Despite the challenging conditions in the economy, starting and running a business remains an ambition for millions of people.
One of the best ways to achieve this dream is to buy into a franchise system, where the work of establishing the effectiveness of the business plan has already been done.
For both franchisors and franchisees, there is a continuous need to maintain working capital, market the existing business or even expand it, while retaining maximum control of the business itself. ‘Traditional’ funding, such as bank loans, hand significant control to the lender, while also requiring personal guarantees from the business owner, such as the family home, to support the loan.
Pension-led business funding offers a sophisticated alternative involving business owners’ accrued pension benefits, held within a director-owned pension scheme, allowing them to back their own franchise and put them in control of their future.
For franchisees and franchisors alike, recommending a funding alternative to potential clients, there are a number of aspects to consider before choosing pension-led funding:
1. The Options
The two main pension-led funding vehicles are Self-Invested Personal Pensions (SIPP) and Small Self-Administered Schemes (SSAS).
For franchisors, the main funding options are – a commercial loan from the pension scheme to the sponsoring limited company, or the purchase of the company’s Intellectual Property (IP) by the scheme. For franchisees, funding is similar, except the valuation of the business is primarily through the value of preference shares – which requires a limited company – and which are an entirely separate class from the ordinary shares you are probably more familiar with.
2. The rules
When considering a SSAS loan to the business, the main regulatory requirements are:
- It must not exceed 50 percent of the pension fund’s net asset value.
- It must be secured via a first charge against an asset of equal or greater value to the loan capital, plus interest over the period of the loan.
- The maximum term is five years.
- An interest rate of at least one percent higher than the Bank of England base rate should be applied.
- It must be repaid with equal instalments of capital and interest throughout the term.
With pension-led funding, there is no requirement for business charges and personal guarantees. The security of a director’s non-pension personal assets will no longer rely on the fortunes of the franchise.
Equally, if balance sheet assets are used to secure the loan, the pension can create its own charge over all assets and the pension scheme becomes a preferential creditor to the business. This means, in the worst case scenario of business failure, the scheme has priority in claiming back its security, although that level of priority will depend on the status of any other creditors that might hold a secured charge on the business’ assets – such as a bank.
Following clarification in the Finance Act 2004, intellectual property (IP) is an HMRC recognised asset class for pension-led business funding. The most common IP assets are patents, trademarks, designs, copyrights, databases and domain names.
IP needs to be valued by an independent expert to meet HMRC requirements. The asset can then be used either as collateral for a pension loan to the franchisor, or purchased by the pension from the
The IP is held within a creditor-protected pension environment and any appreciation in the value of IP, or income derived via lease/ licence agreements, is free from direct tax when paid back into the scheme.
Pension-led business funding is not appropriate for every franchise. A pension pot of more than £80,000 is required to make the process viable. The funding also has to benefit the owner(s) of the pension scheme, so no responsible pension advisor or scheme trustee is going to agree to pension-led funding for a failing franchise. A Pension-led funding strategy requires detailed assessment of company accounts, track record and business plan, as well as an assessment of the business and the motivation of its owners and directors.
Some pension funds are more suitable than others and a qualified advisor should be used for all aspects of pension analysis. The advisor should have a proven track record, supported by a robust corporate and compliance infrastructure, as the penalties – for unauthorised transactions or incorrect due diligence can be significant, for both the scheme and its member trustees.
6. Pension Benefits and Self Investment
The rules regarding drawing pension benefits from a SSAS or SIPP engaged in business funding are no different to those applied to all personal pensions. Providing sufficient cash remains within the scheme, the 25% pension commencement lump sum and an income can begin / continue to be taken once the director has reached the age of 55. It should be remembered that monthly repayments are being made to the scheme as a result of the funding, so the available cash will be re-generating.
7. Scheme Structure
SSAS and SIPP are established under trust rules. The trustees are typically the stakeholders in the business. Technically, the scheme can be run by the trustees themselves; but, it is advisable to appoint a professional administrator specialising in pension investment to ensure governance and investment decisions are in the best interests of the members.
Pension-led business funding should not be seen as a quick fix. A minimum six to eight week timeframe for the whole funding process is usual; longer for more complex arrangements and where pension transfers into the new scheme are required. Using an advisory firm and experienced trustee will ensure a faster development of strategy and make sure that necessary due diligence is carried out with minimal impact on company time.
9. Cost vs. Benefit
The set-up costs of pension-led funding are likely to be more expensive than ‘traditional’ lending arrangements. A significant cost will be the initial specialist advice. However, you will avoid third party arrangement fees, interest-debt and, more importantly, the requirement and potential cost of personal guarantees. The facility can also be used for future rounds of funding, which are priced at a cheaper rate as some of the initial “groundwork” has already been done for the initial round of funding.
The perfect scenario is the franchise and the pension growing in tandem, with one working for the benefit of the other. However, the most difficult variant to quantify is the impact self-investment funding will have on the business and retirement wealth of the owners. Ultimately, it is the directors of the business who are best placed to measure this opportunity cost.