Yield-cos have been grabbing headlines lately. Typically, large utilities spin off their high-yield alternative energy operations into separate smaller companies called yield-cos. These new companies are then taken public to attract individual and institutional investors.
Smaller companies in the renewable energy field can seek investment capital by going down a different path. They appeal to the millions of American’s with self-directed individual retirement accounts (IRA), which have a collective asset value of $90 billion. To bring in some of this money, companies create what are known as alternative investment products such as private stocks, limited partnerships, promissory notes and similar financial instruments. These investments aren’t traded on an organized public exchange and require special expertise to establish value.
Of course, the competition to attract these retirement dollars is intense among companies sponsoring a multitude of alternative investments tied to residential and commercial real estate, raw land, industrial operations, precious metals and even movie production. The IRA holders’ decision about which alternatives to add to their portfolio must be made by themselves and perhaps their financial advisors.
Successful alternative investment sponsors must understand how financial service firms, known as self-directed IRA custodians, can be allies in their pursuit of these investors. These firms are the banks, trust companies or third-party administrators that have been approved by a Federal or state agency to provide asset custody services to individual investors and financial advisors. IRS rules stipulate that all self-directed IRAs must be established through one of these firms. However, custodians never provide their clients or advisors any investment, legal, or financial advice related to an alternative investment nor do they offer any opinion to sponsors about whether a current or prospective client has sufficient wealth to be considered an “accredited investor,” which is often a sponsor’s requirement.
So, What Does a Custodian Do?
When one of its current IRA clients is considering an alternative investment or if a prospective client wants to open an account and purchase a specific alternative, the custodian’s first duty is to review all of the sponsor’s offering documents to determine if it meets clearly defined IRS suitability requirements. Assuming it does, the custodian handles the purchase (explained below) and then assumes responsibility for all related administrative functions until it is sold, matures or is otherwise removed from the account.
Individuals can open self-directed IRAs or add new alternatives to an existing IRA administered by any custodian willing to service them, so sponsors may eventually find themselves working with a number of different custodians.
Given this scenario, sponsors may consider having several custodians perform a preliminary IRS suitability review of their investment products. Assuming they meet all IRS requirements, sponsors may opt to refer prospective IRA investors and their advisors to custodians in order to speed up the investment process.
Investors may become aware of a renewable energy-based alternative through their own research, financial advisors or even investment sponsors themselves. Those wishing to add an alternative to their retirement funds but do not have a self-directed IRA must seek a custodian that accepts these investments. Investors who already have such an IRA can use funds in the account to make the purchase unless their current custodian will not administer alternatives. If that is the case, a new account must be opened with a willing custodian.
The Financial Relationship
Once the IRA is open and IRS-verified, the account holder signs the sponsor’s offering documents while the custodian purchases the investment in the client’s name using funds in the account — thus begins the relationship between the sponsor, the custodian and the client. The sponsor sends all revenue payments to the custodian, who deposits them in the clients’ accounts. If any payments are due to the sponsor, the custodian issues them from funds in the accounts. When authorized by an account holder, the custodian will sell, liquidate or close out the investment.
There must be a way to annually establish the value for every IRA investment for the benefit of the account holder and to satisfy the IRS. Given that alternatives are not traded on any exchange, an agreed-upon independent third party must determine their value. That value is provided to the custodian, which in turn provides it to the account holder and the IRS.
Custodians also monitor the activities of the sponsor and account holder during the life of each alternative investment to confirm that it complies with IRS rules. This is identifies any activity that the IRS classifies as a prohibited transaction and would in turn result in a financial penalty for the IRA.
One of a custodian’s most important functions for self-directed IRAs is communications. Most custodians maintain a trained staff to gather, process and retain all investment-related information. They have access to an electronic information management and communications platform that enables them to compile and prepare reports for account holders, financial advisors, the IRS and investment sponsors while also being accessible to these audiences to answer questions or provide assistance at any time.
Though sponsors may seek preliminary IRS suitability confirmation from one or more custodians, the reality is that other investors may already have accounts with their own custodians. This means they must not only appreciate the role of custodians but should recognize that like all groups of businesses, there are distinctions among them in terms of their experience and their way of doing business. A custodian’s web site, social media pages and published contributed articles and quotes may provide a wealth of information.
Among the key points to consider when evaluating a custodian’s approach to administering self-directed IRAs with alternatives are:
- How long has the firm been in the business of providing the required range of custody services required for self-directed IRA accounts clients that hold alternative investments?
- How many accounts and how many different types of alternative investments do its clients hold?
- Does it have specific experience working with renewable energy company sponsors?
- Does it use its website, social media sites and printed materials to provide information to clients and prospects about alternative investments as a retirement investment?
- What administrative, processing and communications technology does it employ to open and administer accounts, accept transferred funds, as well as report to and communicate with clients, advisors, the IRS and sponsors? How is this combined with the availability of client service staff?
- What are its fees to open and administer self-directed IRAs and handle purchase and sales transactions?
- Do media and professional organizations consider the firm a source of information about self-directed IRAs and alternative investments?
Given that the IRS approves of individuals investing in alternatives for their self-directed IRAs and that custodians facilitate these investments, it is certainly in a sponsor’s best interest to fine tune its ability to work with both.
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