7 Strategies for Incorporating Private Equity and Venture Capital Into Your Retirement Portfolio

Including private equity in your retirement plan can take many forms. Shutterstock

Private equity was noticeably left out of retirement savings portfolios for many years. A 2020 Department of Labor ruling changed that when it clarified that private equity was an acceptable form of investment in retirement savings plans. Due to the high reward potential of private equity and venture capital investments, the popularity of these types of investments has grown in recent years.

When you invest in private equity, you are investing in private companies with the goal of improving their value over time. Usually, it’s not until a larger company buys the company or goes public that you see a return on your investment. Venture capital is a subset of private equity focusing on early-stage startups with high potential growth.

Including private equity in your retirement plan can take many forms, and at first glance, it can seem both appealing and overwhelming. Consider these seven ways to take advantage of private equity’s benefits in your retirement portfolio.

Strategy 1: Use Self-Directed Individual Retirement Accounts (IRAs)

IRAs are a retirement savings accounts used by tens of millions of Americans. They allow investors to buy into stocks, bonds, and mutual funds to grow their retirement savings. But, private equity is not one of the assets available to traditional IRA investors. This is where self-directed IRAs (SDIRAs) come in. SDIRAs allow for a broader range of alternative investments and are one of the key ways to invest in private equity.

Riskiness

Private equity provides unique investment opportunities that are not available in public markets, such as private businesses, startups, and real estate deals, that have the potential to offer high returns. However, most experts will tell you they are riskier than traditional IRA investments for several reasons:

• Less Liquidity. Private equity usually involves long-term commitments. Investors will likely need to hold these investments for several years before seeing any returns.
• Increased Complexity. IRS rules regarding SDIRAs are more complicated and generally require expert management.
• Less Transparency. There is usually less information about private companies, making it harder to assess performance and risks.

Steps to Invest in SDIRAs

If you decide the risk is worth the potential reward and go ahead with this investment strategy, you must follow several steps. First, you must find a trusted custodian specializing in SDIRAs. Some popular SDIRA custodians include Equity Trust Company, Entrust Group, Advanta IRA, and New Direction Trust Company.

Once you have chosen a custodian and opened an account, you can transfer money into your SDIRA by rolling over from an existing IRA or 401(k), transferring from another IRA, or making a direct contribution.

The last but most important step is to identify the right private equity investments for you. Doing your due diligence before choosing where to invest your hard-earned retirement savings is crucial. It may also be worth consulting with a trained professional before pulling the trigger.

Strategy 2: Pension Fund Allocation to Private Equity

Since the 1980s, pension plans have been eclipsed by the formidable 401k. However, millions of Americans still depend on pension plans for their retirement savings.

A pension fund combines contributions from employers and employees and invests the pooled funds to provide retirement savings for the company’s staff. Once an employee buys into a pension fund, fund managers are in charge of the financial decisions, and they may (or may not) decide to invest in private equity.

Private equity might attract pension fund managers because it can diversify their portfolios, reduce volatility, and even produce higher returns. However, the same risks associated with private equity mentioned above apply to pension funds, too. Less transparency and liquidity, combined with long-term horizons, can have consequences that affect the overall health of the pension fund.

It is important to reiterate that whether or not your pension fund invests in private equity is largely out of your control. If your pension fund allocates funds to private equity, it is important to know the risks and benefits.

Strategy 3: Equity Crowdfunding Platforms

At their most basic level, equity crowdfunding platforms offer companies and small-scale investors an opportunity to connect. They allow companies to secure funding without going to banks or venture capitalists and enable everyday people to invest in startups or businesses they believe in and support.

You will first need to choose an equity crowdfunding platform to get started. Some popular equity crowdfunding platforms include WeFunder, StartEngine, Republic, and DealMaker. Once you have created an account, you can browse the platform’s investment opportunities. When considering investing in a company, please do your best to understand its inner workings and financial health.

It is also essential to understand your exit strategy. You will likely only see returns if the company goes public or a larger company buys it. Remember that you may never see returns; if you do, you must be patient.

Pros of Equity Crowdfunding

• Companies can raise money without going to banks or venture capitalists.
• Anyone can invest in startups or businesses they believe in and support.
• If the company does well, the value of the shares can increase, potentially giving investors a return on their investment.

