles could move their retirement account funds to a self-directed IRA to invest in your company.  And certainly, unrelated third-parties would not be restricted by the prohibited transaction rules from investing in your company. What if you are only one of the founders or partners of a business, and you want to invest your IRA or your spouse’s IRA into the company? This is possible if your ownership and control is below 50%, but this question is very complicated and nuanced, so you’ll want to discuss it with your attorney or CPA who is familiar with this area of the tax law.

If a prohibited transaction occurs, the self-directed IRA is entirely distributed. That’s a pretty harsh consequence and one that makes compliance with this rule critical.

Need to Know #2: UBIT Tax

The second rule to understand is a tax known as Unrelated Business Income Tax (“UBIT”, aka, “UBTI”). UBIT is a tax that can apply to an IRA when it receives “business” income. IRAs and 401(k)s don’t pay tax on the income or gains that go back to the account so long as they receive “investment” income. Investment income would include rental income, capital gain income, dividend income from a c-corp, interest income, and royalty income. If you’ve owned mutual funds or stocks with your retirement account, the income from these investments always falls into one of these “investment” income categories. However, when you go outside of these standardized forms of investment, you can be outside of “investment” income and you just might be receiving “business” income that is subject to the dreaded “unrelated business income tax.” This tax rate is at 39.6% at $12,000 of taxable income annually. That’s a hefty rate, so you want to make sure you avoid it or otherwise understand and anticipate it when making investment decisions. The most common situation where a self-directed IRA will become subject to UBIT is when the IRA invests into an operational business selling goods or services who does not pay corporate income tax. For example, let’s say my new business retails goods on-line, and is organized as an LLC and taxed as a partnership. This is a very common form of private business and taxation, but one that will cause UBIT tax for net profits received by self-directed IRA. If, on the other hand, the same new business was a c-corporation and paid corporate tax (that’s what c-corps do), then the profits to the self-directed IRA would be dividend income, a form of investment income, and UBIT would not apply. Consequently, self-directed IRAs should presume that UBIT will apply when they invest into an operational business that is an LLC, but should presume that UBIT will not apply when they invest into an operational business that is a c-corporation.

Legal Tip: IRAs can own c-corporation stock, LLC units, LP interest, but they cannot own s-corporation stock because IRAs and 401(k)s do NOT qualify as s-corporation shareholders.

Now, if you’re an LLC raising capital from other people’s IRAs or 401(k)s, you should have a section in your offering documents that notifies people of potential UBIT tax on their investment. UBIT tax is paid by the retirement account annually on the net profits the account receives so it doesn’t cost the company raising the funds any additional money or tax. It costs the retirement account investor since UBIT is paid by the retirement account. Despite the hefty tax, many IRAs and 401(k)s will still invest when UBIT is present as they may be willing to pay the tax on a well-performing investment or their investment strategy. Alternatively, many self-directed IRAs may be investing with an intent to sell their ownership in the LLC as the mechanism to receive their planned return on investment. When selling their LLC ownership, the gain in the LLC units would be capital gain income and would not be subject to UBIT.

If the investment from the self-directed IRA was via a note or other debt instrument, then the profits to the IRA are simply interest income and that income is always investment income and is not subject to UBIT tax. Many companies raise capital from IRAs for real estate purchases or for equipment purchases. These loans from an IRA or IRA(s) are often secured by the real estate or equipment being purchased and the IRA ends up earning interest income like a private lender.


So, here’s a brief summary of what we’ve learned. First, there’s $25 trillion in retirement plans in the U.S. These retirement accounts can be used to invest into your start-up or private company. You need to comply with the prohibited transaction rules and you can’t invest your own account or certain family member’s account into your business as that would invalidate the IRA. But everyone else’s IRA can invest into your company. And lastly, depending on how the company is structured (LLC or C-Corp), and how the investment is designed (equity or debt/loan), there may be UBIT tax on the profits from the investment. Remember, UBIT tax usually arises for IRAs in operating businesses structured as LLCs where the company doesn’t pay a corporate tax on their net profits. This income is pushed down to the owners and in the case of an IRA this can cause UBIT tax liability.

Here’s the bottom line, retirement account funds can be a significant source of funding and investment for your business, so it’s worth some time and effort to learn how these funds can most efficiently be utilized. While there are some rules unique to retirement accounts they can easily be understood and planned for.

Quitclaim Deed Versus Warranty Deed, What to Use?

When it comes to transferring property, such as rental properties into LLCs or your personal residence into a Trust, it can be confusing understanding whether you should use a quitclaim deed or a warranty deed. Here is a brief description of each type of deed and when they should be used.

