Lily Sam is a beauty therapist from south London who has just opened her first salon, Lyttle Minx Nails and Beauty, in Gipsy Hill. The entrepreneurial 24-year-old from Lewisham has four self-employed members of staff who work beside her and aims to open more salons over the coming years.
Having managed to avoid taking out a bank loan to set up the first salon, Ms Sam expects to make a modest profit of £5,000 at the end of her first year, £10,000 in year two and £20,000 in year three. The cost of setting up a second salon, she calculates, will be roughly £28,000 and her aim is to do this in two years' time.
To keep her outgoing costs to a minimum, Ms Sam is renting out the property she owns and is living with her parents. After she has paid her mortgage, she makes approximately £150 per month from her tenant, but a proportion of this goes to the letting agency. She is earning another £150 per week from her work at the salon, although this money is going straight back into running the business.
While Ms Sam is already showing great confidence, the financial planners believe she should think again about expanding her salons before the first one has developed a solid track record of profit.
James Brooke, the managing director of Altior Vita, a financial planning firm based in London, says it could be counterproductive for Ms Sam to rush into further business ventures before she is ready. "It looks as if Lily is trying to run before walking. She says her salon will break even in year one and turn a profit in year two, but there is no point in even thinking about opening other salons until she knows she can turn a profit in the first."
If Ms Sam is to achieve her goal of setting up another salon in two years' time, Mr Brooke says she will need to start saving immediately.
"Given the current low interest rate environment, and because Lily can't afford to take risks, she will need to save £1,166 per month to have £28,000 after two years. Failing that, she will need more outside investors as no bank will lend to a new business with no positive cashflow or track record."
"If the mortgage on Lily's property is on a repayment basis, she should see if she can convert it to interest only so that she reduces her outgoings. Also, now it is, in effect, a buy-to-let business, the interest is set off against the income for tax purposes."
Ultimately, says Mr Brooke, she may need to look at a longer timeframe and reconsider whether she wants to set up a franchise or chain of salons, as he says the business and financial implications will vary significantly. "How realistic raising the extra money is will depend on how successful the first salon in the business becomes. If Lily is really successful and she wants to offer a franchise opportunity, then the franchisees will provide the money and she won't need to. If she wants to build a chain, then she will need three years of profitable trading and accounts before most banks will consider lending to her. Otherwise, she will need to approach friends, family, and other potential investors and possibly give away a share of her business in return."
Covering all bases
Julie Bayley, a chartered financial planner at Keswick-based True Bearing, says Ms Sam would do well to read over her existing insurance contracts. One of the most common mistakes for new businesses is a failure to put in place necessary insurance to cover unexpected events.
"While most business owners in the UK will gladly cover their premises, statutory liabilities and equipment against loss or claims, they neglect to put in place sufficient or any protection regarding personnel, which is often the most important component of their business. People and organisations never plan to fail but if they fail to plan, the consequences can be devastating," she says.
Although Ms Sam already has a business insurance policy with Zurich and another holistic insurance policy, Ms Bayley says she should read the fine print to check she has sufficient cover for public and employer's liability insurance as well.
"Public liability insurance is not compulsory but it is advisable for any business that deals directly with the public or works away from home at other premises. It protects a business from being sued by a client or member of the public for damages in case of mishaps, bad practice, etc. The standard limits for public liability insurance are £1m, £2m and £5m."
"Employer's liability insurance is required by law if a business employs any staff. The cover is normally at standard limits. This insurance enables businesses to meet the costs of compensation and legal fees for any claims from employees. Even if you use self-employed staff or volunteers, you may still need cover."
Planning for the future
Retirement may seem a long way off to Ms Sam, and with the Government's proposals to raise the default age to 68 for men and women from 2020, she can reckon on at least another 40 years of work before she will be eligible for a state pension. This means she will have a number of choices when it comes to planning for the future. Christopher Morgan, a financial planner at Cardiff-based Hedley Asset Management, says Ms Sam may want to consider other savings.
"In the first few years of building the business, Lily is probably better advised to save for her future using individual savings accounts (ISAs) rather than pensions," he says. "This means that while she will lose valuable income tax relief on any pension contributions, at least the capital within her ISAs will remain available if the business runs short of cash. While pensions are granted valuable income tax relief when a contribution is made, the downside is the pension cannot be tapped until age 55 at the earliest. Pensions might not suit Lily's situation right now.
"But, as Lily's business grows, she could look to make use of a self-invested personal pension (Sipp). This means Lily could actually buy commercial property for future salons in her Sipp and the business could rent the property from her Sipp. Upon eventual sale, there would be no capital gains tax to pay on the increase in value of the shop. Meanwhile, paying rent from her business into the Sipp will be a good way to extract cash from the business tax efficiently," Mr Morgan.
While Ms Sam will need to accumulate a sizeable amount of money if she wants to have a decent standard of living in old age, Mr Morgan says that her rate of saving will be largely dependent on how well her business does. "To give Lily some idea, in today's terms, if she wants an inflation-protected pension income of £15,000 at 65, she would need to accumulate a pension fund worth over £350,000. Her business is unlikely to grow at a fixed rate, so Lily's income is also unlikely to grow in a straight line. In fact, the majority of her future wealth might be generated by a sale of the salons."
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