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Corporate bonds are the bread and butter of raising capital. A corporate bond is essentially a loan issued by a company to investors, for a predefined duration of time. In return for the risk an investor takes in loaning money to a corporation, a set (usually annual) interest rate is paid to the investor in the form of a coupon, across the course of the bond’s lifespan.
A corporate bond is essentially a loan that is issued by a firm and sold to investors for a predefined duration of time. The bond is a type of debt security, which an investor risks capital on. Occasionally, physical assets may be used as collateral, but the bond is normally issued based on the ability to repay, and an evaluation of likely future business performance.
This arrangement allows for a few things to happen:
A bond will ‘reach maturity’ after a certain period, after which the original investment will usually be returned (see convertible bonds for more).
Bond issuance is typically one of the fastest and most efficient ways for a company to go public via the use of securities, and are particularly advantageous as low risk investments which will beat inflation – which is at record low levels for pure cash holdings. In theory, there are no real fluctuations when it comes to bonds, the interest rate (coupon) and initial investment are set.
This being said, most bonds that are sold to retail investors are done via accredited financial advisers to ensure that the buyer understands what they are buying, to reduce any liability should the investment go wrong. This had proven an issue in the past, leading the FCA to ban the advertising of mini-bonds to retail investors.
The process of ensuring that buyers understand the risk of bonds is far easier to calculate for investors, which is why bond issuance is relatively fast, particularly in contrast to equity issuance. This is only compounded by bond issuance to accredited/institutional investors, who clearly understand the risk of bond ownership.
Initial discussions would begin regarding the approach we would take to the operation. We would aim to understand your financial situation and identify whether bond issuance was the right move for your strategic aims. Questions around the need to create a prospectus and the need to list the bond on an exchange would be asked and a strategy prepared.
We would then work to create the bond itself by instructing a securities solicitor that we are familiar with, and begin laying the foundation for bond issuance. This solicitor would create the legalistic framework for the bond and include term length, interest, and other options within the contract according to the needs of a client. After this, the solicitor would create a subscription agreement, for investors to sign up to.
This work from the solicitor would be incorporated into an information memorandum. This document is not strictly necessary for compliance reasons, but is customary to provide when issuing a bond, for investors to be able to understand the bond terms, and the operating company itself. This memorandum would bring together financial information alongside intangibles about a client’s business; directors, projections, working culture, products, services, marketing and much more. The memorandum brings a lot of credibility to the bond as an investment product, and encourages investors to back the issuing. We would work significantly with clients to ensure that the best insights and information are demonstrated to investors through the memorandum.
Concurrently, Swordblade would create a Special Purpose Vehicle, or SPV. This would usually take the form of a UK PLC (or in the US, an LLC). The SPV would be the company that issues the bond created by the solicitor, to protect a client’s operating company from any liabilities that come in the form of bond issuance. The SPV would then lend the capital raised back to the initial operating company.
Dependent on a client’s needs, we would then consider whether there was a need for a prospectus. A solicitor would be instructed to create a prospectus, but this would depend on whether the bond was public or not (see our section on compliance). A prospectus would usually be developed from the information memorandum by a solicitor, with a time-tested formula for success and tailored to each client’s aims regarding the bond.
In our experience, most investors have a preference for buying via the subscription agreement, but we would also list a bond to be issued an ISIN. An ISIN allows a bond to be traded electronically and is easily transferable. This has the dual purpose of also bringing a company to one of the largest global markets, whether that be Frankfurt or London. Placing a bond onto a financial market is an extra step in the process, but is usually worthwhile for the tax advantages that come alongside it.
The bond would then be sold to investors, via the SPV, raising capital for the clients’ operations.
Our specialists are also proud to offer convertible bonds to our clients. A convertible bond is identical to the bonds previously described. The only real difference is that within a convertible bond, bondholders may have their initial investment returned in equity, usually at a discounted rate.
But why consider a convertible bond?
For example, a three-year, £100,000 bond could become £125,000 in equity (at the current market value) once the bond matures. This could also be advantageous to the bond issuer.
