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Shave and prosper

Steven Black, a banking and finance specialist at law firm Osborne Clarke, looks at the emerging trend of firms offering non-transferable bonds direct to their customers

Bonds issued directly to the public are nothing new and can be issued and listed on the stock exchange in a similar way to shares but a new development is the issue of non-transferable bonds to the public.

By excluding the possibility of transferring the bond to a third party, the issuer steps outside most of the regulatory regime. This makes the bond cheaper and easier to issue and its simplicity can be a blessing, allowing the management to concentrate on making the profits needed to pay the bond.

However, for investors it is very much a case of buyer beware and they need to weigh up the merits of the issuance and consider if it is a tax-efficient form of investment.

A traditional retail bond with a listing requires a certain amount of disclosure and regulatory compliance by the issuer. Some companies have decided to go for a more informal option and reach out directly to the public, asking them to lend cash for a set period in return for an interest rate.

To avoid burdensome regulations, the loan is put in the form of a non-transferable bond issued by the company. This can be an attractive option for small to medium- sized companies which may view their traditional loan providers, often the banks, as too expensive.
In addition, they can sweeten the deal by offering incentives such as discounts on their products.

Men’s grooming company, the King of Shaves launched the first non-transferable retail bond in 2009. The bond paid a 6 per cent a year return, had a three-year term and offered investors some free products for its duration.

The following year Hotel Chocolat, the confectionary business, launched its own chocolate bond. The return to investors was paid exclusively in the form of chocolate. This issuance was aimed at existing customers who were interested in getting regular supplies of chocolate.

It raised £3.7m and allowed Hotel Chocolat to expand its operations.

Both issuances had an element of marketing as the management cleverly used the publicity to expand brand awareness.

This trend continued when Ecotricity, the green energy company, launched its bond in late 2010. It did so in a blaze of publicity and raised £10m. The interest rate on the bond was 7 per cent plus a 0.5 per cent bonus for their customers. It has since issued a second bond and its website reveals plans for a third issuance.

In 2011, John Lewis launched the biggest of this type of bond, which had a 6.5 per cent coupon, 4.5 per cent paid in cash and 2 per cent in vouchers to be spent at its stores. The issue was made available to staff and customer cardholders only.

Caxton FX, a foreign exchange and international payments business, issued a bond last year which was also targeted at its customers and paid an annual return of 7.25 per cent.

Most recently, April saw Mr & Mrs Smith, the luxury travel brand, launch a bond with a headline rate of 7 per cent or 9.5 per cent if you take the payment in “loyalty money” to be spent on booking hotels or guesthouses with them.

Often, the return is high-lighted as being significantly more than is available to savers from banks or building societies.

This is true but there has been some negative comment as people have pointed out that the bonds are not covered by the Financial Services Compensation Scheme and as they cannot usually be put into an Isa, an investor will need to pay income tax when the interest due on the bonds is paid out.

Bonds can only be included in Isas if they are for a term beyond five years, listed on a recognised stock exchange or if the company itself or a parent with at least a 75 per cent shareholding is listed.

For these purposes, Aim is not a recognised stock exchange, so it is unlikely SMEs will qualify.

This may change. A recent Government taskforce led by Tim Breedon in its report, Boosting Finance Options for Business, recommended: “Retail investment in smaller companies could be encouraged through the existing tax-incentivised Isa scheme.”

Allowing a greater range of retail bonds into Isas would fulfil this recommendation.

It is worth keeping an eye on this area to see if the Government does implement the recommendation and a tax incentive becomes available.

The retail bond is an unsecured debt of the issuer and, without a guarantee, is wholly reliant on the issuer’s ability to pay. This can make the bond a risky proposition.

When issuing a non-transferable retail bond, regulation is very light and the issuer needs only to comply with the FSA’s rules relating to financial promotions.

This, in effect, means the materials relating to the issue must be reviewed by an FSA-authorised firm which must ensure they are fair, clear, not misleading and, in relation to the yield, give a balanced impression on the long and short-term prospects for the investment.

There is no duty to reveal all pertinent information or keep investors updated, although the fact that investors’ cash is at risk must be made clear.

An investor should ensure they have confidence in the management team’s ability to deliver on their promises and have faith that the company is well run with good growth prospects.

As has been seen, customers have been successfully targeted as investors by issuers and it would appear a liking for the a company’s products or services goes hand in hand with confidence they will be able to repay a loan with interest but it must be stressed this is not an infallible guide.

The high return and incentives are there to entice investors to make what is an unsecured loan to a company for the medium term in a difficult trading environment.

The Government has expressed its desire to help SMEs get greater access to credit and a tax incentive in this area through the use of Isas may well be a way forward. There would then be another positive reason to look at retail bonds of the type described above.

At the moment, they are investments for those with faith in the issuer and an appetite for some risk.

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