Pension-led funding: Could it help grow your business?
Alongside crowdfunding, peer lending and invoice finance – business owners could consider tapping in to their pension pot as an alternative finance option. Find out more here
There is a very large amount of money in the UK pension system – around two trillion pounds, in fact.
A significant proportion of this (around £200bn) belongs to business owners, or those who are about to start their own business.
What has not been very well understood, until recently, is that this money, your money, is not ‘locked away’ and beyond usable reach to grow your business.
For many years a business owner has been able to deploy some (or indeed all, although this is not advisable) of their pension into their business to support its growth and help realise its potential. It just has to be done carefully and with respect for the letter and spirit of the rules surrounding the transaction.
So, how does pension-led funding work?
A business owner needs funding and has accumulated pensions from present or previous employment. Several owners/ directors could also act together to pool their pensions and create a bigger ‘investment pot’.
These pensions are transferred into either a self-invested personal pension (SIPP) or a small self-administered scheme (SSAS). Both are pensions that allow the owner, not the insurance company, to make decisions as to where their money is going to be invested.
In the case of pension-led funding from Clifton Asset Management, a review of the business is then undertaken.
The following questions would be asked:
Is the business plan robust?
Is there a cumulative pension of at least £80,000?
What should the repayment schedule look like in the event of an investment by the pension? What, if any, security is available?
Is there any intellectual or physical property available to support the deal?
Essentially we (in the shape of our credit committee) test the business to make sure, as far as reasonably possible, that any investment by the pension will be repaid and generate a profit for the scheme. It is, after all, your pension and you will want to retire on the proceeds some day!
Assuming that the case for investment is sound, the transaction normally takes one of two shapes.
Asset loan or asset purchase
Either the pension scheme will grant a loan to the business, secured on an asset of equal or greater value than the loan and total interest repayments due, or the pension scheme will purchase an asset from the business and lease it back.
In the latter case pension-led funding has helped realise the hitherto unrecognised assets that belong to a small business, such as brands, databases, key skills, domains or web content – in other words its intellectual property (IP).
Leveraging the IP in this way is particularly useful when there are other lenders, such as a bank, involved, as it allows funding against the IP which the bank is usually happy to release as security, whilst retaining charges against the more mainstream assets. Many very good collaborative outcomes have been achieved in this way.
Once the loan or leased deal is complete, a process that normally takes six to eight weeks, the business has full use of the cash invested by the pension and the pension is now in receipt of a stream of repayments which should generate a sensible commercial return and thus, in time, increase its value.
How much does pension-led funding cost?
Like most other funding products the answer to the question about cost is ‘it depends’. Cost is influenced by deal size, complexity and the levels of advice needed to secure a compliant outcome.
It is important to remember that with pension-led funding interest costs do not get paid to a third party, they go back to the business owners own pension scheme, and thus in most cases the real cost is likely to be less than a more traditional loan style arrangement.
For instance, an AccountingWEB Alternative Funding Guide published last year compared the cost of different business funding solutions to a small business when borrowing £75,000 over a five year term. It concluded that pension-led funding was more competitive than peer 2 peer funding, a bank overdraft, invoice discounting and factoring. Compared to a bank overdraft, pension-led funding was almost half of the cost – £11,296 over five years compared with £20,625 for the bank overdraft.
What are the benefits?
There are several key benefits, the most obvious being that the interest costs associated with funding your own business are now serving to build your own pension, something that is just not possible with most other forms of business funding. Equally the ability of pension-led funding to collaborate with other lenders as part of a funding package is often a real advantage. Pension-led funding frequently plays a lead role in facilitating a larger overall funding solution as lenders are normally keen for a business owner to show willingness to back themselves.
The ability to leverage the value of the business’s Intellectual Property (IP) is also a prominent benefit. Existing lenders may already have a charge over the debtor book, machinery or other assets but virtually all are happy for Clifton to fund against the IP – the ideas, relationships, brands or processes that characterise the business. This often means that a greater overall level of funding is achievable.
There are numerous other benefits but as each funded deal is uniquely tailored to the circumstances of the business and its owners an examination of the all of the possible advantages would be too exhaustive for this piece.
What are the risks?
All business carries risk, especially businesses that have sourced finance from a third party. With pension-led funding the initial risk is clear. If you invest some of your pension money into your business and the business subsequently fails, you may lose some or all of your investment. This is why the screening and testing process for a pension-led funding deal is rigorous and robust.
In reality virtually no business fails immediately after securing a pension-led funding deal. More likely a problem will occur a few years into the life of the deal so the individuals risk is mitigated by the length of time since the deal occurred and the number of repayments that have been received by the pension. Risk is therefore apparent on a declining scale back to zero when, typically, five years after the original funding took place, the pension has received back all of its original investment plus its profit.
It must be emphasised, however, that a sensible candidate for a pension-led funding deal would have both a high degree of confidence in their own enterprise and also a broad balance of personal assets to fall back on in the event of a business failure.
Increasing your company profits
With pension-led funding, a theoretical virtuous circle has thus been created since a well-funded business should be capable of generating greater profits, which, in turn can be used to fund more generous pension contributions for the business owner.
We’ve covered the risks and it’s not a decision to take lightly but whether the whole thing is a good idea is usually the starting point of any pension-led funding discussion.
Adam Tavener is chairman of Clifton Asset Management. To date Clifton and pensionledfunding.com have provided finance to over 2,000 businesses across the UK, with a total invested value in excess of £250m.