Angel investors are often the lifeblood of early-stage and startup businesses. In addition to providing much-needed capital, angels also typically provide strategic insight, guidance and expertise for new businesses.
The importance of the financial stimulus provided by angel investors for early-stage companies can’t be overstated. The Angel Capital Association estimates that angel investors provide as much as 90 percent of outside equity for startups, with individual investments averaging between $10,000 and $25,000. Software companies constitute the largest angel investment sector, followed by healthcare, pharma and biotech, and commercial services.
Founders typically use angel investments to prove that there is a market opportunity for the business, and also to receive validation of their business plan. Once businesses receive a certain level of validation, founders can leverage that success to raise additional capital through venture funding, or raise additional funding from angels as their businesses enter the growth stage.
Angel investing using a Rocket Dollar Solo 401(k) or Self-Directed IRA makes sense for a number of reasons. Here are the top three:
- Hold time
- Tax Benefits
Angel Investing With a Rocket Dollar Account
1. Hold time
Angel investing through a retirement account should be viewed as a long-term commitment. Average hold times for angel investments in startups is about seven years, and oftentimes that horizon is much longer. Due to the length of time, mid-career professionals and younger investors are well-suited to use a Rocket Dollar Self-Directed IRA or 401(k) plan for angel investing. Average hold times also stretch to more than a decade when companies accept venture funding. According to Strategic Exit Corp’s AngelBlog, accepting VC investments lengthens exit time to 12 years after angel investment. Angel investing also can be risker, since there is no guarantee a startup or early stage business will be successful. Angels should use a relatively modest percentage of their total retirement net worth for angel investing since it can take years for the investment to actually pan out. Angels should know that investing through a Rocket Dollar Self-Directed retirement account limits their ability to be a head or key employee of the company or own more than 50 percent of company equity, as there are some IRS rules against self-dealing.
2. Tax benefits
Angels can invest using pre-tax dollars from their retirement accounts and avoid paying capital gains taxes, which range from 15 to 20 percent. If the business is successful, angels either pay no taxes on their investment if they use a Roth IRA as the investment vehicle or defer taxes until retirement age with a traditional IRA. Perhaps the best-known example of using an IRA for angel investing is PayPal co-founder Max Levchin, who invested in Yelp through his Roth IRA. His investment was reportedly worth tens of millions, and the gains will remain tax free.
Putting your retirement dollars to work in pre-tax angel investments preserves on-hand liquidity. Angels not only save the ready cash in their after-tax accounts for other uses, but they also can easily grow the scope of their angel investments if companies are successful. An angel may decide to use pro-rata rights and increase their investment, but make the investment from a retirement account. Angel investing with a Rocket Dollar account allows investors to protect important liquidity and also diversify their retirement assets using tax-free dollars.
Angels can unlock the investment power of their retirement dollars using a Rocket Dollar Self-Directed solo 401(k) or Self-Directed IRA. These accounts offer significant tax savings for angel investments, and accounts are created entirely online in just a few minutes.