I was reading a story on TechCrunch.com today, the influential technology blog based in Silicon Valley. The story says First Round Capital has set up an echange fund for their portfolio companies to use to diversify their risk. The idea is founders will put some of their stock in this fund, and if they go out of business, they will share in the results of the companies in the fund that have successful exits.
I think this is a great concept, and it’s particularly great that a venture firm is sponsoring it, since to participate you have to have received an investment from this firm. So participating startups are already going through a tough screening process to get in. I hope more venture firms set up funds like this.
I do have a question: Would it be possible for the entrepreneurs to hold their ‘exhange shares’ of the other companies in the fund within their Roth IRAs? To my knowledge, you can’t have your own Roth IRA buy stock in your own startup. But it is OK to have your Roth IRA buy stock in tiny private startups, provided you don’t work on them at all. So I suspect there is a way to get these exchange shares into your own Roth IRA. Maybe by segregating the shares in your own startup from the shares in all the other member companies.
The beauty of having your Roth IRA hold startup stock is that if there’s a big exit, you pay no capital gains tax, even if there is a Google sized exit. Then you could have your Roth IRA sell the stock and diversify. The downside is if there is a loss, you can’t deduct your losses on your taxes, as far as I know.
I’m not a lawyer, so don’t act on this without consulting with one. I have had my Roth IRA buy private company stock several times, so I know that can be done. Not many financial institutions will handle this transaction. For example, Fidelity won’t. But T Rowe Price will, and their fees are reasonable. I pay $35/year for them to hold private stock in my Roth IRA. I think there was a $100 fee to set everything up in the beginning.
Here’s the link to the TechCrunch story that inspired this post: http://www.techcrunch.com/2010/01/29/first-round-capital-entrepreneur-exchange-fund/