The Complete Guide to Mini Bonds

Bonds are considered to be an efficient way for a more established business to borrow large sums of money from investors, and considered to be a viable alternative to offering equity in the form of shares.

The borrowing landscape has changed considerably over the last decade and it is no longer the default option for an SME to just call on their bank to provide their business with the finance that they need to fund their growth plans.

Due to a greater availability of private investors who are using the internet-based sources such as Crowdcube, Funding Circle and others that are almost too numerous to mention, business owners with a track record now have far more avenues to explore when they want to raise some money.

The concept of sharing the risk as a private investor with other like-minded investors appeals and this is why there has been such a growth in the number of crowdfunding platforms launched.

A mini bond is a concept that therefore appeals to investors and might be a good opportunity for someone with a £1,000 or more, to invest in a mini bond which might be typically offered over 3-4 year fixed period and with an interest rate that is typically around 7% to 8%, depending on the risk profile and other circumstances.

It is important to understand that when you invest in a business via a mini bond you are making a debt-based investment which involves lending money to that company for a fixed period and a fixed return.

This is entirely different to purchasing equity or a percentage of the business in return for your cash and with a mini bond you have no ownership or voting rights. What you are doing is purchasing debt in the form of a bond, and in return for this financial commitment you will become a creditor of the company and receive regular interest payments, together with the capital sum being returned at the end of the fixed term.

Evaluating risk

if you are investing money in a startup via a crowdfunding investment for example, you are taking a stake in that business and if it takes off you could make  a decent return, but if it fails to prosper as intended, there is always the risk that you could lose all of the money that you have invested.

The risk attached to a mini bond should be lower than taking an equity stake in a startup but there is still a risk. Your money is still at risk when you invest in a business via a mini bond and your lending is unsecured, with liquidity not guaranteed.

Evaluating the level of risk involved is something you need to develop your own strategy for by taking a look at each opportunity and deciding whether the rate of return being offered is an adequate compensation for the risk involved.

The point to bear in mind about a mini bond is that you are being asked to help provide finance to a more established business that is seeking the capital it needs to grow rather than being a startup with no or very little trading history to offer some comfort to investors other than the plans they have for the product or service they are launching.

Portfolio diversification is the key to successful mini bond investing for a number of regular investors.

If you have for example $10,000 to invest, you could conceivably invest in as many as 20 different companies and spread the risk around. You may well achieve the same rate of return as you would have done by investing the money in just one mini bond, but in the event of one of these companies failing, the fact that you have a diverse portfolio will have helped to minimise the damage to your capital.

Different to retail bonds

You may well already be aware of the idea of retail bonds which is where a company borrows money for a fixed term which is often between three and five years and regular interim interest payments are made during that period, with the capital sum returned at the end of the loan term.

A retail bond and a mini bond are similar in one respect in particular, which is that they are both non-convertible and neither type of bond is protected under the Financial Services Compensation Scheme either.

There are however, several fundamental differences between a mini bond and a retail bond.

The first point to remember is that a mini bond is not listed on the LSE and are not transferable, secondly, this also means that they lack the liquidity of retail bonds.

The fact that these mini bonds are not listed does also mean that there is regulation surrounding them and you could therefore potentially argue that there is potentially a greater risk attached to a mini bond, although the interest rate is often designed to compensate for this fact.

The other attraction for some investors with a mini bond is the fact that you may be offered some extra incentive in addition to the interest rate. An example of this would be when the restaurant chain Chilangos offered investors free burritos or when the department store John Lewis tempted investors with a 2% store discount.

Making the decision to invest

The offer of a free meal or a store discount should not be the reason you decide to invest in a mini bond, but it is one of the attractions to some consumers who like the brand they are investing in and feel they are getting a bit extra for their cash in addition to a reasonable interest rate.

When you decide to invest in any financial product, you have to be fully aware of the level of risk to your capital as best as possible, so provided you look at the financials very carefully and consider a diversified portfolio, a mini bond can be worth considering.

That is on the proviso that you know that a mini bond is unsecured lending and because they are not tradable, you will have to leave your money invested for the duration of the term. So you should only invest money that you can afford to tie up for somewhere between three and five years.

A mini bond should basically be viewed as a high-risk but high-reward financial product that has the added dimension of allowing you to engage with a product in a more direct way, if it is a retail opportunity that is being offered.

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Elizabeth Goldman is the editor of AlternativeInvestmentCoach.com. She has written for Investing.com, Bullbearings.com and many others.