In part 5 of our series,”Start Investing with your Solo 401k” we’ll cover Venture Capital. Click the links below to read the other installments in the series:
What is Venture Capital?
Venture Capital investing is a type of investing that is very high risk, but can sometimes have a high reward. With VC investing, you’re putting money into a new idea or company that has yet to prove itself. Because of the “newness” factor, there is a high probability that the new idea/company will fail. However, because you’re investing in the very beginning of the idea/company, your rate of return if the idea/company succeeds is much higher than investing in a well-established company.
For example, Jeff Bezos (the founder of Amazon) invested $250,000 into Google in 1998. 6 years later that investment was worth over $280 million. Today, that investment would be worth 1.8 billion!
Keep in mind here that when Mr. Bezos originally invested, Google was still in the “garage” stage. Think: Steve Jobs and Steve Wozniak creating the Apple empire. The investment would have been considered risky and maybe even reckless. This is the nature of Venture Capital investing.
All investments carry risk, but VC is one of the riskiest out there.
How do New Companies Get Started Fundraising?
Silicon Valley is flooded with Venture Capital firms and companies pitching to those firms. These Venture Capital firms stay afloat because they know that, even if they invest in 10 companies and 9 of those companies fail, the 1 company that succeeds (and succeeds big), will make up for the other losses.
These large firms, using accredited investor’s funds, have been able to invest in this way for quite some time, but only recently, due to changes in laws, has the average investor been able to also invest in this way and reap the rewards. Keep in mind that because of the speculative nature of VC investing, many opportunities are limited to accredited investors.
Where to Find VC Opportunities
What should a a Solo 401k trustee do to find companies to invest in? What’s the due diligence process for vetting potential companies? How do I invest small amounts in multiple different deals, so as to mitigate any losses?
Like all the other investments we’ve covered, there are many websites that cater to both startup companies and Venture Capitalist investors.
Below are some sites that allow for entrepreneurs to pitch their concepts/new businesses and for investors to invest in the ones they like.
VC Online Resources
- WeFunder – You can start investing in a start up with as little as $100.Their motto is “Kickstarter for investing” as they fund the startups via crowdfunding. Investments here will be held long term. Wefunder encourages investors to invest in something they love and believe in.
- SeedInvest– The minimum investment here is $200. After signing up, you’ll need to contact the company to supply your Solo 401k trust information. They also have live chat available on their site for questions.
- StartEngine – StartEngine has a $100 minimum investment. View their investing success stories on their main page. Each startup has a different initial investment amount, so check out their startups for details before investing.
- EquityNet– This site is unique as you aren’t able to invest directly on their site. EquityNet’s role is to connect you with entrepreneurs who are seeking funding.
Always verify if the above-named sites require you to be an accredited investor. If so, you may be required to prove your accredited investor status.
What is the best way to invest in VC?
If you’re looking at using your retirement funds for the largest tax advantage, consider investing with Roth funds.
Let’s look back at our original Jeff Bezos example. Jeff invested $250k in 1998 which later turned into $280,000,000.
If Jeff would have made the investment with traditional (pre-tax) retirement funds, his growth would ultimately be taxed upon distribution. That means he would have potentially owed taxes on literally hundreds of millions of dollars! Even if he kept the majority of funds in the retirement account, any amount he distributed would be subject to taxation.
However, if Jeff invested with Roth 401k funds, all of his earnings and profit could later be distributed tax free!
Tips for investing in Venture capital
Here are some best practices we’ve found for VC investing:
- Only invest as much as you’re willing to lose. While the returns on VC investing can be very lucrative, most startup companies fail, leaving you without your investment funds and a 0% return.
- Invest small amounts in several companies, not a large amount in one company.
- Do your research. Always due diligence the company you’re investing in: Look at the history of the founders, the processes in place, and the setup of the company. Most of these sites will allow you to contact the startup company directly, so if you have questions you can contact them directly.
- Start small. Don’t bet your entire Solo 401k balance on high risk investments. Because these investments have such a high rate of return, only a very small percent of a portfolio is needed to reap the benefits.