The term angel investing comes from the Broadway theater shows that received funding from wealthy patrons during the production phases long before opening night. The benevolence infused a shared belief in the cast and crew: this thing will be a hit.
Today, angel investing in private startups is similar. It’s pre-seed funding committed to the earliest-stage ventures and can play a crucial role in the startup ecosystem:
Angel investing isn't easy, and participating in this asset class requires an abundance of caution, in addition to a general willingness to potentially lose some or all of an investment. The good news is that new entrants can study what others have done in the past, as the sector has been growing for decades. Several high-profile examples of angel investors and their self-directed investments serve as great case studies for investors as they think about the strategy.
In this overview, Alto covers…
Many investors are familiar with traditional, Roth, SEP, or simple IRAs, which allow investors saving for retirement to defer taxes on the growing value of their accounts. Investment options in these vehicles are usually limited to publicly traded stocks and bonds, mutual funds, and exchange-traded funds (ETFs).
An SDIRA can give individuals more control over their investments. The freedom lets them participate in markets beyond general equities to invest in alternative investments, like real estate, private equity, cryptocurrencies, fine art, and, yes, angel investments.
While this illustration is for demonstrative purposes and does not guarantee a specific outcome, consider a capital infusion of $30,000 into a pre-seed stage idea. In time, say the venture’s founder and team turn the concept into a thriving business, and your allocation grows 3x — or even 10x — in value.
Investing in alternative assets with self-directed IRA capital can combine the potential for multiplicative growth of angel investments with tax-advantages, fueling a portfolio’s realized gains after taxes.
Despite that potential, using SDIRAs to fund angel investments seems to still be underutilized. Many investors don't even know they can self-direct, so there's a general lack of public success stories. And those retirement savers who do know about this option have largely found the process difficult, tedious, and time-consuming.
One factor may be the important concern for investing incorrectly. Many individual investors don’t know whether they need to create a separate entity, or understand the IRS requirements involved.. Most individuals who are new to the space don’t know how to find IRS-approved custodians, or how to coordinate with them. Even if one is able to get set up, how does one execute a transaction properly?
In these cases, it’s easy to inadvertently step outside of compliance, because the old saying rings true: “You don’t know what you don’t know.” Such was the case with one investor, Mrs. Donna McNulty. She used her IRA funds to purchase gold coins, but instead of managing the transactions correctly, she took possession of the asset for safekeeping at home. Court filings reveal that the government saw Mrs. McNulty’s custodial move as a distribution instead of mere “management” of the fund. The misstep cost hundreds of thousands in fines.
Even amid the barriers, more and more investors are increasingly open to using their SDIRAs to participate in alternative investments, including angel deals.
The growth in the public profile of self-directed IRAs for alternative investments is fueled by success stories like that of Peter Thiel.
In 1999, Thiel used just $1,700 of Roth IRA funds to buy underpriced stock in PayPal as part of his founders’ compensation package. It’s a common scenario: in their early stages, many startups can offer very little cash to executives and employees, so they offer compensation in the form of company ownership.
PayPal’s growth exploded in the years to come, with Thiel’s IRA investment returning 227,490%. Upon selling the shares, he didn't take them from the protection of his Roth IRA, so they remained untaxed. The sale’s proceeds went directly to his retirement account, then worth $28.5 million.
But Thiel wasn’t done. He had seen the power of his self-directed IRA’s tax benefits and the growth potential of early stage ideas. So, he used his Roth IRA to buy shares of his new venture, Palantir. The following year, the target was Facebook, where a $500k investment bought him a 10.2% stake, again using Roth IRA funds. He would go on to sell these shares for about $1B in 2012.
Thiel’s story was first reported by ProPublica, painted perhaps as a criticism against runaway capitalism. But Thiel did nothing illegal or immoral. In fact, while critics have aired their opposition, so too have proponents of Thiel’s methods studied his story as a way for savvy investors to use legal tax benefits and existing alternative investment sectors to grow retirement capital.
Thiel’s story took years to unfold. By the time his returns earned public attention, many of the moves to achieve those returns were a decade old. But other stories emerged to show investors what’s possible when they combine retirement funds with alternative investments like pre-seed equity.
First, Thiel’s impressive returns reminded commentators (and their readers) that before the Roth IRA was created in 1998, Mitt Romney was seen as potentially having done something similar.
Some individuals, like Erin Axelrod and Alex Wright-Gladstein, have generously shared their personal experiences with others in webinars, blog posts, and discussion forums. Conversations like these reflect the growing interest in the practice. Whether their goal is to maximize returns, encourage entrepreneurs, or even reduce their own ecological harm — as in Erin’s case — individual investors are increasingly exploring options for self-directed IRA angel investment strategies.
Angels use their own money instead of funds from limited partners (LPs), institutional investors, or intermediaries who can supply leverage in other vehicles . The personal nature of the investment makes pre-seed deals riskier than other asset categories. But it also means that angel investors avoid sharing returns with investment partners and stakeholding financiers.
In 2023, 19,000 startups received $30 billion worth of angel capital. As for the capital provided, startup founders and their co-founders typically deploy those funds to:
But the involvement of angel investors benefits pre-seed companies in other ways, too. Many founders value the advisory services and networking opportunities they receive from some business investors just as much as the funding to launch.
As a practice, angel investing is on the rise. In the past two years, an estimated 300,000 individuals made angel investments. Stories like Thiel’s, the rise of shows like Shark Tank, and even personal anecdotes are making an impact and generating interest. The buzz has created an increase in pre-seed deal value and deal count in the last decade:
With the rise comes widespread societal benefits. Champions of pre-seed deals from the ACA’s Desert Angels investment group note that these capital infusions serve as a 21x economic output multiplier.
Angel investments led to many of the products and services used today. You may know of the more famous startup success stories like Uber and Airbnb, but for every unicorn, there are many less newsworthy but still notable examples.
Consider Hearth Display. The company’s founder pitched 60 investors and only one agreed to fund the pre-seed startup. “With that investment, we built two prototypes and launched a preorder campaign that sold out in three weeks — with revenue valued at four times our initial angel investment,” the company’s cofounders told AlleyWatch.
If more investors knew they can use retirement funds to capitalize on pre-seed offerings like Hearth Display, perhaps finding a match wouldn’t take so much time and effort from both sides. The Angel Capital Association reports that even the most sophisticated angels make ten or more pre-seed investments before expecting to return anything.
To be a successful angel investor, a person doesn't need to be an ultra-high-net-worth individual (UHNWI) or even have an existing IRA. Nor do they need to fit into any particular gender, race, or lifestyle category.
First, you need to find a custodian that can set up and hold your SDIRA. A custodian of self-directed IRAs typically provides account holders full control and ownership, allowing for angel investments, amongst other alternative assets too.
Alto is among the few custodians that can connect you to potential angel investment opportunities and administer the deal. We give investors access to opportunities with AngelList, our Private Raise Portal allows investors and issuers alike to coordinate private investments in startups, and we regularly feature early-stage startups on Alto Marketplace.
We act as custodians to self-directed IRAs that unlock a wide variety of investment strategies, facilitating an ecosystem of opportunities with a breadth of alternative asset categories.
When you access the money within your IRA to make an angel investment, there’s a lot more involved than just writing a check. Set up an account now to learn how Alto can help you facilitate your first experience.
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