Treasury Today Country Profiles in association with Citi

Could the mini-bond work for your business?

Big and small bird sitting on a fence

Mini-bonds are relatively new debt instruments being utilised by a number of organisations to raise finance. Here, we take a look at the product and its rather unique characteristics.

In April, English rugby club Harlequins launched its first corporate mini-bond, joining a number of other companies who have recently used the fledging debt instrument to raise finance.

The London-based team are looking to rise £15m through the bond, which has become a popular way to raise finance for some companies, especially considering the reluctance of banks to lend large sums to SMEs at present.

Classified as an alternative finance product, the mini-bond is, in simple terms, a financial instrument that is issued by a company to retail investors (typically its core customer base) in order to raise funds for capital requirements or for a specific project.

However, in comparison to traditional retail bonds, mini-bonds are unlisted and non-transferable. As a result, they are not as heavily regulated and provide a number of advantages for firms looking to raise finance relatively quickly and with greater flexibility.

A colourful history

British cosmetic company King of Shaves was the first to recognise the potential of tapping into its customer base and issued the first mini-bond in the UK in 2009.Whilst not the most successful issuance, other companies soon caught wind of the product and numerous other issuances followed.

One of the most successful of these was that of Hotel Chocolat, who re-defined the mini-bond by offering investors chocolate in return for their investment in lieu of cash. The so-called ‘chocolate bond’ was a huge success and saw the company not only raise £4m from their investor base to fund the company’s expansion plans, but also win a coveted Treasury Today Adam Smith Award for their innovative approach.

Although many of these early issuances involved niche companies looking to raise relatively small amounts, the £50m raised by the John Lewis Partnership in 2011 was arguably a significant milestone for the product.“This deal really gave the mini-bond a stamp of approval and more companies viewed it as a viable fundraising option,” says Jen Clarke, Associate Director, Corporate Finance at Grant Thornton.

Flexible offering

For larger corporations, of course, the need to use the instrument is reduced given their ability to access bank funding more readily or tap the traditional bond markets. That being said, the rather unique characteristics that define a mini-bond may make it an attractive proposition.

As mentioned earlier, the fact that the mini-bond is unlisted and non-transferable means that it is treated with a ‘regulatory lite’ approach with no requirement to issue a formal Prospectus. There is no need to obtain a credit rating and go through all the work required when issuing a listed bond. Instead the issuer creates an information memorandum that can be presented to investors. “Therefore the complexity around issuing these instruments is greatly reduced,” explains Clarke “and this means that it can be a relatively quick and cheap way to raise finance for a business compared to listed financial instruments.”

The instrument doesn’t escape regulation completely however as the mini-bond does fall under the financial promotion regime.“Everything stated in the information memorandum and any marketing materials need to be fully verified and signed off by an FCA authorised firm,” adds Clarke. “This can take time, but typically companies are able to go to the market 10 to 15 weeks after beginning the process.”

As well as simplicity and speed, flexibility is offered in terms of how the bond is structured. Typically these are short-term instruments (around three to five years), offer yields of around 6% to 8% to investors and the terms of the bond are left to the discretion of the issuer.

“Although the company is able to select the terms of the bond, we would advise that market realities feed into this decision making,” says Clarke. “Any issuing company should conduct an analysis of the market to see what is selling and who is selling it.After this preliminary research, the business can then take into account its own unique circumstances – what type of company is it and how large is its investor base, for instance – and then feed this into its decision making.”

The company can also decide if it wants to offer something in lieu of cash as yield – as seen by the Hotel Chocolat mini-bond. “This can of course reduce the cost of the financing for the company, especially if they are offering benefits that have no cost – such as providing investors the chance to buy tickets to events before the general public,” adds Clarke.

Marketing exercise

It is this ability to tailor the product to suit the audience that sets it apart from other alternatives.And, in many respects, issuing a mini-bond is a marketing exercise as much as a financing exercise.

“One of the main benefits of issuing a mini-bond is not just that it offers an alternative way to raise finance, but that it can also strengthen customer engagement,” explains Clarke.“The company is providing an opportunity to its customers to take an active role in its future growth.Plus the ability to offer money can’t buy opportunities such as early access to highly sought-after tickets can only sweeten the deal for investors.”

Risk and reward

Issuing a mini-bond is a highly public process and therefore can pose numerous risks to the business, in addition to those that are found with traditional bonds.

This biggest risk is, of course, a default and not just because of the financial implications. The public nature of the deal and the fact that the business is borrowing directly from its core customer base can have an enormous reputational impact. As a result of these risks, some companies who demonstrate the ideal fundamentals to issue a successful bond, are staying away from the product.“Some companies just have no interest in mixing their customers with financing,” explains Clarke.

“Whilst this risk cannot be fully mitigated, a business can go a long way to ensuring the risk is limited by making sure its financials are in order and that the business is actually in a position to issue a bond,” says Clarke.“We would only advise that those companies with historically consistent and strong profitability, tied with realistic forecasts that demonstrate sustained future growth, are suitable for this type of instrument.”

From a reward prospective, if a company is successful in its mini bond issue, then it can be a great profile raising exercise.Companies, such a Caxton FX, have been able to issue subsequent mini-bonds, with investors opting to roll over their investment into the new bonds.

A mini future?

At present, the mini-bond market is flourishing.The combination of low interest rates for individuals and companies finding it hard to access traditional finance have created the perfect environment for the product to thrive. But can the product survive once conditions change?

Grant Thornton’s Clarke believes so. “The product can adapt to the market,” she says. “The marketing element and how it can drive customer engagement will mean that it will always appeal to those more innovative brands with strong customer or fan bases.”

Regulation however, may have a large say in the future success of the product.“There is potential for regulators to restrict the growth of the alternative finance market,” says Clarke.“If regulation places too much burden on it then it may lose its appeal. The beauty of the product right now is its lack of complexity and inherent flexibility. For many companies with the right fundamentals, mini-bonds could offer the perfect funding solution.”