What are mini-bonds?
A ‘bond’ is a debt instrument under which an investor lends money to a borrower, usually a corporate entity. Bonds are issued by the borrower on specified terms which are contained in a ‘bond instrument’.
Traditional bonds are issued by companies to both private and institutional investors and are traded on a stock market. Such bonds are commonly known as ‘corporate bonds’ or ‘retail bonds’ (although unlisted bonds are also sometimes referred to as retail bonds) and are issued by a variety of companies, including well known brands such as Tesco, National Grid and GlaxoSmithKline.
There is no legal definition of a ‘mini-bond’. However, the term is generally used to describe bonds which are offered mainly to private individuals and which are not listed or traded on any stock market. Typically, mini-bonds are not redeemable prior to maturity and are non-transferable, so the investor is tied in for the term of the bond.
Mini-bonds, as opposed to corporate bonds, tend to be issued by much smaller companies. Mr and Mrs Smith, Hotel Chocolat, Ladbrokes and the University of Cambridge are examples of some more well-known companies and organisations which have issued mini-bonds to raise money.
Mini-bonds, like crowd-funding, have become an attractive method of raising capital for smaller companies as a result of the difficulties in securing bank finance over the last seven or eight years. As Capita Asset Services, a leading administrator of mini-bonds, says “Mini-bonds offer a number of other potential benefits to companies including brand building, increased company profile and customer loyalty.”The market has seen mini-bonds issued across a wide range of sectors including commercial real estate, confectionary, leisure and gambling, retail, food and beverage and education.
One of the main attractions of mini-bonds is the better interest rates they offer compared with the high street banks. Typically, mini-bonds will have a coupon of anywhere between five and 10 per cent., whereas current deposit rates offered by banks may be as low as one to two per cent.
Who can issue mini-bonds?
Any corporate entity can issue mini-bonds. As mentioned above, mini-bonds are unlisted instruments and it is likely the issuer will also be unlisted. Under the UK Companies Act 2006, private limited companies are not permitted to offer securities (which includes bonds) to the public. Due to this restriction, many issuers of mini-bonds are unlisted public companies.
Typical commercial terms
Mini-bonds are often, but not always, unsecured, non-convertible and non-transferable. Most mini-bonds offer a fixed rate of interest over a fixed term, which is typically between three and five years in length. However, some mini-bonds have been issued with a term of up to 10 years. Interest is often paid annually but can be accrued and paid at the end of the term, when the principal amount invested will be redeemed.
Issuers often include loyalty vouchers for their products as part of the coupon to the bond or as a perk. It is hoped that this will strengthen the relationship between the bondholder and the issuer. For example, Mexican restaurant chain, Chilango, raised over £2m (its target was £1m) and anyone who invested more than 10,000 is entitled to one burrito a week for their life. Hotel Chocolat offered a loyalty card which could be used in stores as part of the terms of its mini-bond offer. According to Capita Asset Services, knowing your potential investor is crucial to the success of the bond. “Due to the characteristics of a mini-bond they tend to be attractive to relatively small retail investors, or those who already have a connection with the company or brand. Therefore, companies should research their audience to understand who will invest and which features will appeal to them, then ensure that the launch of the bond is supported with advertising to raise awareness.”
Who can invest?
In theory, anyone can invest in mini-bonds but most investors at this level are individuals (or their SIPP or SSAS) rather than companies or institutions.
However, the Financial Conduct Authority (FCA) introduced new rules earlier in 2014 aimed at protecting investors in non-listed products, including mini-bonds. For example, if an investment is offered or promoted by an FCA authorised firm, that firm will now need to take certain steps to ensure the recipient is either an appropriate investor or that independent financial advice on the investment has been received. The new rules enable the FCA to hold authorised firms accountable should they promote or offer investments to the wrong type of investors.
Although the income returns may be relatively attractive, there are some risks which come with investing in mini-bonds, particularly because they are generally illiquid products. In other words, although the principal amount lent will be returned at the end of the term together with any accrued unpaid interest, the holder will not benefit from capital growth through trading during the life of the mini-bond. In addition, if base rates go up during the term of the bond, the coupon will become less attractive but the bondholder will remain locked in.
Not all mini-bonds will be eligible for inclusion in a SIPP, SSAS or ISA. If a product cannot be wrapped up in one of these schemes, then the advertised income return is immediately less attractive to the extent it attracts more tax.
Mini-bonds are not protected by the Financial Services Compensation Scheme (unlike savers who may get £85,000 per account).
Anyone offering or promoting investments such as mini-bonds will need to comply with legislation governing financial promotions, including the Financial Services and Markets Act 2000 (FSMA). In particular, where a mini-bond is not being offered or promoted by an FCA authorised firm, in order to comply with FSMA, an issuer will need to take steps to ascertain the financial sophistication of each individual investor and satisfy itself that such investor has the requisite ability to invest in the mini-bond in question.
However, financial promotions approved by a firm that is authorised and regulated by the FCA will benefit from an expanded number of recipients who are permitted to receive the promotion under section 21 of FSMA. If approved, the appointed FCA authorised firm must ensure that the promotion is clear, fair and not misleading.
In addition to FSMA, the legal and regulatory framework for debt and equity investment products is complex and constantly developing, especially with the raft of recent EU Directives being transposed into law in the UK. It is important that mini-bonds are structured in the correct way so that they do not inadvertently fall under the remit of regulation primarily aimed at different types of financial products and investment vehicles.
Companies thinking about issuing mini-bonds will need to appoint various advisers to ensure the process is run properly and compliantly.
Lawyers will advise issuers on the legal aspects of mini-bonds, such as establishing the corporate structure, advising on the contractual and regulatory aspects of the offer and preparing and verifying the bond offer documentation.
FCA Authorised Person
The offer document may be approved as a financial promotion by a firm that is authorised and regulated by the FCA.
The tax ramifications for the issuer and the investors will need to be considered and general advice to this effect is usually provided with the offer document for prospective investors and their advisers to consider prior to subscribing.
A registrar issues the bonds, creates and maintains the bond register and processes interest payments to bondholders.
The Receiving Agent receives and processes subscriptions, usually via an online subscription process, and allots the mini-bonds and provides investors with bond certificates.
Some issuers choose to appoint a trustee to represent the interests of the bondholders.
How we can help you
Pure FS Support Limited manages the launch and plays an integral part in all aspects of a bond offer by working closely with issuers, other advisers and FCA authorised firms who approve financial promotions, in order to ensure compliance with all regulatory matters relating to the offer document.
Marriott Harrison LLP provides issuers with all of the legal advice and support needed to launch their mini-bonds.
Capita Asset Services can act as Registrar and Receiving Agent on behalf of issuers and provides trustee services.
We are able to recommend independent advisers with whom we work.
If you would like to discuss how we can help you with your mini-bond and financial promotion, please contact us and we would be delighted to advise and support you:
Pure FS Support Limited
T: 07977 274 628
Marriott Harrison LLP
T: 020 7209 2000
T: 020 7209 2000
Capita Asset Services
T: 020 7954 9705
This article has been jointly written by Pure FS Support and Marriott Harrison LLP with contributions from Capita Asset Services. It has been written for information purposes only.