Warranty Deed – A warranty deed transfers ownership and explicitly promises the buyer that the transferor has clear title to the property, meaning it is free of liens or claims of ownership. The terms of a warranty deed should state that the transferor “warrants” and conveys the property.  The warranty deed may make other promises as well, to address particular problems with the transaction. But generally, the use of the word “warrant” means that seller/transferor guarantees the new owner as to clear title. Because the seller “warrants” clear title under a warranty deed, it is a preferred method of title transfer and should be used by real estate investors and property owners as the default method of transferring title. When transferring title from your own name to your LLC or Trust, the use of a warranty deed typically allows the title insurance you bought when you acquired the property to remain in effect.

Quitclaim Deed – A quitclaim deed transfers whatever ownership interest a person has in a property. It makes no guarantees about the extent of the person’s interest. If you are buying a property from a third-party, you would never want to use a quitclaim deed because they aren’t making any guarantee as to whether they own it or not, or if they have clear title. It would be like paying someone on the street for a set of keys to a car. Who knows whether they own the car or not? You gave them money for it, and if they do own it, you just bought it. But, if they don’t own it, then you’re out of luck and you’ll have to resolve the ownership issue with the person who legally owns it. There are limited situations where a quitclaim deed is used. In some instances, a quitclaim deed is used when the buyer and seller are aware of legal issues or defects to title, so the seller transfers their interest and the new buyer has to resolve the title issues. Another situation, perhaps more common, arises in states that have a transfer tax. For example, some states will exempt transfer taxes on the transfer of title from the owner to their own LLC, but only if it is by quitclaim deed (e.g. Tennessee). When transferring title to your own LLC, we generally aren’t worried about title issues, so the savings on transfer taxes make the quitclaim deed a better option.

Most states don’t have a transfer tax, but to make matters more complicated, some states use the term “grant deed”, California being one of the most prominent. The reality is that a grant deed can be used as a quitclaim deed OR a warranty deed. It essentially depends on the verbiage used inside the terms of the deed itself. If you see words like “warrant” and “convey,” then you probably have a warranty deed. Bottom line: Make sure that you look at the language used in the deed itself. Don’t think that because you have a grant deed you have all of the benefits of a warranty deed.

Our Recommendation – Always double check the local state and county laws regarding the type of deed to use when transferring property, and what the different types of deeds actually provide. HOWEVER, as a general rule of thumb, we recommend the warranty deed when transferring property to yourself, your trust, or your own company because we want to make sure that the Title Policy and all of its benefits transfer to the Grantee of your deed.

Pitching Your Business or Deal with Kevin Harrington from Shark Tank

pitching-your-dealI had the pleasure of interviewing Kevin Harrington on our Refresh Your Wealth podcast last week. Kevin was an original shark on the hit TV Show Shark Tank and appeared on 160 episodes. He is also the founder of the infomercial, a pioneer of As Seen On TV, and a co-founder of Entrepreneur’s Organization (EO). He also took a $500M company public on the NYSE. In short, he’s the perfect person to ask on how to pitch your business, product, or investment. In the podcast you can hear Kevin provide his Top 9 tips for pitching your deal, business, or product. I’ve noted the Top 9 list below and you can check out the podcast here.

  1. Get Their Attention. Start strong and don’t get too far into the details.
  2. Show Problem. Why is your deal, product, or business needed?
  3. Show Solution. What is your solution to the need?
  4. Why are You Unique to Solve. What makes you so special? Why are you the person or company to solve this problem?
  5. Magical Transformation. Show me how this works. Wow me with how cool this is.
  6. Have Testimonials. Have testimonials of people who’ve experienced your company, product or service.
  7. Irresistible Offer. Make an irresistible offer. In the case of courting an investor, make me feel good about getting my money back first. Provide a term that I get paid back my cash investment first before you take any profit. For a product or service, give me a call to action.
  8. Use of Proceeds. If I’m investing money, tell me how the money is going to be used. Is it buying a property, inventory, funding R&D, or paying your salary? That makes big difference.
  9. Create an Invest or Buy Now Incentive. I may be interested but why should I do this now while you have my attention. Close the deal and give me comfort that this will be okay (money back guarantee, warranty, personal guarantee).

I’ve listened to plenty of clients explain their deal and/or business and found this list to be very insightful and practical. Enjoy!

You can find this interview as well as hundreds of other episodes on iTunes under Refresh Your Wealth or at Pleas subscribe and tune in weekly for new episodes.


College Savings Accounts: Coverdell Versus 529


Its college application season and like most parents, I’ve had to plan on how to help my kids afford college. As you make your plans, consider the two most common tax favored savings tools available.

There are two types of accounts that you can establish to save for higher education expenses in a tax favorable manner. These two types of accounts are Coverdell Education Savings Accounts and 529 Plan accounts.

