How A Startup Or Private Company Can Issue Mini-Bonds
A bond is essentially an IOU, a promise by a borrower (also called an ‘issuer’) to pay money to an investor (also called a ‘bondholder’), usually with interest. What is often called a ‘mini-bond’ is a type of bond which is issued in small amounts directly to consumers, avoiding the requirement for a full stock market listing of bonds on the stock exchange.
Typically, mini-bonds offer investors returns of up to 7% per annum over 3 to 5 years. Mini-bonds are unregulated, non-transferable (cannot be traded between investors) and often unsecured instruments.
Anyone who purchases a mini bond must hold it for the full term until maturity, unless the company that issues it decides to redeem early or there is a permitted transfer under the bond terms and conditions. Mini-bonds are not usually subject to the Prospectus Directive and so a prospectus is not required to be prepared.
Issuers of mini bonds are usually less established companies, with lower turnovers. They sometimes include vouchers for their products as part of the coupon, so to further entice investors.
What is required to create a Mini-bond?
The following documents usually make up the legal framework of a mini-bond:
1) Term sheet
- Sets out the principal terms for the proposed issue.
2) Mini bond instrument.
- Terms and conditions of the bond, including payment and early repayment conditions, financial covenants, representations and warranties, events of default, meetings and powers of bondholders and, if applicable, a guarantee.
3) Offer document
This is the principal marketing document (where a prospectus is not required) which includes the following information:
- A description of the mini bonds and their terms and conditions.
- A description of the issuer’s (and, if applicable, the guarantor’s) business and operations.
- Financial information about the issuer (and, if applicable, the guarantor).
- Risk factors relating to the mini bonds and the issuer’s (and, if applicable, the guarantor’s) business and industry sector.
- A summary of the selling restrictions and tax provisions relating to the bonds.
- The form of the mini bond instrument.
Note that the offer document must only be distributed by entities which are FCA authorised. The offer document will be subject to the financial promotions regime under the Financial Services and Markets Act 2000, and so the issuer and the platform (or relevant distributer) should be especially vigilant that the information contained in the offer document is accurate.
This agreement governs the relationship between the issuer and the investor in which the issuer agrees to issue the mini bonds and the investors agree to subscribe for the mini bonds. It may be in written form or in electronic form and entered into on the platform’s website. This agreement usually includes the following:
- The issuer agrees to issue the mini bonds in the form set out in the mini bond instrument.
- The investor agrees to subscribe for the mini bonds in accordance with the terms of the mini bond instrument.
- Details of how payment and delivery of the mini bonds will be effected on closing.
Issuer’s board minutes
These will authorise the issue of the mini bonds and include the necessary resolutions of the board approving the relevant documents and actions. The minutes aren’t required but will often be reviewed by the distributor. If applicable, there will also be board minutes from the guarantor.
If the mini bonds are secured, then a debenture and often a security trust deed will be required.
Avoiding the need for a prospectus
To avoid the need for a prospectus the two main points to bear in mind are that the mini bonds must usually be issued:
- so that they are non-transferable; or
- where the total consideration of the offer is less than EUR 5,000,000 calculated over a period of 12 months.
It is sometimes possible for a legal or natural person to issue their own mini bonds, without having to be FCA authorised to do so (see the ‘Exempt investors’ paragraph below). However, making arrangements for the sale and purchase of mini bonds, and promoting the sale of newly issued bonds, can be quite complex, in particular in relation to financial promotion rules and how they relate to the modern realities of crowdfunding on the internet (i.e. arranging for the sale and purchase of mini bonds through a digital platform).
Under section 21 of the Financial Services and Markets Act 2000 (FSMA), it is unlawful to communicate an invitation or inducement (also called a “financial promotion”) to buy or sell a mini bond, unless one of the following applies:
- The person making the communication is PRA or FCA authorised.
- The communication has been approved by a PRA or FCA authorised person.
- The communication will only be directed at those who fall into one of the exempt categories of recipient.
