Mini-bonds

Find out about mini-bonds and why retail investors should exercise caution when buying them.

What is a mini-bond?

There is no legal definition of a ‘mini-bond’, but the term usually refers to illiquid debt securities marketed to retail investors.

A mini-bond is essentially an IOU issued by a company (the issuer) to an investor, in exchange for a fixed rate of interest over a set investment term. At the end of the term the investors’ capital is due to be repaid.

The return on investors’ money entirely depends on the success and proper running of the issuer’s business. If the business fails, investors may get nothing back.

Are mini-bonds risky?

You should be very careful if you’re considering investing in mini-bonds and particularly if it is more than 10% of your net financial assets or any smaller sum the value of which you would not be prepared to lose.

You should examine not only the nature of the investments, but also their legal structure. For example, if the mini-bond is intended to be secured by security or charges over the underlying assets of the issuer, you should check that such security or charges exist. You should also ask to see evidence of the arrangements for holding your cash before the mini-bond is issued to ensure that your cash is properly segregated and held as a matter of law for your benefit.

All investments carry risks. Mini-bonds typically offer high yields but this reflects the much higher risks involved. Mini-bonds are typically issued by small or start-up companies, or companies that find it difficult to raise capital from institutional investors. The issuer could face cash flow problems that delay interest payments, or it could fail altogether and be unable to repay the money investors have lent it. Mini-bonds are also highly illiquid. Unlike ordinary retail bonds, mini-bonds do not have a secondary market. Investors are usually locked in until the bond matures and cannot trade their way out of their investment. That said, there are degrees of risk, and some mini-bonds will be riskier than others.

Investors considering mini-bonds may wish to seek professional financial advice before making their investment decision.

Are mini-bonds regulated, and am I protected? 

Generally speaking, a business does not have to be regulated by the FCA to raise capital by issuing shares or debt securities (whether ‘mini-bonds’ or otherwise). But any investment services provided to these investments are regulated in the usual way. For example, if an authorised firm provides investment advice about mini-bonds, it must make sure it is suitable. Mini-bonds are sometimes distributed by an authorised person (eg online investment platforms), and if so that person will be subject to our rules. In addition, financial promotions will usually need to be approved by an FCA-authorised person. They must check that the promotion complies with our rules – for example, that it is clear, fair and not misleading.

Mini-bonds are not like deposits. There is normally no protection by the Financial Services Compensation Scheme (FSCS) if the issuer is unable to repay investors’ capital. This may mean there is no guarantee you will receive any of your money back.

If you received a regulated investment service, such as investment advice, about the mini-bond from an authorised person and they failed to meet our standards, you may be able to complain to the Financial Ombudsman Service. If the authorised firm has gone out of business you may be able to bring a claim to the FSCS. If you received no service from an authorised person, it is unlikely that you will have recourse to either the Financial Ombudsman Service or the FSCS.

How can I tell how the issuer intends to use the money raised from mini-bonds?

This should be included in the details of the bond offer. Mini-bonds are usually purchased directly from the business you are investing in. You should research the business of the issuer before purchasing a mini-bond. This will help you to form a view of their prospects and the level of risk involved with the investment. These are often complex considerations, and the information necessary may not be readily available, or may be difficult to understand. The safer approach is to seek professional financial advice before making the investment decision.

Can I hold a mini-bond in an Individual Savings Account (ISA)?

You can hold some mini-bonds in Innovative Finance ISAs (IFISA), but not in cash ISAs. A mini-bond can only be held in an IFISA if it meets the relevant requirements for crowdfunding debentures (debentures facilitated through a crowdfunding platform) in the ISA Regulations 1998. Only a very small proportion of existing IFISAs will include mini-bonds.

Are there scams? How can I tell if a mini-bond is legitimate?

Mini-bonds can be a legitimate way for a business to raise money. As with many investment propositions, it can be difficult to assess if a business is run in an appropriate and knowledgeable manner, or will use investors’ money in the way it said it would. Mini-bonds are no different.

The FCA urges consumers to be vigilant when making investment decisions. Each of the following 6 warning signs, though not necessarily a problem, often indicate something to avoid:

  1. Unexpected contact ​​​​– traditionally scammers cold-call, but contact can also come from online sources eg email or social media, post, word of mouth or even in person at a seminar or exhibition.
  2. Time pressure – they might offer you a bonus or discount if you invest before a set date or say the opportunity is only available for a short period, so as to rush your decision-making.
  3. Reliance on social proof – they may share fake reviews and claim other clients have invested or want in on the deal.
  4. Unrealistic returns – fraudsters often promise tempting returns that sound too good to be true, such as much better interest rates than elsewhere.
  5. False authority – scammers often using convincing literature and websites, and falsely claim to be regulated. They may come across as highly knowledgeable about investment products.
  6. Flattery – it is a common tactic to build a friendship with you to lull you into a false sense of security.

Go to www.fca.org.uk/scamsmart for more tips on how to avoid investment and pension scams.

What do you need to know before buying mini-bonds?

If you are thinking about purchasing a mini-bond, here are some general considerations:

  • Weigh the interest rate up against the risk involved. In general, the higher the rate on offer, the higher the risk.
  • Check the cash flow is healthy and consistent, and look at the interest cover. This is the ratio which shows how easily an issuer will be able to meet interest repayments on its debt.
  • Are the issuer’s liabilities to investors secured on any of its assets? Are there other creditors who would get priority if the issuer went bust?
  • Research all recent reports and accounts from the business you are investing in thoroughly.
  • It can be harder to judge the risk involved in investing in some bonds than in others. For example, it is easier to assess the likelihood of a large supermarket going bust than smaller and more specialist businesses.
  • If you consider yourself to be an unsophisticated investor, or unfamiliar with the kind of business the issuer is in, it would be wise to seek independent financial advice before making your decision.
  • If you are considering making the investment through a person who claims to be authorised by the FCA, look them up on the Financial Services Register.
  • Because mini-bonds are generally risky and illiquid, as a rule of thumb it is a bad idea to invest more than 10% of your net wealth in this kind of asset. You should not invest money you cannot afford to lose, or which you might need access to before the end of the investment term.
  • Remember that you are not protected by the FSCS if the issuer goes bust.