Mini-bonds

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

Key points

Mini-bonds typically offer high returns and this reflects the much higher risks involved compared to other types of investments.

A business does not generally have to be regulated by the FCA to issue mini-bonds. There is normally no protection from the Financial Services Compensation Scheme (FSCS).

You should think carefully before investing in a mini-bond, and not invest any money you can’t afford to lose.

From 1 January 2020, it is against our rules to promote what we are calling ‘speculative mini-bonds’ to retail consumers, unless they are considered to be ‘sophisticated’ or have a high net worth.

What is a mini-bond?

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 period of time. At the end of this period, the investors’ money is due to be repaid.

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

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.

Video: What is a speculative mini-bond? (44 seconds)

Firms issue speculative mini-bonds to raise money from investors to lend to a third party or invest in other companies or property. These investments offer high rates of return but are usually very risky.

Are mini-bonds risky?

Mini-bonds typically offer high returns and this reflects the much higher risks involved in investment.

This is because mini-bonds are usually issued by small or start-up companies, or companies that find it difficult to raise funds from institutional investors.

This type of company could face cash flow problems that delay interest payments, or it could fail altogether and be unable to repay any of the money investors have lent it.

Mini-bonds are also highly illiquid, which means they cannot easily be converted into cash. Unlike ordinary retail bonds, mini-bonds do not normally have a secondary market so they cannot be sold on. Investors are usually locked in until the bond matures and cannot trade their way out of their investment.

There are degrees of risk, and some mini-bonds will be riskier than others. 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.

If you are considering mini-bonds you may wish to seek professional financial advice before deciding to invest.

Are mini-bonds regulated?

In general, a business does not have to be regulated by the FCA to raise funds by issuing shares or debt securities (whether ‘mini-bonds’ or otherwise).

But any investment services provided in relation 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.

From 1 January 2020, it is against our rules to promote what we are calling ‘speculative mini-bonds’ to retail consumers, unless they are considered to be ‘sophisticated’ or have a high net worth. The particular kind of mini-bond we’re concerned with is where a company raises money from investors with the intention of lending the money to a third party or investing in other companies, or property. Being able to pay interest and repay the original investment depends on how these lending or investment activities perform. Where these products are marketed to ‘eligible’ investors, they will have to clearly state the risk of losing all of the investment, and also provide clear information on the costs and charges associated with the product.

Are mini-bonds protected? 

Mini-bonds are not like deposits. There is normally no protection from the Financial Services Compensation Scheme (FSCS) if the issuer is unable to repay investors’ capital. This means that, if the mini bond issuer fails, you could lose all of your money.

Complaining about mini-bonds

If you receive a regulated investment service, such as investment advice, relating to a mini-bond from an authorised person and they fail 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 purchase a mini bond without receiving a service from an authorised person, it is unlikely that you will be able either to use the Financial Ombudsman Service or to make a claim to the FSCS.

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 says it will. Mini-bonds are no different.

Be wary of adverts online promising high returns, and be especially cautious if you’re contacted out of the blue or pressured to invest. Find out more about how to avoid investment scams on our ScamSmart pages.

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 a measure known as the ‘interest cover ratio’. This is the ratio which shows how easily an issuer will be able to meet interest repayments on its debt - it can be a useful indication of a company’s financial health.
  • 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.
  • Be aware that 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, it is usually 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 will not usually be protected by the FSCS if the issuer goes bust.

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. You should research the business of the issuer before purchasing a mini-bond. This will help you to judge their prospects and the level of risk involved with the investment.

You should examine not only the nature of the investment, but also how the investment and its issuer are set up. For example, if the issuer is indicating that your investment will be secured through charges over its assets, you should check that these charges exist. Ask to see evidence of the arrangements for holding your cash before the mini-bond is issued to ensure that your cash is kept separate from the issuer’s funds before it is invested.

These are often complex considerations, and the information you need may not be easily 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.

Page updates

26/11/2019: Information added Update about 1 January 2020 'speculative mini-bonds’ rule introduction and video added