Venture capital investing with a Solo 401k is on the riskier side of private placements. All investing is about risk and reward. With venture capital, the risk is high but so is the potential reward. At one end of the risk-reward spectrum are low-risk investments such as rental houses that typically seek a return of 10% or slightly higher each year. At the other end of the spectrum are angel investors and capital investors that are often seeking a return of 5X, 10X, 50X, or more of their original investment.
How to Turn $1K into $3.6 Million
One of the most famous of all startup company stories has to be how Bill Gates and Paul Allen started Microsoft. As a couple of high school computer geeks in the early 1970s, the two were caught hacking into the school computer system when access to computers was hard to come by. Instead of being expelled or banned from the computer lab, they were offered unlimited computer time in exchange for helping to improve the school computer’s performance. In 1975 they developed software for use on an early personal computer (PC) – the Altair. By 1980, they had sold the basic PC operating system (MS-DOS) to IBM for its first PC. Microsoft was originally founded in 1976 and became a publicly traded corporation in 1986. Many would say that Microsoft is the father of the information technology (IT) industry. An investment of $1,000 at the initial public offering (IPO) was worth more than $3.6 million in 2021. A venture capital investment made before the IPO would be worth much more.
What is Venture Capital?
Every great company starts with a great idea, but even the best ideas won’t go far without money. That’s where angel investors and venture capital investors play a critical role to take a great business idea from a home garage operation to an IPO worth $Billions$. Different stages of venture capital are needed to fund the growth from a vision, through preliminary development, into a prototype, a viable product/service, and into a profitable income stream.
Many of the most successful companies, such as Google and Amazon have been funded and grown from venture capital investments. Of course, that doesn’t mean that every venture capital investment will grow into a global company. Many companies die during the early development phases even when they have solid financial backing. Venture capital investing is definitely at the risky end of the investment spectrum.
There are multiple stages of venture funding that a growing company passes through. Venture capital investing with a Solo 401k can occur at any stage or during all stages. Each stage of funding offers the VC investor an opportunity to own a larger share of the company. Generally, the major rounds of venture capital investing are:
- Seed round funding. This is the first round of VC funding. It is also usually the smallest round of funding. It is often known as the ‘angel investor round.’ This round usually requires the smallest investment for a relatively large ownership share of the company because it is the highest risk investment. The typical intention of seed capital is to help a new company develop its business plan and create a viable product. This is the stepping stone toward advanced funding stages in a startup’s lifecycle.
- Early-stage funding. Typically designated as series A, series B, and series C rounds, early-stage capital helps startups get through their first stage of growth. The funding amounts are greater than the seed round, as startup founders are ramping up their businesses.
- Late-stage funding. Series D, series E, and series F rounds happen after the company is earning revenue. The company might not be profitable, but money is coming in. Hopefully only series D funding is needed for the company to become profitable so that it can begin financing its own growth. The E and F rounds might not be needed, or they might be used to finance robust growth beyond what company profits can fund. Late-stage funding is also used to keep the company private a little longer before an IPO makes it subject to Securities and Exchange Commission (SEC) rules.
Venture capital investing with a Solo 401k has the objective of growing a company or portfolio of companies to become attractive targets for acquisitions by larger companies or IPOs. The point is to sell off your stakes for an extremely high profit.
How Venture Capital Investing with a Solo 401k Works
Venture capital investing with a Solo 401k gives you the freedom to invest with the ease of a checkbook control structure. That means no middlemen are required to approve the investment and no separate or annual transaction fees are charged. Venture capital investing with a Solo 401k has major tax advantages because the gains from the investment flow back to the retirement account without being subject to tax. In the case of a Roth Solo 401k, the income or gains can be fully tax-free.
Note: If you invest through a managed venture capital fund, they will likely charge a fee for managing the fund (typically around 2%).
Think of venture capital investing as another form of private placement – another alternative investment not available to most other retirement fund investors (such as employees invested in a corporate 401k). When venture capital investing with a Solo 401k, the business owner or plan participant (you) serves as trustee. You make a venture capital investment the same as you would a private placement – simply by writing a check or wiring funds directly from your Solo 401k bank account to the appropriate account of the startup company. Of course, you would first perform your due diligence and complete all necessary investment documentation between your Solo 401k and the startup company. This would include assuring that all returns on your investment are directly deposited in your Solo 401k to maintain the tax-advantaged status. You will have total control over your retirement funds.
Venture capital investing with a Solo 401k can be with or without a formal business structure. It will be through the tax number of your Solo 401k but your Solo 401k can be set up for a sole proprietor. Your Solo 401k can also be set up as an LLC, C Corporation, S Corporation, or partnership. Your Solo 401k can make a venture capital investment right alongside much bigger investment funds such as institutional investors. pension funds, and wealth managers.
