Starting up and growing a business is no easy task, and the majority of new businesses can’t get off the ground without some form of funding. Despite the government encouraging banks and lenders to approve business loans, there are still a large number of small companies being refused funding.
This has led to an increase in business owners seeking alternative sources and non-traditional business funding methods, such as pension-led finance. Pension-led finance is an innovative and sophisticated alternative that allows you to use your existing pension pot to fund your business. It can be an excellent option for those with pension savings to use this money to help a new business grow, but it is not without its risks.
This guide explains what pension-led finance is, how it works and some top tips to help you choose the right funding for you and your business.
What is pension-led finance?
Pension led finance is a form of lending that allows you to use an existing pension pot as security against a loan for your business. It can make for a cheap and flexible financing option for your business when used correctly and can also help your pension to earn a competitive return.
In simple terms, pension-led finance allows you to borrow money from your pension savings and then pay it back with interest over time. Pension led finance is a complex funding product with significant business benefits when appropriately used in certain situations.
There are two main types of interaction between a business and a pension. These are Self-Invested Personal Pensions (SIPP) and Small Self-Administered Schemes (SSAS). It is essential to understand both to know which is right for you and your business.
How does pension-led finance work?
Like with many types of funding, pension-led finance has different types, and it is vital that you understand both. The two types of pension-led finance are:
A commercial loan from a pension
This option is the simpler of the two and allows the business to borrow money from your pension pot and then pay it back plus interest over the duration of the loan. It is available by using Small Self-Administered Schemes (SSAS) with approval from a trustee, and the maximum loan you can receive is up to 50% of your pension pot’s value. The interest rates on this type of pension-led finance must be ‘commercial’ rates, and 1st charge security is also required and can be in the form of Intellectual Property (IP) assets.
An unlisted share investment
If you have a Self-Invested Personal Pension (SIPP), then you can choose an unlisted share investment or a preference share investment. This type of pension-led finance allows you to use up to 70% of your pension pot’s value and is suitable for businesses that have no other assets to use. You will need an independent share valuation appraisal from a suitably qualified accountant for this type of pension-led finance.
Intellectual Property (IP) is an important asset to many businesses, and includes things like Patents, Copyrights, Design and Trademarks. A lot of businesses are not aware of the value that their IP holds for them.
Understanding Intellectual Property (IP) sale and leaseback
Almost all lenders will want some form of security in order to provide funding for a business. In most cases, this is a charge over a commercial property or other business assets, and it gives the lender some security that they can claim their money back if the loan is not repaid.
As pensions are not a tangible asset, such as property or vehicles, it makes securing lending a more difficult task. Intellectual Property (IP) is used to help with this problem, as pension funds are able to hold intangible assets, a business can sell IP to a pension and then lease it back.
When you want to start using your pension you have the choice to either sell the IP back to the business or continue leasing it into the business and use it as a source of income. As your business grows, your IP will increase in value. This means that your pension pot will receive a number of lease payments, as well as profit in the form of a lump sum when you sell it.
When you choose pension-led finance, you will get a lot of flexibility and independence over your business funding because it is your company borrowing money from your own pension. This gives you the freedom to decide how much is borrowed, as long as your pension provider agrees.