One often-quoted feature of the last recession has been the lower-than-expected levels of unemployment in the UK, with a corresponding pick up in self-employment and business start-ups. Also striking is that, within the changes we are seeing in working patterns, more individuals are now deciding to set up in business later in life.
The profile of entrepreneurship is evolving. According to this year’s Global Entrepreneurship Monitor, the level of over-50s engaged in entrepreneurial activity has grown to 6.5% compared to 4% over the period between 2002 and 2008. And the number of later-life entrepreneurs has now overtaken that of 18- to 29-year-old entrepreneurs.
What is more, when pension investment firm AXA Wealth asked 1,500 over-55-year-olds about their intentions around the pension reforms that came in earlier this year, its researchers found one in 10 to be considering starting up their own business. Of those, almost half said they would use the 25% tax-free lump sum to fund their start-up.
On that basis, AXA Wealth says over half a million individuals in this age group could be on the verge of starting their own company. A third of this ambitious group said the new pension freedoms represented an opportunity to realise a long-held desire to start a business. One quarter said they were motivated by the idea of monetising a hobby, while nearly one in five wanted to take advantage of the skills and experience amassed in their professional career.
In the context of changing employment patterns, for this demographic to set up their own ventures makes a certain amount of sense. Many businesses are self-funded at the outset. Some early retirees will have spotted genuine opportunities, others may be finding new ways to face up to redundancy in a job market that doesn’t tend to favour older candidates.
“If they have lost their job, then becoming self-employed may be a necessity,” says Sue Moore, technical manager, private client at ICAEW. “It makes perfect sense to them to use their pension pot to fund a start up.”
Individuals who are relying on access to their pension pots to set up businesses will need to make sure that it stacks up from a tax perspective to avoid triggering a tax charge. One possibility would be to withdraw just enough funds to use as income while the business gets up and running. Using the new facility to bolster personal income is an approach that is in the spirit of the pension reforms, after all.
“To do it tax efficiently, they would probably need to withdraw cash over a period of years. If it took them into a higher rate band, it might not be worth it,” advises Moore.
A sensible approach would be to draw as little as possible, so as not to disrupt a pension that still has growth potential. “There is no point drawing it out if you don’t need it, when it can grow tax-free inside the pot,” she says.
If, on the other hand, individuals wanted to fund a capital expenditure, they would be able to take advantage of the annual allowance, which currently stands at £500,000, but drops to £200,000 in January. Doing so would helpfully reduce profits. “If the business made £250,000, it can effectively reduce its profits to £50,000 using the annual allowance,” says Moore.
Schemes that enable would-be entrepreneurs to access or borrow against their pension savings have been available for some time. Innovation charity Nesta mentions pension-led funding in its 2014 report, Understanding Alternative Finance. According to the report, UK SMEs used pension-led funding to access £25m in 2014, or an average of £70,000 per business using this approach.
To access funds in this way, business owners have to transfer their pension into a self-invested personal pension or a small self-administered scheme. The pension fund loans money to the business secured against the retirement fund. Another device is for the pension fund to buy intellectual property assets from the business, which the business owner then leases back.
But Denis Kaye, founder of business support website Firm Ideas, thinks such schemes are fundamentally wrong-headed. “What you’re actually doing is taking money from your pension pot and risking it in a business.
“Having had 40 years to watch entrepreneurial clients, they almost always believe that their business is the best place for their money. They put money aside into pension schemes only reluctantly in the first place and they’ll take any opportunity to release it.”
Lynette Lackey, partner at Greenside Real Estate Solutions, says she has seen a number of people setting up new businesses using part of their pension pot, with mixed outcomes.
She cites a case of one retired businessman who invested in a leisure business that he understood and, having built it up with the management team, he stands to make well-deserved money from the exit. “But there is a huge difference between success as a corporate executive in a large business and the challenges of a start-up,” she says.
“Another investor I know has fallen into this trap. He invested part of his pension in a small start-up and is becoming very frustrated by the absence of any infrastructure, or sophisticated financial reporting.” This kind of investment can all too easily fall prey to culture clashes, she says, with regrettable outcomes.
“The minority shareholding is illiquid, so he has little hope of getting his money out in the foreseeable future.”
There is additionally a cultural question as to whether an individual who has spent their life in employment is going to do well in a start-up business. “There is a great difference between having a successful career in a big corporate and the rolling up of sleeves and graft that goes into setting up a business – the kind of business that will mature and secure a viable exit,” says Lackey.
“Be prepared for the energy, persistence and stress involved in setting up a new business, making sure there is a real market need and growth opportunities. And make sure there is an exit route so you can get the investment back out in the future,” she says.
Andrew Shaw, partner at Kingston Smith, says he has not had contact from any clients wanting to use their pension in this way, but says he has reservations about the additional risk of using part of a pension pot. “I do have misgivings about using a pension fund for spending on non-retirement expenditure,” he says.
“Every individual has a different risk profile, and anyone even contemplating doing this needs to be made fully aware of the much-increased risk that is being taken on.
“The individual’s view of risk will be influenced by their overall level of assets; if they have sufficient assets elsewhere it merits closer thought,” he says.
One common sense point is that simply because individuals are in a position to self-fund a new business, they shouldn’t omit to run the numbers or put together a business plan that includes cash flow and profit forecasts.
“It would be a good discipline to still write a business plan as if you were applying to a bank for funding. And if it doesn’t stack up, if a bank wouldn’t advance funds, then perhaps you shouldn’t look to pursue it,” says Moore.
Given the high risks, most advisers suggest looking at some alternatives before taking the plunge.
Lackey advises a more arm’s- length approach.
“Ask yourself whether you are you the right person to run this business given your experience, skills and resources,” she says. “Or are you better off investing in a professional team, which you will need to pay in cash or equity to incentivise?”
Other viable alternatives include investment in property, small-scale angel funding – which can be made tax efficient via the very generous EIS or SEIS arrangements – or even peer-to-peer investment on a crowdfunding site.
For Kaye, risking the pension pot or a part of it represents a considerable gamble, particularly for this age group: “The prudent way would be to leave the pension pot where it is to maximise the value, grow a smaller business than you might otherwise have done and use that to supplement your income.
“For individuals who have been made redundant or taken early retirement, I think this is the wrong time in life to bet the pension. If you think about what fund managers are doing with pension funds at this stage, they are in the process of de-risking those funds. If that’s good pension and fund management advice, then this impulse runs contrary to that.”