The first type of account is known as a Coverdell Education Savings Account. A Coverdell account is typically set up for the higher education expenses of a child.  The contributed funds grow in the account tax deferred and the money comes out for education expenses tax free. There is no tax deduction for amounts contributed to a Coverdell but you do have significant investment options including self-directed investment options (similar to IRA rules). A Coverdell has the following rules and benefits.


  • $2,000 annual contribution limit per beneficiary (e.g. child or grandchild).
  • Parents (or grandparents) can contribute without limitations to a Coverdell until a beneficiary reaches age 18 if the contributor has income of $190k (married joint) or $95,000 (single).  For high-income earners, keep in mind that the child can always contribute to their own account with gifted funds (no need to have earned income).
  • Funds can be used for tuition, fees, books, and equipment for college as well as certain K-12 expenses too.
  • There are zero federal or state income tax deductions on Coverdell accounts.


  • Accounts can be invested into stocks, mutual funds, and can even be self-directed. They operate similar to an IRA.
  • Contributions grow tax-free and can be withdrawn for education expenses until the account beneficiary reaches age 30. Unused amounts can be transferred to another family member beneficiary.

The second type of account is a 529 Plan account. Contributions to 529 Plan accounts can be eligible for a state income tax deduction (depending on the state). Money contributed to a 529 Plan account is invested into a state managed fund. A 529 has the following rules and benefits.


  • Amounts are invested into a state run program.
  • Amounts can be withdrawn for tuition, fees, books, supplies, equipment, special needs, room and board.
  • Up to a few hundred thousand dollars can be invested per beneficiary by any person.
  • There are no federal tax deductions or credits for contributions.


  • Many states offer tax deductions for contributions to 529 Plan accounts. For example, Arizona offers a $4,000 tax deduction for married tax filers and a $2,000 deduction for single filers. Thirty-five states offer some type of state income tax deduction for 529 Plan contributions. However, there are some states, like California, who offer no tax deduction for contributions to 529 Plan accounts. Click here to see a comprehensive list that outlines the different state funds and tax deductions (or credits for some states).
  • Downside, invested amounts must be invested solely into state run programs. There are no other investment options.

In summary, Coverdell accounts have the benefit of allowing account owner’s to decide how the money will be invested with zero tax deductions available on contributions while 529 Plan accounts give you zero investment options (all funds go to state run fund) but offer state income tax deductions in most states.

If you live in a state that offers a tax deduction on contributions, such as Arizona, then the 529 Plan account is a great option if you can stomach having the money go into a state run fund. On the other hand, if you live in a state with zero income tax (e.g. Texas or Florida) or if you live in state with zero 529 Plan deductions (e.g. California) then you might as well use a Coverdell account because you’re not trading any tax deductions for investment options. For those who can’t make up their mind and who have the funds, consider doing both. There is no restriction against doing a Coverdell account (no tax deductions, but investment options) and a 529 Plan account (possible state tax deductions but no investment options).

Raising Capital in a Partnership or Joint Venture

Partnerships and Raising Capital

Raising Capital in a Partnership or Joint Venture

We’ve all heard the buzz words of crowdfunding, PPMs, and IPOs, but there are less complicated ways to raise money and start a business and one of the most reliable and most used methods is that of partnerships or joint ventures.

If you ‘re raising money from others in an LLC, partnership, or joint venture, you must take specific precautions in structuring your documents so that the investment of money from any member, partner, or joint venturer does not constitute a violation of federal or state securities laws. Failure to comply with the securities laws can result in civil and criminal penalties. Many real estate investments, real estate developments, and emerging companies rely on numerous strategies to raising capital that are outside of publicly traded stock and that do not require registration with a state securities division or the federal Securities and Exchange Commission. This article addresses those strategies and outlines some of the key issues to consider when raising funds through an LLC, partnership, or joint venture arrangement. This article addresses the legal considerations that should be analyzed when bringing in “cash partners” or “investors” into your LLC, partnership, or joint venture.


The courts have widely held that an investment in an LLC, joint venture, or partnership is a security when the investor is investing solely cash and has no involvement, vote, or say in the investment. In these instances where the investor just puts in cash (sometimes called “silent cash partner” arrangements), the investment will likely be deemed a security. In a famous securities law case called Williamson, the Fifth Circuit Court of Appeals held that a joint venture contract investment is a security if the investor has little say or voting power, no involvement in the business or investment, and no experience that would provide any benefit to the business or investment.Williamson, 645 F.2d 424. As a result, to avoid triggering these factors and having your investment or business deemed a security we strongly recommend that all investors in Joint Venture agreements, LLCs, or partnerships have voting rights and that they participate in the key decision-making functions of the investment or business. Investors do not have to be part of the management team but they do need to have voting rights and need to have real opportunities to use those voting rights. For example, they could have voting rights on incurring additional debt, on management compensation, and/or on buying or selling property.