Who Can Become a Venture Capital Investor?
Anyone can become a venture capitalist (VC) as long as they have the necessary skills and knowledge needed. This includes investing with a Solo 401k. You do not need a license.
VC investors may or may not be accredited investors, a classification that is given only to investors with very high incomes or net worths. With the passage of the 2012 Jumpstart Our Business Startups Act, the criteria for startup investors were expanded to include more everyday retail investors, including crowdfunding campaigns.
VC investors are found in many professions and have various backgrounds including:
- Business professionals, such as lawyers, doctors, accountants, financial advisors, and other professions.
- Small business owners and entrepreneurs who have launched and managed successful companies.
- Corporate executives with experience managing successful businesses.
- Crowdfunding platforms that raise pools of money in groups, with each person investing a small amount in exchange for a small share of any eventual profits, if the company proves successful.
- Other investors know how to recognize startups with a bright and profitable future.
Becoming a VC doesn’t require a college degree or any other formal education. However, you need some basic knowledge which you can read from many books written by experts and is widely available on the internet. Still, nearly 50% of VCs have an MBA degree. Therefore, having a college degree or an MBA is not a bad thing.
Advantages and Disadvantages of Venture Capital Investing with a Solo 401k
Every opportunity is different and performing due diligence is essential before venture capital investing with a Solo 401k. It’s always wise to recognize that VC investing is at the high-risk end of the risk-reward spectrum. But the rewards can also be at the high end.
VC Investor Advantages
- The most obvious advantage of VC investing is the potential to make a substantial amount of money. For instance, if you have a 10% early stake and the company becomes worth $3 million, you could get a $300,000 payout.
- If most of your investments are delivering low or no earnings (stocks and bonds), becoming a VC is one way to diversify your investment portfolio.
- You receive an equity share in the business.
- You are getting in at the ground floor and a small initial investment might grow exponentially.
- Successful startups are often acquired by a large company for a substantial amount of money that is paid to the business owners.
- The startup might go public, making your shares much more valuable immediately and with an opportunity to grow even more in the short-term future.
- After an IPO, you can sell enough shares to recover your original investment and continue to earn free money as the company grows.
- Many venture capitalists take on these investments because they enjoy being able to help young companies gain their footing.
VC Investor Disadvantages
- While investing in startups can have incredible rates of return, it’s also a risky endeavor.
- Not all investments will generate hefty returns. It’s estimated that for every 20 investments, a VC makes, only one will likely be a huge win. Some will do moderately well, and others will fail miserably.
- If a startup tanks, investors might not be able to recover any of the funding they’ve provided. Even if the company has assets, they’ll first be used to pay any outstanding debts before the rest is divided up among the investors – depending on how the business deal was structured.
- Even if the company does go public, there’s no guarantee that its stock value will climb as high as you expect it to.
- Even if it does perform well initially, the stock could always sink later on.
- Venture capitalism requires a certain degree of expertise and an understanding of how startups operate and how they fit into the larger financial market.
How You Can Hedge Your VC Investment
If you’re thinking about venture capital investing with a Solo 401k, there are a few things you can do as a hedge to protect your investment as much as possible. Clearly, you’ll want to research investing opportunities as thoroughly as possible. If you’re unsure about where to start, you might want to start with a VC group making smaller individual investments. These groups can be a source of invaluable help when you’re a new VC investor.
Before doing anything, you need to gauge how much money you can reasonably afford to lose if the investment doesn’t pan out. If it’s your first time, you might want to start by investing a smaller amount of cash. Also, you might not want to put all of your eggs in one basket. Before you jump into the VC pool, you may want to make sure you’ve got a well-rounded portfolio of other alternative investments. The more diverse your investments are, the easier it’ll be to cushion the blow if your venture investment doesn’t pan out. Investing is the linchpin of any sound wealth-building strategy, but that doesn’t mean you have to limit yourself to playing the stock markets. VC investing is a way to potentially reap some major returns.
Set Up Your Account Now for Tax-Advantaged Venture Capital Investing with a Solo 401k
Not only will you be able to invest in startups, but your Solo 401k also opens up your investment opportunities to other private placements, precious metals, houses, cryptocurrency, land, mortgage notes, and more! Let the gains, rents, and profits go back into your Solo 401k without taxation. Our Unlimited® platform gives you the freedom to invest in virtually any alternative asset, whether it be a rental home, cryptocurrency, a syndicated “insider” business startup, or something else.
Opening your Solo 401k involves very little work for a ton of benefits.