Cons of Equity Crowdfunding

• Many new businesses fail, and investing in startups and small businesses can be very risky. There’s no guarantee the company will succeed or that the shares will become valuable.
• It can be hard to sell your shares if you need the money back.
• Businesses that raise money through equity crowdfunding rarely pay dividends to investors. Investors usually prepare for a long wait to receive a return finally.

Strategy 4: Fund of Funds Approach

A fund of funds (FoF) invests in funds that invest in private equity rather than investing in private equity itself. When you invest in a fund of funds, your money is pooled with money from other investors, and the FoF manager spreads it across private equity funds. Once you buy into an FoF, the manager handles your financial decisions, making it more hands-off than equity crowdfunding or SDIRAs.

Another benefit of funds of funds is that they give investors access to private equity who don’t have the financial means to invest in funds with higher barriers to entry, such as hedge funds.

However, funds of funds are complicated beasts, and the fees associated with them are typically quite high. You pay fees to both the fund of funds manager and the managers of the underlying private equity funds, which can quickly add up.

Strategy 5: Secondary Market Investments

Some investors find the long waiting periods and inflexibility of primary market private equity investments to be a turnoff. For those types, the private equity secondary market can be an appealing option because it alleviates some of the risks associated with investing in private equity.

Secondary market investments refer to trading existing investments in private equity. In the secondary market, investors can exit their investments earlier than the fund’s intended lifespan and feel at ease knowing their assets are liquid.

Private equity in the secondary market is also more transparent. Since secondary investments have been held for some time, more data is available, making understanding the actual market value easier.

Secondary markets are a great way to incorporate transparency and flexibility into your private equity portfolio in the otherwise long-term and illiquid private equity landscape. Although the minimum investment in secondary markets is generally relatively high, some funds pool capital from multiple investors, allowing individuals to participate with smaller investments.

Strategy 6: Direct Investment Through LLCs

Limited Liability companies, or LLCs, are business structures that protect your assets, provide tax advantages, and create an image of professionalism and credibility. For these reasons, many investors in the private equity market choose to pass their investments through an LLC.

But, setting up an LLC entails a fair amount of paperwork and comes with many federal and state regulations. To maintain an LLC, you must pay annual filing fees and comply with state and federal regulations.

One of the main drawbacks of an LLC is the bureaucracy involved in setting up and maintaining it, and it is important to consider whether this strategy is worth the headache. If you are interested in investing through an LLC, it is always a good idea to discuss the pros and cons with a qualified professional and utilize their services if you decide to move forward.

Strategy 7: Venture Capital Trusts (VCTs)

Venture Capital Trusts (VCTs) are investment companies designed to incentivize investment in smaller, private companies in the UK.

Although VCTs are listed on the London Stock Exchange, the companies they invest in are not publicly traded. They are merely a vehicle through which everyday investors can support and benefit from these companies while also boosting startups and small businesses in the UK.

This investment opportunity was designed for UK taxpayers, and the tax advantages associated with them are specific to the UK tax system. Although non-UK residents can technically invest in VCTs, it is important to remember that many of the tax advantages of VCTs, such as tax relief and tax-free dividends, will not apply to them.

Working With Experienced Professionals

Seeking expert guidance is key when deciding whether to include private equity in your retirement portfolio. Different specialists can help you understand its many considerations, such as complicated tax requirements, fees, exit strategies, and long-term investment horizons. Some professionals you may want to consult include financial advisors, tax experts, accountants, and legal advisors.

If you decide to invest in private equity, ongoing management of your investments is essential. Experts can help you manage your investments and ensure you are making the most of them.

Practical Considerations for Retirement Investors

There are many factors to consider when deciding whether to invest in private equity. The first is to determine your own level of risk tolerance and decide whether riskier (yet higher potential yield) options like equity crowdfunding are excellent options for you.

Another important consideration is your investment horizon. Because private equity investments are less liquid and take a long time to produce returns, it is essential to determine when you expect to start tapping into your retirement savings. Private equity might be a good option if you don’t plan on touching your retirement investments for tens of years. Private equity investments might not be the best idea if you want to tap into your retirement savings in the next few years.

Conclusion

Ultimately, your commitment, risk tolerance, and unique financial goals will determine whether you should incorporate private equity and venture capital into your retirement portfolio.

If you do decide to take this route, there are many options, each with its own advantages and pitfalls. Doing your own research is an excellent place to start, but it is always a good idea to seek professional advice before making investment decisions that significantly impact your future.

By John Boitnott

The Epoch Times copyright © 2024. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.