In most LLCs with cash partners, the person organizing the investment and running the operations is often the manager of the LLC, partnership, or joint venture and has the ability to bind the company or partnership. When making this selection as the manager, it is key that you do not give yourself unlimited control and authority. If you do give yourself unlimited control as manager, your investors may be deemed to have purchased a security since their voting rights will have been extinguished by placing to much control and power in the manager/management. What is recommended is that the members have the ability to remove the manager by majority vote and that the manager may only make key decisions (e.g. incurring debt, selling an asset, setting management salaries, etc.) upon the agreement and majority vote of the investors. While key decisions and issues should be left to the members, day to day decisions can be handled by the manager without a vote of the members/investors.


The Courts have consistently held that even if an investor is given voting rights and has an opportunity to vote on company matters that the investor’s interest can be deemed a security if there are too many other investors involved in the LLC, JV, or Partnership. Holden, 978 F.2d 1120. As a general rule of advice, you should only structure investments and partnerships that include 5 or less cash investors as the securities laws and the involvement of more individuals than this could potentially cause the investment to be deemed a security. When there are more than 10 investors it is critical for clients to consider structuring the investment as a Regulation D Offering and that they complete offering documents and memorandums and make a notice filings to the SEC. Many people refer to this type of investment structure as a PPM.  When there are a lot of investors involved, a Regulation D Offering provides the person organizing the investment with exemptions from the securities laws and can allow someone to raise an unlimited amount of money from an un-limited amount of investors.

In sum, there are many factors and issues to consider when raising money from others in an LLC, JV, or partnership and it is crucial that you properly structure and document these investments so that they can withstand these challenges of securities law violations. For help in structuring your investments please contact the law firm at 602-761-9798

SEC Rule 506 in 2016: Advertising and Raising Money From Unaccredited Investors Explained

advertising-and-raising-money-from-unaccredited-investorsIn 2012, the JOBS Act amended the rules for private placement offerings (aka “PPMs”) to allow companies to advertise and solicit their offerings to prospective investors. Under prior law, a PPM could not be marketed or solicited to people whom the offeror did not have an existing relationship with.  Hence, the use of the word “private offering” in the labeling of these types of investments.

This new type of offering allows advertising and general solicitation and is known as a Rule 506 (c) Offering. Under Rule 506 (c), the company raising money could create a website soliciting the funds, or they could hold seminars or meetings with potential investors and could solicit the investment of funds from those in attendance. This is a significant change to the prior offering rules that clearly prohibit such activities.

Under the new Rule 506 (c) Offering there is one hitch: the person raising funds may only accept funds from accredited investors. An accredited investor is someone who has $200K in annual income ($300K if married) or $1M in net worth (excluding equity in home). The accredited investor status must be documented by the investor or certified by a third party such as an accountant or financial planner. This verification rule is a new requirement for Rule 506 (c) Offerings and is ALWAYS required if you make general solicitation and marketing efforts for investors.

Under the traditional Rule 506 offering, now known as Rule 506 (b), you may not make general solicitations for investors and that is the major downside. However, you may raise money from up to 35 unaccredited investors per offering and that is something you cannot do under the new Rule 506 (c). Keep in mind, the offering must remain private. So, moving forward, those seeking to raise money under Regulation D approved offerings have two options. First, raise money under the current rule and you can accept up to 35 unaccredited investors but are restricted from advertising. Or, second, only accept money from accredited investors but be allowed to advertise the offering. You don’t get both options in one (advertising and unaccredited investors) but at least you now have another option in being allowed to advertise and solicit under the new rules.

Here’s a quick chart the outlines the two Rule 506 Options. The key differences are highlighted below.


Rule 506 (b)Rule 506 (c)

Total Amount You Can Raise


Offering Docs Required


Offering Memorandum, Sec Form D Filing, State Securities Filing, Company LP or Operating Agreement, Investor Suitability Quest. 

Offering Memorandum, Sec Form D Filing, State Securities Filing, Company LP or Operating Agreement, Investor Suitability Quest.


Accredited Investors 


Un-limited accredited investors and up to 35 unaccredited investors who are sophisticated enough to invest.


Accredited investors only. Unlimited accredited investors. Must verify they are accredited.
Marketing of OfferingMust remain private. Can only market to persons with an existing relationship. 


Marketing and general solicitations are allowed. You amy market via websites, e-mail campaigns, and at events or meetings.