How can an investor utilise alternative finance in such a low-rate environment? Transferring to an Innovative Finance Isa is one option. Crowd2Fund, one of the platforms that’s already secured approval from the regulator, offers tax-free returns of around 8.7 per cent APR. And P2P lending outside of a wrapper can yield decent returns for investors. The Liberum Alt Fi returns index, which benchmarks UK P2P and marketplace lending, shows the current industry return is 6.27 per cent annualised.
But what about specific products? One option is minibonds. While differing from retail bonds because they’re not traded on a market, minibonds enable private investors to lend money to a company, club or charity for a set period, in return for interest. I spoke to David Walker, partner at Memery Crystal, to find out more about minibonds and why he thinks now is a good time for investors to consider them.
What is it about minibonds that may appeal to the retail investor now?
Following the Brexit decision, lower interest rates are likely to see investors looking for alternative ways of seeking returns on their savings. It’s too early to say what the attitude of banks will be, but it’s plain that investors will be looking at other ways to get a return on their money. Minibonds are a way to do that.
Those minibonds that have been most successful historically are ones where there’s customer loyalty and knowledge of the brand – and those customers become investors. That’s why sports clubs and gyms can do so well and frequently make good candidates. Surrey County Cricket Club raised £5m in five days.
One of my biggest bugbears is that people often don’t realise that, if they invest in equity, there is no contractual date for when they’re going to get a return (if any) – by way of dividend or on exit. With minibonds, an investor should see income paid out bi-annually or quarterly. The average interest paid on minibonds commonly ranges from 5 per cent to 7.5 per cent gross per annum. Obviously that’s significantly higher than anything we’re seeing commonly offered on the high street.
Interestingly, we’ve started seeing returnee firms in the market. These firms have shown proof of concept: they have used the money raised in the manner originally described, paid interest when due, and made bondholders feel part of their growth journey. Now some of these bond issuers are seeking to repeat their success and go back to their original bondholders, many of whom are deciding to roll their bond into a second one and/or invest additional funds.
Obviously your capital is at risk if you invest it in a minibond. Are there certain red flags investors should look out for?
As is usually the case in life, if it looks too good to be true, it probably is. First of all, remember that these investments are predominantly illiquid and unsecured. Then, you should be looking for business-specific risk factors. If it’s a beer company, what’s the risk of it losing its licence? What would happen if the brewery burnt down? Those kinds of questions should be bottomed out and, if the information hasn’t been made available, you shouldn’t be afraid to ask why. Investors should also be seeing a return on a regular basis – ask why if it’s rolled up and only paid at the end of the maturity period.
In the minibond sector, we tend to see two types of offering. The platform offering and the standalone offering, which is via a business’s website. In my view, while there are some fantastic platforms out there, minibonds are not suitable for every crowdfunding initiative. In some cases, the information can be limited to a one-pager with an (admittedly well-produced) video. This will explain why the business wants to raise money, but it won’t always provide historic financials or easily-digestible business-specific risk factors.
This brings us to another point: a minibond is not appropriate for a startup; the company issuing should be profit-making. Moreover, most platforms make money through deal volume. That said, those that recognise the need to only promote viable and responsible propositions certainly do exist and can thrive.
We’re seeing better practices from businesses raising funds via their own sites. Of course, you might say ‘well, he would say that, wouldn’t he?’, but there are some distinctly improved practices. The most important is that these deals must be approved by a third party – and that’ll be the likes of Grant Thornton or BDO and other established names. They are responsible to the FCA and add experience to the offering – so you shouldn’t get situations where risk factors are hidden or insufficient, or where unsupported information is included in the offering documentation.
Unlike their listed counterparts, retail bonds, minibonds are subject to far lighter regulation. Would you like to see that change?
I would welcome some form of checklist for the content of mini-bond offerings and a tighter form of appropriateness test i.e. to ensure that investors understand the nature of the investment in which they are about to make. I think the FCA will in due course create a benchmark for the product. So far, the regulator hasn’t used its teeth to draw out examples of bad practise – I suspect it will and, to a certain extent, this will encourage self-regulation until more formal guidelines are introduced.
The question I always ask myself is: “would my mum understand this?”