Can an SMSF invest in a private company?
Generally yes, an SMSF can invest in a private company provided that it is for the sole purpose of providing retirement benefits to the members and, unless you are under the 5% in house asset rules, the company is not controlled by a member or their associate. However, while it is generally permissible it is important to remember the key rules that must be followed and how the auditor will view the investment and the paperwork that they will require in order for the fund to remain compliant.
Sole Purpose Test & Private Company Shares
The first test a trustee must always remember when investing on behalf of an SMSF is the Sole Purpose Test. This is the rule that any investment made must be for the sole purpose of providing retirement benefits to the members of the fund and not for any other purpose or personal gain. This means that the documentation around the investment (investment strategy, trustee minutes and the like) must make it clear why the decision is driven for the benefit of members and not any personal, business or family interests, such as supporting a member’s or their dependents private business.
Best Interests
As part of creating the minutes around the investment decision it needs to be made clear why the trustees believe that the private company investment, despite generally being illiquid, how a risk/reward profile that is beneficial to the members of the fund when compared to alternative investment options available in general public or private markets. This does not need to be a full financial SOA style undertaking but just enough to be able to show the auditors, members and other stakeholders the reasoning behind the decision-making process.
Check the Investment Strategy
When asking can an SMSF invest in a private company the first check an auditor will make is to review the Investment Strategy. This should go without saying but every investment decision made by the trustees must link back to the investment strategy document. This document outlines the fund’s investment objectives and is written and administered by the trustees themselves. This strategy must mention (among other things) considerations of diversification, liquidity, insurance and the ability of the fund to meet its ongoing obligations. In circumstances where the private company shares represent a large proportion of the funds total assets then it is important to include in this document how that concentration and illiquidity risks have been assessed.
Remember that an auditor is not checking whether or not the strategy is correct, sensible or going to make/lose money. They are only checking whether or not it is compliant under the Superannuation Industry (Supervision) Act 1993 and the associated regulations.
In‑House Asset Rules & Private Company Shares
In circumstances where the private company does count as a related party assets such as when the company is controlled by the members of the funds or their associates such as relatives the shares will count under the In-House Asset rules. These rules limit the SMSF to holding no more than 5% of its total asset base in any and all In-House assets at a time. Exceeding this limit can lead to major compliance breaches and regulatory action including the forced wind up of the fund.
Acquiring Private Company Shares in an SMSF
As part of acquiring the shares we need to distinguish between circumstances whereby the new shares are being issued by the private company as part of a capital raise versus being purchased from existing members. This is because SMSFs have a prohibition from acquiring assets from related parties (regardless as to whether they are at market value) unless a specific exception applies which won’t be in the case of private company shares. This means that the method that is generally used is for the SMSF to subscribe to new shares as part of a share issue by the private company as opposed to a share transfer or other disposal by a member.
Valuation of Private Company Shares
One of the requirements of running an SMSF is to value all assets of the fund on the 30th June every year and provide proof to the auditor that satisfies them that the valuation is correct and verifiable. This is easy with public shares, cryptocurrency or even residential property where there are easily accessible valuations we get for you as your accountant as part of our fixed annual fees either from the ASX, exchanges or the Cotality RP Data figures.
However, when considering the question can an SMSF invest in a private company one of the key things we need to understand is how we are going to get a valuation each 30th June. Questions such as whether the company provides audited financial statements and indicative valuations at the end of each financial year is a core consideration. If you are looking to invest in private companies via your SMSF we highly recommend reaching out to your SMSF accountant to review what information is planned to be made available so they can ensure it will be sufficient for the auditor to limit the potential for Part A or B qualifications or, in serious cases, contraventions.
Non‑Arm’s Length Income Risks
We always need to make sure that the SMSF is receiving income, by way of dividends, from the private company on commercial terms which generally means it is on the same basis as the other shareholders. If the income is deemed to be on non‑commercial terms then the ATO may classify it as NALI which is taxed at a significantly higher rate and can lead to other compliant issues.
Conclusion
So, we are agreed that an SMSF can definitely invest in private company shares but subject to a lot of caveats which require careful planning with your SMSF adviser before the investment is made to ensure you don’t have any ongoing compliance risks. Key areas you should always consider as Sole Purpose Test, Investment Strategy, In-House Asset test and associated limited and the valuation and NALI risks.
As always if you need any help with your Self Managed Super Fund reach out to one of our friendly team today for ongoing support and advice.