Through option agreements, the bond issuer can have the opportunity to take this conversion, or not. If after the term of the bond, the issuer decides they do not wish for equity to be given (perhaps due to more investors being interested after growth) and so would pay back the initial £100,000. This would be advantageous to help raise more funds in the long term.
Convertible bond options are available from the initial creation of the bond and are directly tailored to the collaborative strategy employed between ourselves and clients in fund-raising activities.
By contrast to issuing equity, red tape, regulation and compliance issues are far simpler when it comes to bond issuance.
As outlined within our process, a securities lawyer from our network would be contacted to ‘create’ the bond, outlining its terms within a legal framework. A subscription agreement would then be created, which is how investors would usually purchase the bond.
A prospectus would be required for the bond if it was public. A bond is considered private if:
Otherwise, the bond will be considered to be publicly offered. If a bond is public, an approved solicitor would be asked to approve a prospectus, which comes at the cost of more time and money, so would be factored into any bond process before any undertaking was made. The bond would then have to be approved by the financial supervisory authority in the country where the bond is issued.
Furthermore, even if a bond is public, smaller bonds (up to £8 million) can be exempt from having a prospectus so long as the bond is structured properly in its initial stages. The cost to write a prospectus can usually be estimated in the range of £50,000-£100,000.
A prospectus’ style is determined by the country in which the bond is marketed, and therefore where the buyers of the investment are. For example, if a bond was issued in the US by a UK company, then the regulations for the bond’s prospectus would be based on US regulations. The UK’s regulations remain aligned to the EU’s prospectus guidelines, but is developing its own guidelines for the future due to Brexit.
The bond must also be sold through regulator-approved financial advisors, and so this cost must also be considered within the process.
Early on in the bond issuing process, it would need to be decided whether the bond should be listed onto a stock exchange. Though this process may be slightly more expensive, it saves a company 20% in Withholding Tax when making interest payments (paying the coupon) to bondholders – so is usually worthwhile.
If the bond is issued in a different country, usually European, this tax is listed within HMRC’s exemptions, for eurobonds, alongside an exemption for bonds with a term of <365 days (see the full list here).
In our role in the process, our analysts carefully evaluate each clients’ wishes, alongside the most efficient practices for their combined business strategy and approach to going public and securing financing. Our initial free assessment can be found here, so you can begin to understand our methodology, and so we can best understand how we here at Swordblade can help you.
The most common question from clients is the question of whether issuing bonds is a better way to raise capital than equity. This section will focus on demonstrating the differences between the two.
As a general rule, bonds are measured in weeks and equity in months. Bonds tend to take around 4-6 weeks to create and issue, contrasted to around 6 months for equity. Depending on the urgency of funds to business operations and expansion, this would be something to consider.
Another advantage to bonds over equity is the usefulness of bonds to fund large capital expenses. For example, if a company wished to finance £100m for the cost of a new real estate venture, for a smaller company looking to go public this would be very difficult to do via equity. By contrast, using the property value as collateral, a bond could be issued, financing the same amount with no issues – as there isn’t a finite limit on the amount raised, as there is in equity.
Without being chained to a certain valuation like with equity, bond issuance can be very useful particularly to smaller companies whose valuation is either too small or isn’t confirmed in light of the business actions that would increase it substantially. With the use of convertible bonds, this value can be brought into a deal at the end of the process, which is helpful to issue equity when in an industry when initial expenses are high and demonstrating a certain valuation is an issue.
Bonds are also far simpler to issue than equity when it comes to compliance, which makes for a more cost-efficient issuing process. Most exchanges are often very picky about what they list and don’t list, they would be hesitant to list equity on a company if there is a reputational risk. By contrast, most exchanges are happy to list bonds.
Furthermore, as outlined above, regulations regarding selling bonds are stringent, but a drop in the ocean when contrasted to equity issuance and IPO’s. For example, in micro/nano-cap companies, the issuing of mini-bonds is subject to distribution by an ‘authorised person’ – to ensure that the sale is ‘clear, fair and not misleading’ per FCA rules.
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