Many mini bond issuers are not PRA or FCA authorised and they do not want to pay a PRA or FCA authorised person to approve their financial promotions. They therefore restrict their communications to those who fall into one of the exempt categories of recipient in section 21 of FSMA. These communications will be lawful, but only if they:
- Include the prescribed warning language set out in, and meet the other tests required by, the Financial Services and Markets Act 2000 (Financial Promotions) Order 2005.
- Are directed at (for example): “overseas recipients”, “investment professionals”, “certified high net worth individuals”, “high net worth companies”, the trustees of “high value trusts”, “sophisticated investors”, and/or “self-certified investors”, as defined in and by the Financial Promotions Order.
Does the issuer need to be a PLC?
Subject to certain exceptions, a private limited company is usually prohibited from offering any of its securities to the public under section 755 of the Companies Act 2006. However, a number of platforms have taken the position that section 755 of the Companies Act 2006 does not apply to offers on their platform by either:
- Ensuring that all persons wishing to invest are a “member” of the Platform, so that offers can be considered to be made to defined individuals rather than the public.
- Requiring investors to “join” the platform, in order to satisfy the exemption under Section 756(3)(a).
These exceptions are now relied on widely and have not been challenged, but if an offer to the public is made in contravention of section 755, please note that this may lead to:
- An order restraining the company from contravening that section (section 757, Companies Act 2006).
- An order to re-register the private company as a PLC (section 758(1), Companies Act 2006).
- An order to wind up the company (section 758(3)(b), Companies Act 2006).
FCA bans sale of certain mini-bonds
From 1st January 2020 the FCA banned the promotion of speculative mini-bonds to retail consumers.
The FCA felt it was necessary and expedient to introduce immediate temporary intervention measures in order to protect consumers, especially given that the average investment in speculative illiquid securities is over £25,000. The ban comes into effect on 1 January 2020 and lasts until 31 December 2020, after which time the changes will lapse as the FCA is not able to renew temporary intervention measures beyond 12 months. This temporary restriction limits who ‘speculative illiquid securities’ can be promoted to and how they can be promoted. The FCA regards both debentures (including mini-bonds) and preference shares, as speculative illiquid securities provided that they are denominated, or have a minimum investment of less than £100,000 and the issuer uses or purports to use some or all of the funds raised to (i) lend to third parties, (ii) buy or acquire investments or (iii) purchase interest in or fund the construction of property. This legislation is not intended to capture (i) companies raising debt or equity for the purposes of its group, (ii) credit institutions, (iii) listed debt or (iv) peer-to-peer lending (which is covered by the non-readily realisable securities regime).
On 9th December 2019 the Solicitors Regulation Authority (SRA) published the following guidance:
“We have long warned of the serious risks for solicitors involving themselves in investment schemes that appear to be dubious. Often, the involvement of a solicitor is purely to give the scheme a veneer of credibility. No actual legal work takes place.
Investors – ordinary members of the public looking for a decent return on their savings – have reported hundreds of millions of pounds of losses over the years. They usually have no way of reclaiming these losses, and applications to the Compensation Fund are not successful because they were not users of legal services.
The vehicles used for these investment schemes can vary, and new products emerge all the time. A new report we are finalising for publication in the New Year identified mini bonds as one such product.
Last week, the Financial Conduct Authority (FCA) banned those it regulates from selling mini bonds that aim to raise funds which are then lent to third parties. High-profile cases involving such bonds, and affecting nearly 12,000 investors, sparked the ban.
The sale of mini bonds aimed at fund raising directly for their companies are not banned.
Unregulated mini bond sellers are also unaffected as they are outside of the FCA’s remit.
This ban should serve as further warning to the profession to take great care when helping an investment scheme operator.”
Further information from the SRA on how solicitors should or shouldn’t get involved in investment schemes can be found here.
How can you help?
On a fixed fee basis starting from £2,500 plus VAT, we are happy to prepare and advise on the relevant bond documentation that will help you succeed in raising finance. This typically involves us producing and advising on a suitable offer/invitation document (together with accompanying notes), the main bond instrument and a subscription form
We can also assist with a verification process. This includes writing up a set of verification notes and collecting all verification material referenced within the notes.