Fundraising from customers: Should you consider retail bonds?

Caxton FX joined King of Shaves, Hotel Chocolat, and others in raising finance via retail bonds issued to customers. Would it work for your business?

Nobody needs reminding that trading conditions are hard for small companies, nor that it is particularly hard to raise money in the present climate. Options are few; investors are unwilling to take on risk, and the banks are retreating behind the barriers. So if you need an injection of capital, perhaps to take advantage of a growth opportunity, you might think it better to put your plans on hold until the financial markets ease.

But for companies conceived and founded in the spirit of entrepreneurship that is not good enough. Your bank doesn’t want to play? You don’t want to part with equity? Fair enough – there is another way. It cuts out the middleman, and allows the people who trust you most, your own customers, to have a real stake in your future growth.

Retail bonds: raising finance from customers

Retail bonds are not for everyone. You need a broad constituency of stakeholders willing to tick your ‘like’ box. But for companies that conform to a clearly defined set of parameters, none of them particularly onerous, this is an effective, innovative and relatively low cost way for privately owned UK companies to raise funds from UK investors. Caxton FX has just closed a bond issue that does just that.

The FX part stands for foreign exchange of course – Caxton claims to offer its corporate customers unbeatable exchange rates together with convenience and control over their employees’ overseas travel. Its success depends entirely on the confidence these customers are prepared to place in it, through repeat business, referrals, and ultimately the ability consistently to save them money.

Like all businesses it needs working capital. “We had the option of taking bank debt, but though banks may be starting to lend again, the conditions they insist on are very onerous,” says Caxton’s founder Rupert Lee-Browne diplomatically. His company has got by so far without bank debt, and more importantly bank debt is something he considers inappropriate for a business whose USP is offering a better forex service than these same banks.

Another option would have been to sell equity but in common with most entrepreneurs, he says: “Dilution is something I am not very keen on! The third option was to issue a retail bond. That fits neatly with our ethos of customer service. It provides investors with a better rate of return on their savings than the UK high street banks and gives us working capital to accelerate our growth.”

Why retail bonds are attractive

The Caxton FX bond offered investors the chance to earn 7.25% per annum over the four year term of the bond. With CPI inflation now at 5.2% that’s an arresting return. “It is unsecured lending, so there is risk, but you have to take some risk if you are going to go anywhere in the current market,” says Damon Clark who has bought into the issue. An entrepreneur himself (he is founder of Brandwidth Marketing), his company has used Caxton’s service. “You can’t know exactly what is going on in any organisation but it is nice to deal with a company that you know has been a success over a period. You know where their offices are; if you pick up the phone you can talk to them; and you have built up a trading relationship with them.”

Not many retail bonds have been issued by small and medium sized businesses to date, but this market is expected to grow. The success of green energy supplier Ecotricity’s £10m EcoBond in 2010 should be enough to convince most. By the offer deadline it was oversubscribed by nearly 50%. About 80% of the bond issue went to existing customers.

The lesson to be learned from both exercises is the importance of the relationship between the company and its customer community. Ecotricity attracts conscientious subscribers because it sells electricity generated by wind power and in each of the last six years has invested 10 times as much as any of its ‘big six’ competitors in building new sources of green energy. It may also be significant that these are people willing to pay a premium to reduce their carbon footprint.

One thing is certain; a bond issue won’t be successful if the market is not behind the issuing company. This may mean a real ethical consensus, or just old fashioned customer satisfaction. In July 2011 a Which? survey gave Caxton FX an 89% customer satisfaction rating, the highest in the market. “We always thought a large proportion of the money would come from our clients because they already trust us with their money,” says Lee-Browne. Previous high profile bond issues by Hotel Chocolat and King of Shaves were able to leverage the exclusive ‘club’ ethos of the brand.

In Hotel Chocolat’s case, the chocolatier went to the 100,000 members of its ‘tasting club’ and raised £3.7m in July 2010. While £5m had been the initial target, the handsome fundraising, for which customers staked £2,000 at a gross annual return of 6.72% or £4,000 at 7.29%, enabled it to invest in a new chocolate factory in St Lucia, expand its existing Cambridgeshire factory to take on more staff, and open new stores. The ‘chocolate bond’ was FSA-approved.

King of Shaves was less successful in attaining its target of £5m for its ‘shaving bond’, but still managed to amass a healthy £627,000 and was pioneering in its move as the company did this in June 2009. Founder Will King promised 6% interest over three years, plus free product, to its buyers of bonds.

In a related move, independent Scottish brewer BrewDog, raised £700,000 from an ‘online-only IPO’, which it called ‘Equity for Punks’. A huge success, 3,000 customers bought shares at £230 a pop. Started in 2007 with a £30,000 bank loan the company is now on track to hit a turnover of £6.5m in 2011. The company, founded by James Watt and Martin Dickie (who were named Growing Business Young Guns in 2009), is now promoting its second share sale ‘Equity for Punks II’. Interested parties can click to find out more, download a prospectus, or instead click on the third option: “f*** that I just want to buy some shares”.

The process of creating retail bonds

So could your business raise money through a bond issue? “At least investigate this route, even if it turns out in the end not to be right for you,” advises Rupert Lee-Browne. “SMEs need an alternative to the banks and this is an exciting way of raising funds.”

There’s a cost attached to the process. Typically the fees you will pay to the lawyers and financial advisors will add up to between 2% and 3% of the sum raised – the proportion is of course higher the less money is raised, and it is probably not cost effective to consider an issue of less than £2m. And these professionals need to know what they are doing, insists Lee-Browne.

Ultimately a bond issue is a financial promotion regulated under the Financial Services and Markets Act 2000. From outset to issue takes about 10 weeks according to Richard Kleiner of chartered accountants Gerald Edelman, who in partnership with corporate law specialists Memery Crystal handled both the Ecotricity and the Caxton FX bonds. The lawyers and accountants will require your accounts to be up to date and will require you to prepare as diligently as you would for an IPO, in some measure equating to the NOMAD in that process.

You will have to convince these professionals that your business plan is robust enough and your growth trajectory strong enough not only to cover the interest but also to repay the entire amount at the end of the agreed term – though it should be borne in mind that you are at liberty to redeem the bond at an earlier date should you so wish. The point about customers choosing to back individual companies is an important one from their point of view as they are taking the risk in believing the company will continue to grow in what is a very tough environment – and loyalty could be sorely challenged if performance doesn’t follow your projections.

It’s also worth being aware that some analysts have suggested retail bonds are not tax efficient for investors. They cannot be incorporated into individual savings accounts or self-invested personal pensions as they are not listed.

In theory any company could create a bond but as with any product you have to be able to market it. Without a strong brand presence or a substantial niche following it may fail says Memery Crystal’s David Walker. “If it just to be general marketing campaign the company needs to be aware that it may not get the response it wishes.”

Even if bank lending becomes more accessible retail bonds will remain an attractive alternative debt funding route. It has the added advantage that it can be used as a marketing tool as well. It creates a new link with your customers and forms a link with people who were not previously customers: the marketing exercise automatically raises the profile of your company. But is it right for you?

Ticking the bond boxes

If your company: … Has a sound track record … Has credible growth expectations … Can demonstrate a robust business plan … Has a close relationship with its customers, a strong brand presence and a good name in the marketplace … Has the backing of experienced legal and financial professionals … you too could raise capital through a private bond issue



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