The alternative finance market has expanded apace this year, with new launches cropping up weekly as investors increasingly embrace the sector.
Assets have been tipped to reach £4.4bn by the end of this year, according to Nesta, having climbed sharply from last year’s total of £1.74bn.
But even as alternative finance grows in popularity, investors must exercise extreme caution when assessing many of the mini-bonds coming to market.
We know from experience that start-ups desperate for finance are chomping at the bit to raise money from anywhere and everywhere. The reality is, however, that many are so embryonic that they do not even have any revenue history to speak of.
Due to a lack of regulation thus far, literally any company can come to the market seeking funding via mini-bonds. As such, we have to do our own due-diligence to ensure companies and their propositions can pass the testing questions journalists – let alone experienced investors – might throw at them.
In practice this means we refuse far more businesses than we accept, but the flipside is we know what to look for when screening for the most attractive offers.
So what are our key criteria? In our view, there are four key components to launching a successful mini-bond.
- Solid financials
First and foremost we look at a company’s financials to make sure they are in order. This means assessing revenues, profits (or losses) and balance sheets, using external advisers where necessary to ensure we understand the ins and outs of businesses.
- Strong management team
As most professional investors will tell you, a strong management team is a key driver of any business which wants to thrive in the long term. They can truly be the difference between success and failure, and a business whose owner does not have a track record can often be a red flag for us.
- Established company/brand
We have worked with some market-leaders on mini-bonds over the past four years, including John Lewis and The Jockey Club, and there is no denying that focusing on big brands is a huge advantage.
By their very nature, these businesses are typically well-managed, well-known, and have strong balance sheets, allaying fears investors might otherwise have about their viability.
- A clear goal
Like any professional investor, consumers want to know what their money is going to be used for when they invest. If you have a savings account at a bank, for example, you understand that your money is going to be lent to other customers, in return for receiving interest on it.
This clarity is important for mini-bond investors as well. The more compelling and easy to understand an offer is the better.
When The Jockey Club raised £25m in 2013, for instance, the money was used to fund the development of its Cheltenham racecourse; a very tangible project which investors understood.
Robert Wardrop, who runs a unit studying alternative finance at Cambridge University, analysed The Jockey Club’s raising and found almost all the investors had been fans of horseracing who liked the idea of putting their money into something they could see and touch.
It also drew them closer to the club itself, according to Wardrop. “An important outcome for the Jockey Club is that it has changed the psychological relationship with the fans. They have had new experiences and they now want more,” he told the FT after the successful raise.
When done well, mini-bonds have the potential to offer far more to businesses than just capital. They can help forge a much stronger relationship with their customers – be they sports fans or beer connoisseurs – and even grow their client base as word spreads of their positive experiences.
What the checklist helps us do is ensure we work with businesses that fall into the above category, allowing us to concentrate on those companies that can get the most out of mini-bonds.
It also helps us avoid the speculative investments which pose the greatest risk to investors, and which we expect to see stamped out as regulation becomes a more prominent – and welcome – feature in this space.
Richard Wheat is an entrepreneur and founder of MRM, an award-winning communications consultancy.