Article 4.5 ‘Crowdfunding' muscles in on the bond market

By Thomas Hale

Financial Times June 24, 2014

‘Crowdfunding’ is coming for the bond market. Two UK restaurant chains have raised fixed-income debt in the past week through Crowdcube, a crowdfunding platform with 75,000 registered users.

Chilango, a Mexican restaurant chain, is looking to raise up to £3m through its crowdfunded retail bond - the ‘first in the world’ of its kind.

The 5-year bond, which yields 8%, also included a free weekly burrito for those willing to invest over £10,000.

Just days later, River Cottage, a restaurant chain founded by Hugh Fearnley- Whittingstall, the celebrity chef, also crowdfunded a £1m bond.

So-called ‘mini-bonds’, a type of retail security used by smaller, high-growth companies, have grown in popularity in the past few years. Research by Capita Registrars suggests that the market for mini-bonds could rise to £8bn by the end of 2017.

But this market is ‘archaic’ and ripe for disruption, said Luke Lang, one of Crowdcube’s founders. Rather than paying fees, which it says usually total more than £100,000, Crowdcube charges companies 5% of the total raised once the target has been met.

‘We’re trying to cut out some of the fat from the City of London,’ said Mr Lang. ‘With mini-bonds, fees from financial advisers, lawyers, compliance and marketing companies can rack up pretty quickly.’

While attracting high-yield investors, the bonds have also drawn scrutiny. Critics point out that there is no secondary market, and the bonds are unsecured - meaning that investors rank behind secured investors in the case of a default.

‘Some of the conventions of the institutional market have been thrown out the window, but those conventions are there for a reason,’ said James Tomlins, a high-yield bond portfolio manager at M&G.

He added that the products represent a ‘new area of capital’ and that the use of the word bond may be inappropriate.

Previously, companies such as Crowdcube have targeted equity investors looking to benefit from the profit potential of small but fast-growing companies. In issuing bonds, crowdfunding companies hope to diversify their investment offerings and attract companies with the cash flow available to service fixed income debt.

While the average size of an equity issuance on Crowdcube is £200,000, retail bonds are all expected to raise at least £1m. The company says it is currently in talks with companies - including ‘household name brands’ - over future bond issuances, some of which may reach a price of up to £15m.

Source: Hale, T. (2014) ‘Crowdfunding' muscles in on the bond market, Financial Times, 24 June.

Infinite variation

Corporate bonds come in an infinite variety of forms in many different curren­cies and maturities, with the most common currencies being the US dollar and the euro.

Straight (plain vanilla or bullet) bonds

These are straightforward bonds and the most commonly issued, with regular (usually semi-annual or annual) fixed coupons and a specified redemption date. If the entire issue matures on a single date they are often called term bonds.

Floating-rate notes (FRNs)

A major market has developed over the past three decades called the floating­rate note (FRN, also called variable-rate note (VRN)) market. Two factors have led to the rapid growth in FRN usage. First, the oscillating and unpredict­able inflation of the 1970s and 1980s caused many investors to make large real-term losses on fixed-rate bonds as the interest rate fell below the rate of inflation. Lenders became reluctant to lend at fixed rates on a long-term basis. This reluctance led to FRNs being cheaper for the issuer because it did not need to offer an interest premium to compensate the investor for being locked into a fixed rate.

FRNs pay an interest rate that is linked to a benchmark rate - such as the Libor. The issuer will pay, say, 70 basis points (0.7 of a percentage point) over the ‘reference index' of Libor. The coupon might be set for the first six months at the time of issue, after which it is adjusted every six months, so if Libor was 3%, the FRN would pay 3.7% for that particular six months. The most common reference rates are three-month or six-month Libor. Interest rates may be linked to a variety of other benchmark rates, such as the Fed Funds rate, muni­cipal and mortgage interest rate indexes, a particular money market rate or the rate of inflation. The interest rate may be fixed daily, weekly, monthly, etc.

In 2013 concern about rises in interest rates led to an upsurge in the number of FRNs being issued - see Article 4.6.