Question: I have a self directed traditional IRA with a custodian that allows private placement investments.
I would like to invest some of the IRA in an early stage S-Corp, initially as a 1 year unsecured convertible note at 8% interest that then converts into common stock once the company turns into a C-Corp (this will likely be a Series A VC event).
In doing diligence on the company I have found that it is not only attractive as an investment, but I am also a perfect fit for it and they agree and want to hire me.
Can I invest $100K via my IRA and take about 2.5% ownership in the company (no other disqualified parties have any relationship with the company), then become an employee, or would this be considered benefitting me and therefore a prohibited transaction? If so, I have to choose being becoming an investor or an employee, but I want both.
I believe it is an excellent investment as well as job opportunity. I would not be “buying” my employment, it’s a great fit. It would be a fabulous job, love to do it and work with some great people on a very worthy vision and business. If important info, none of us are getting paid for the first few months as all money is going into product and biz dev.
Answer: Thank you for your question. In my view you would certainly be taking a risk by having your IRA invest as you suggest in your question. You appear to be well informed of the issues, but allow me to clarify them just in case. First of all, as I’m sure you know the corporation would not be a disqualified person as to your IRA since no disqualified person would own 50% or more of the corporate stock. That’s the good news. On the other hand, you personally are a disqualified person (fiduciary) as to your own IRA, so any investment that you make with your IRA which either directly or indirectly benefits you (other than as a beneficiary of the IRA) could be considered a prohibited transaction. Additionally, the corporation would likely be considered to be a person in whom you have an interest which would affect your best judgment as a fiduciary for your IRA. If you do want to proceed with this investment after consulting with a lawyer familiar with the prohibited transaction rules, you will want to open a separate IRA in case the transaction is later determined to be a prohibited transaction.
I have attached a paper I presented at a boot camp on IRA owned entities last year (found at www.questira.com). Although much of the material is not relevant to your question, there are a number of cases which may be useful to you and your attorney in helping to understand the issues with this transaction. You may want to review Section XII of the paper and the Advisory Opinion Letter 89-03A in Appendix 13. While not directly on point, it does show the sensitivity of the issue of investing in a company where you work. I wish you the best of luck. Let me know if I can answer any more questions for you. Have a great day!