Mini-bond masterclass

Ben Devons, partner at Marriott Harrison LLP, gives the lowdown on mini-bonds and says that they can serve as an attractive way for companies to raise money.

What is the difference between a retail bond and mini-bond?

A bond is a debt instrument under which an investor lends money to a borrower, usually a corporate entity.

Mini-bonds (sometimes referred to as unlisted retail bonds) are unlisted and are not therefore traded on a stock exchange. They are also usually not transferrable. As there is no market on which mini-bonds can be traded, the amount invested is only repaid on maturity of the bonds.

Potential mini-bond investors are typically provided with an offer document or information memorandum which sets out the terms of the bonds. Generally mini-bond offers are structured so as to avoid the need for a prospectus.

Retail bonds are listed and traded on a stock exchange. As such, they must comply with the rules of the particular exchange on which they are listed. All retail bonds intended to be listed on the London Stock Exchange, for instance, will require the issue of a prospectus which complies with the UK Prospectus Rules

Both mini-bonds and retail bonds must be marketed in compliance with the UK’s financial promotion regime under the Financial Services and Markets Act 2000.

Why do companies issue mini-bonds?

As early stage growth companies often find bank finance difficult to obtain and retail investors now seek a better return than low-yielding bank deposits, mini-bonds can serve as an attractive method for companies to raise money. Typically, we have seen the coupons offered on mini-bonds fall in the range of 6–8% per annum.

Mini-bonds are not traded on a stock market so they tend to be subject to less regulation and, as a result, where relatively small amounts are being raised, their issue tends to be more time and cost effective than retail bonds.

Mini-bonds can also raise a company’s public profile. For example, sometimes companies include non-cash rewards in lieu of interest or as an additional perk under the offer. The Mexican restaurant chain, Chilango, raised over £2m and anyone who invested more than £10,000 was entitled to one burrito a week for life!

Are there many mini-bonds on the market at the moment?

It is difficult to obtain an estimate of the number of mini-bonds currently available because they are typically marketed to private investors so information about them is not publicly available. However, some mini-bonds are advertised to the wider public, particularly on crowdfunding platforms. The Financial Conduct Authority (FCA), in their 2015 review of crowdfunding regulation, reported on the recent increase in the number of small companies issuing mini-bonds on crowdfunding platforms.

How are investors protected if they invest in a mini-bond and how does this compare to the protections given to holders of retail bonds?

There is relatively little protection for mini-bond and retail bond investors. In both cases, if the issuer becomes insolvent the investor will have to join the queue along with all the other unsecured creditors and the investments are not protected by the Financial Services Compensation scheme (FSCS) available to bank customers.

However, mini-bonds and retail bonds can be secured against the issuer’s assets or supported by a guarantee from the parent company or directors of the issuer.

Under the UK’s financial promotion regime, the offer document provided to mini-bond investors must be fair, clear and not misleading and approved by an FCA-authorised person, unless the recipient falls within one of the exempt categories of persons.

Retail bonds, being listed, will be subject to the more stringent disclosure requirements of the relevant exchange before they can be issued, meaning investors may have a greater level of information about the offeror and the risks of the offer compared with mini-bonds. However, with offers that are approved by an FCA-authorised person, we have seen that the required contents and level of verification of the offer document is similar to that required with companies that issue bonds which are to be listed.

Why did the recent SEB mini-bond fail? Is this likely to happen with other mini-bonds?

Secured Energy Bonds Plc (SEB) was the subsidiary of an Australian company, CBD Energy, which went into administration. The money invested into SEB through the mini-bonds was reportedly ‘transferred to CBD over time, via various inter-company loans; instead of being used to fund sustainable energy projects in the UK. Partly as a result, SEB defaulted on its quarterly mini-bond interest payment and went into administration.

As with other forms of investment, the risk of the issuing company becoming insolvent is present with every mini-bond. The likelihood of a default will be different for each investment and will depend on many commercial and other factors including the profitability of the issuing company, its total debt servicing burden, the state of the market in which the company operates etc.

What should potential investors consider if planning to invest in a mini-bond?

A few of the key due diligence steps are set out below.

  • Check the issuing company’s latest accounts and, if not included in any offer document, enquire about the availability of recent management accounts, cash flow forecasts and any business plan to gain an idea of the issuing company’s ability to meet principal and interest payments.
  • Establish the purpose of the mini-bonds, whether the proceeds are to be exchanged for realisable assets, whether these are secured in favour of the bondholders and the ranking of the bondholders in the queue of creditors should the company become insolvent.
  • Review the history and market presence of the issuing company, which will help to assess the level of risk.
  • Check the business track record of the company’s directors.
  • Consider whether to spread risk by investing smaller amounts into different mini-bonds rather than just one company.

As with any investment, investors who are unsure about how mini-bonds work should seek independent financial advice.

Interviewed by Anne Bruce.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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