How to Use a Self-Directed IRA to Invest in Startups Without Overstepping IRS Regulations

When considering an investment in a start-up company, the first step is to choose an IRS-approved SDIRA (self-directed IRA) custodian that is able to custody the asset. Start-ups are considered an alternative asset that is not yet publicly traded.

After you have identified the startup investment opportunity, you must do your due diligence on these entities. It is important to research the company financials (if applicable), their legal structure, and their leadership team. Evaluate if it is an equity, SAFE (Simple Agreement for Future Equity), convertible notes, or direct shares investment.

Key Financial Documents:

1. Financial Statements

• • Balance Sheet
  • Profit & Loss Statement (P&L)
  • Cash Flow Statement

2. Revenue Model & Forecasts
3. Cap Table (Capitalization Table)
4. Break-even Analysis
5. Key Financial Ratios & Burn Rate
6. Current & Future Funding Requirements
7. Tax Returns (Last 2-3 Years, if applicable)
8. Corporate Filings
9. Operating Agreement
10. Offering or Memorandum

When conducting your due diligence of the company, a good place to start is by reviewing the company’s revenue generating stream and business model. Ask questions such as how they are generating revenue, how they acquire their customers and if they are scalable. Capital structure and valuation of the startup should also be assessed. How did they structure their capital? Are other investors Involved? Who are they and what are their ownership percentages? Understanding dilution risks and liquidation preferences are also key because it’s important to know how much equity is reserved for future funding rounds or the dilution risk. What is their annual valuation process? SDIRA custodians require an annual valuation of the investment.

Legal and Compliance Due Diligence Key Documents:

1. Articles of Incorporation & Bylaws
2. Operating Agreement (if LLC) or Limited Partnership Agreement (if LP)
3. Shareholder Agreements
4. Intellectual Property (IP) Ownership & Patents
5. SEC Filings (if applicable)
6. Contracts & Vendor Agreements
7. Regulatory Approvals & Licenses
8. Pending or Historical Lawsuits
9. Insurance Policies (Liability, D&O, Cybersecurity, etc.)

Other Things You Should Be Aware of:

You will need to determine if the investment is open to everyone or just accredited investors. What are the qualifications to be considered an accredited investor?

You will Want to Familiarize yourself with IRS Rules and Regulations

Key things to research and question:

• Prohibited Transactions (IRC 4975) – What types of transactions are strictly forbidden? You cannot invest in companies where you or a disqualified person (certain family members) have financial interest. Startups cannot be a company that you already personally own.
• Disqualified Persons – Who cannot benefit from the investment? Simple answer, you and certain family members.

• Self-Dealing Rules – Avoid transactions that personally benefit you as the account holder. You cannot personally receive immediate benefits from the investment. This includes free shares, salary, loans, or perks from the company.
• Required Documentation for Compliance – Ensure that all documents, payments, and transactions are processed through the SDIRA custodian as you cannot personally receive dividends, profits, or distributions from the startup.

You must work with your custodian to make sure that the investment is structured in a way that allows investors to use qualified funds. All earnings derived from the investment are deposited back into the IRA, not to you personally. Consult with your SDIRA custodian to make sure the proper documentation, rules and procedures are being followed. Make sure your custodian reviews and approves the investment to make sure that it is suitable and able to be custodied and held in a SDIRA.

What happens if the company fails, merges or goes public? Knowing how to liquidate and having an exit strategy is recommended. If the company goes public, the investment will need to be transferred to a custodian that is able to custody public investments. Other key elements to consider are how to liquidate a private investment inside an SDIRA, handling M&A, IPOs, buyouts, and tax implications when distributing profits.

Conclusion

Using a Self-Directed IRA (SDIRA) to invest in startups can be a powerful strategy for growing retirement wealth while maintaining tax advantages. However, staying compliant with IRS regulations is crucial to avoid penalties and protect your investment.

By following the proper steps—selecting a qualified SDIRA custodian, conducting thorough due diligence, avoiding prohibited transactions, and understanding UBIT tax implications—investors can safely participate in early-stage funding opportunities. Additionally, structuring investments correctly and ensuring annual reporting compliance helps mitigate risks and maximize long-term gains.

While startup investments carry higher risks, they also offer the potential for substantial returns. With careful planning, adherence of IRS rules, and a well-researched approach, investors can leverage their SDIRA to participate in innovation-driven markets while securing their financial future.