Whilst no one runs a business to fail, the current financial climate presents numerous challenges to entrepreneurs. Consequently many business close, often in their first year of trading, and for different reasons; one of the most common being the unwillingness of traditional finance houses, like banks, to take the risk of lending to developing businesses. This is despite Government led schemes, like
the Funding for Lending Scheme (FLS) which increases the amount available for banks to lend. Nevertheless, for business owners, being able to balance the equation between working capital, money for marketing and investment to grow the business is a crucial one. It is for this reason that many company directors and other types of business owners are taking advantage of the Chancellor’s decision in the 2014 Budget to release private pension savers from the commitment to purchase annuities and are looking to their pension pot as a means of raising funds to invest in their business.
There are two types of pension scheme that are ideally placed to facilitate the release of funds for business purposes:
Self-Invested Personal Pensions
A Self-Invested Personal Pension or SIPP is a type of do-it-yourself pension established through a contract with a pension provider. SIPPs allows pension holders more freedom to decide how to invest their pension funds than other types of personal pensions. Investments could include:
- Quoted UK and overseas stocks and shares;
- Unlisted shares;
- Collective investments;
- Investment trusts;
- Property and land (excluding list residential property); and
- Insurance bonds.
SIPPs can also be used to purchase investment property or used to part-fund the purchase of a property that will then be rented out, with the rental income going back into the SIPP to finance the mortgage payment. Whilst pensions owners can exercise a great deal of freedom in deciding what to invest in, principally they are designed for those who understand investing, or who are willing to pay an expert
pension administrator to act on their behalf to ensure any investment decisions are sound.
Small Self-administrated Scheme
A Small Self-administrated Scheme or SSAS is a trust based pension arrangement usually used by directors (and other designated employees) of limited companies; although they are also available to people in business partnerships or running family firms. SSASs are registered with Her Majesty’s Revenue and Customs (HMRC) and may enjoy tax-exempt status. All investments made through the SSAS are free of Capital Gains Tax and contributions into a SSAS receive tax relief. Trustees of the SSAS, usually the beneficiaries, can run the SSAS or appoint an expert to operate it on their behalf.
Types of pension pot funding
The type of funding you can release from a pension pot depends on the type of personal pension held. Funding is either through a commercial loan or through the sale of Intellectual Property belonging to the business.
Commercial Loans can be granted by business owners with SSASs
to the business, with the effect that funds are transferred from the pension pot. The loan is repaid plus interest with repayments going back into the pension. This type of funding can be relatively straightforward to arrange. However, there are certain rules:
- The amount taken out as a loan cannot exceed 50% of the net asset value of the pension pot;
- The loan is secured through a first charge on a material business asset, like machinery or property;
- 5 years is the maximum term over which the loan is available;
- The rate on interest should be 1% higher than the Bank of England base rate;
- The loan should be repaid through equal payments of capital and interest; and
- It can only be repaid through the SSAS with the approval of the trustee of the pension scheme.
Intellectual Property (IP)
The Finance Act 2004 clarifies that funding can be obtained from either a SIPP or a SSAS through the sale of Intellectual Property (recognised by HMRC as an asset for pension-led funding) belonging to the company. Whilst a pension fund cannot own physical assets it can own non-tangible assets like copyrights, domain names, patents and other types of intellectual property. Usually the sale of intellectual property to a pension fund includes the right to lease it back, with any monies raised through the lease going into the pension fund. The amount available for release can exceed 50% of the value of the pension pot, with releases as high as 70% possible in some cases.
Benefits of releasing money from a pension pot for
the purposes of business investment
Using pension-led business funding from one or more company directors can help put business owners back in control of their enterprise. This is seldom the case with more traditional forms of lending, like bank loans, where the lender usually has the upper-hand and may require personal guarantees, often secured against business owners' personal assets, like their homes. Additionally, releasing monies from a pension scheme is free from from punitive bank charges, demands for payments and the consequences stemming from missed or reduced payments, including of course bankruptcy in the event of default.
There is no denying that those accessing a pension pot are taking a risk. They have planned their pension arrangements to provide them with sufficient funding for the rest of their life post work and business failure will seriously
upset those plans. However, if the risk pays-off and the business succeeds and becomes an asset in itself, growing in value as it increases in size, then any monies borrowed will be returned to the pension pot and in addition the owners can look forward to a comfortable retirement that exceeds their previous plans.
Where a commercial loan has been taken out, a bank or other commercial lender may view the fact that the owner of the pension pot is prepared to risk their own money, as a positive sign and consequently be prepared to make additional funding available through a loan or mortgage that they otherwise would not have done. Should a business fail, the pension pot can invoke any first charge on a business asset. In reality however, whether it received anything would depend on its status when measure against other creditors of the business.
Where IP has been used to facilitate the advance it is worth remembering
that the value of the IP will increase along with the value of the company.
This means that once the owner of the pension pot retires they can sell the
IP back to the company at a profit or create an other income stream in their
retirement by continuing to lease it back to the company. In turn, if the
company buy back the IP they can use it to raise further funding. It is also
worth bearing in mind that, even if the business should fail, Intellectual
Property such as a valuable domain name owned by a pension fund may well
have a value, independent of the failed business.
Other considerations when accessing pension-led
There are a number of considerations that must be met before money will be released from a pension pot. Money will not be released to a business that is clearly failing and the pension pot must be sizeable enough. A great deal of information will need to be supplied to the company arranging the drawdown, by both the pension provider and by the business to demonstrate that it is sound. This will include its track record to date, business plans, forecasts and other projections all presented in the form of a business case. This is a task usually undertaken in consultation with an Independent Financial Advisor who is also a corporate finance specialist. It is import at that advisors have a proven track record and are supported by strong corporate and compliance framework. Where IP is involved in the arrangement, an independent valuation will need to be obtained.
Timings and cost
Raising money to finance a business through a pension fund should not be viewed as a quick fix; at best the process can take a couple of months and longer for more complex arrangements. Things can usually be speeded up a little if the trustees of the pension fund understand the process and are working with an experienced advisor. The cost of set-up is more expensive than traditional forms of lending because, although there are no arrangement fees, interest payments or personal guarantees required, the cost of expert professional advice to review the business, consider due diligence and arrange, where appropriate, for IP to be valued, can be significant. However, whilst it is in no means cheap, the charges usually bear some resemblance to interest that would be charged on a conventional business loan taken over a similar period. Furthermore, the costs
should be considered over the length of time to repay; the longer the time, the cheaper it
A final word
Britain is hailed as the self-employed capital of Europe; around 4.6 million people or 15% of the total workforce, work for themselves. It is no surprise that the number of firms seeking to raise funding by other than conventional means is on the rise and signs suggest that, as ignorance in terms of what it might be possible to do with a personal pension declines, the use of pension-led funding to finance business is likely to increase further. Whilst this can and does offer significant benefits to some, there are other cases where things do not go as planned and the business fails. Pension pot owners should, therefore, take professional advice before accessing money from their pension fund and should also consider what their contingency will be for their retirement in the event of failure.