With bank lending still at a low ebb, entrepreneurs are increasingly turning to their pension pots as a way of financing their businesses
Despite early indicators that recovery is on the way, SMEs continue to struggle to gain access to vital funding. The well-publicised reluctance of banks to lend has made business owners increasingly wary about asking their bank manager for help. Research group BDRC’s SME Finance Monitor for the third quarter of last year found that just one in ten SMEs reported making an application for a new or renewed loan or overdraft in the 12 months prior.
And despite the efforts of the government to increase awareness of alternatives to traditional bank lending (BIS released its SME Access to Finance Schemes paper in February), business owners are still missing out on the vital financial support they need if they’re to grow and flourish. Indeed, the BDRC research found that just 40% reported using any form of external finance – which represents a year-on-year decline.
We’ve written about innovative alternative funding sources, including the likes of peer-to-peer lender Funding Circle, which continues to go great guns and has lent more than £81m to small businesses thus far. But another creative way of raising finance for owner-managed businesses is by borrowing money from their pension pots.
According to financial services provider Clifton Asset Management, pension-led funding could release around £100bn of finance – a welcome injection of cash for the UK’s struggling SMEs (which would no doubt equate to substantial bounty for the government, by way of tax revenue).
Clifton itself has so far lent money to 1,250 small firms, with an average funding amount of between £120,000 and £150,000. But Clifton’s chairman Adam Tavener says this just offers a glimpse of the potential of the funding mechanism. “It’s not an insignificant number of businesses we’ve funded so far, but neither is it anywhere near the market potential,” he explains.
“In very roundabout terms, if you take the businesses that we’ve funded and the people they employ, it’s about 10,000 jobs thus far that have either been created or stabilised by this particular funding methodology,” says Tavener. This is good news too for the government – not just from an employment perspective, but on the tax front, too, Tavener comments. “From George Osborne’s point of view, that’s quite good news because it’s more than £100m a year in payroll taxes he’s collecting.
“That doesn’t make us NatWest Bank, but on the other hand, it’s not insignificant either: it’s two or three Rover groups not going bust.”
Pension-led funding, at its most simple, isn’t a particularly complex principle to grasp. A business owner borrows money against the amount they’ve accrued in their pension pot to date. So that means, at the very least, the party, or parties, will need to have saved at least £50,000 in order to make it a feasible proposition.
“From a financial point of view, it really needs to be north of £50,000 – below that the fixed costs render it a bit expensive,” he admits. “But in pension speak, £50,000 is a pretty small pot, especially if it’s between two or three individuals.”
One of the principal advantages of pension-led funding is that the loan isn’t secured against a personal asset – such as a director’s home, for example. Many of the alternative financiers have long argued that the need for personal guarantees is outmoded, and often causes a business owner – and their family – unnecessary suffering if the business fails. “The consequences of business failure, when there’s a third party involved, are significant and they go beyond the financial – they can be emotional too,” explains Tavener. “Anybody who has had to sit the family down and say we’ve either got to sell the house or it’s being repossessed will tell you it’s not just about money.”
Instead, this form of funding allows business owners and directors to borrow cash from their personal pension schemes offset against the value of the intellectual property of the business. It hasn’t always been possible for businesses to do this: it was only in The Finance Act of 2004 that intellectual property became recognised as an acceptable asset class for use in pension-led funding.
This isn’t to say that businesses need to be clued up on IP: what IP they own, how it can be leveraged and so on. Expert organisations hired by the likes of Clifton will scrutinise a company’s IP. “What we would normally do when dealing with a new organisation is to go through some work around their IP to get some kind of value on it,” explains Tavener. “This isn’t something we do ourselves, we don’t do IP valuations, but we do have a panel of accountancy-led experts who do valuations for us.”
Those experts will take a whole host of things into account: from branding and reputation to relationships with customers and suppliers. All these are part of the intellectual capability of the business, says Tavener. “For a small, privately owned business, that’s never normally discussed because banks won’t traditionally lend against it, unless the business is being sold, at which point it becomes a very important calculation,” he explains. “We’re dealing with exactly the same area of asset, except we’re using it as a means of funding the business rather than simply a means of calculating its value in terms of a potential purchaser.”
Despite banks not being willing to lend against this kind of asset themselves, they often will partner with Clifton. For example, if a business wants to borrow £150,000 and the bank can only lend £75,000, they might suggest the SME-owner borrows the remaining amount from Clifton. “Most of the deals we do are collaborative deals,” says Tavener. “The idea in collaboration – whether it’s with a bank or another style of lender – is that it gets the customer to where they want to be. It’s the outcome we’re interested in rather than the methodology.”
Yet, despite minimalising personal risk, no borrowing should be undertaken lightly. And while this form of lending means that should the business fail, the business owner or director won’t lose their house, they could stand to lose a good chunk of their pension. Tavener says this is still preferable than the alternatives. “There’s always risk involved, but we would say it’s a lower level of risk and one that’s controlled by the individual, rather than by a third party,” he suggests.
As always, when considering borrowing cash, the onus is on the business owner to be truly objective when considering if they should accept external investment – of any description. “I absolutely have to underline this: it’s absolutely based on the fact that the business is investable. If it’s not working for any reason, we’re not going to invest in it. We are the trustees, and we’ve got a responsibility to make sure that it’s a commercial investment done for the right reasons.
“We always say to people, ‘Ask yourself: would I invest in this business?’ If the answer is no, you’re not confident about the business, don’t do it. And while we’re on the subject, don’t ask anyone else to, either.”
Having indulged a lifelong passion for motorsport, Dick Cormack decided to set up a business selling motorsport tyres in 2007. Rather than acting as a channel reseller for one of the major tyres brands, Cormack decided the real opportunity lie in developing his own range of tyres. This meant finding a substantial amount of development money to design and manufacture a single, 13-inch tyre. “Basically, we needed £150,000 to get to the point of production,” explains Cormack.
Cormack’s first port of call was his bank, but they were unwilling to lend him the full £150,000. “Our bank was supportive but wasn’t able to lend me the full amount and it was a case of ‘all or nothing’ for us.”
It was at this point that the budding entrepreneur was introduced to Clifton Asset Management. “We were starting a business in the middle of the financial crisis and people were laughing at us. But Clifton was prepared to listen and provide us with all of the facts on what we could or couldn’t do,” says Cormack.
Leveraging the company’s IP, inherent in Cormack’s tyre design and potential product range, Clifton recommended the use of IP-led pension-based business funding and £75,000 was raised by the pension scheme, with the remaining £75,000 from the business’s bank.
Since, it has gone from strength to strength and is now a global player, thanks to the combination of low cost, good design and excellent performance characteristics. “Before we knew it, we were into Europe, then South America, Australia and New Zealand.” Cormack continues, “Within a couple of years we had a business providing 28 tyre sizes and 50 compound and tread combinations.”