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Minibonds: navigating issuer distress

Restructuring Advisory Partner, David Hudson explores how minibond providers and trustees can proactively work to safeguard investors’ funds in times of distress.

Minibonds have recently received some negative press, but there was a time, not too long ago, when they were in high demand.

At the most basic level, minibonds are agreements between a company (an ‘issuer’) and an investor in which the latter invests money in a business with the promise of it being paid back with interest. The ‘mini’ in the name refers to their popularity with smaller firms and start-ups, particularly in the wake of the financial crisis – attracting companies that might find it harder to raise capital from banks.

More recently, record-low interest rates meant many savers were shopping around for above inflation returns on their savings, and the profits promised by minibonds seemed very attractive.

There were numerous success stories including Hotel Chocolat, which raised £7.3 million in chocolate bonds and later repaid investors through its profits. However, there were also some high-profile failures.

Honouring obligations

More issues may be looming as companies that have issued minibonds are approaching an inflection point, where issued bonds are due to mature and investors will need repaying. The businesses concerned are legitimate companies that sought to raise capital to fund ordinary business activity in good faith.

However, the coronavirus pandemic has created headwinds that no one could have anticipated, putting cashflow under pressure, prompting many businesses to take on new liabilities and lumbering many firms with weak asset bases. In this environment, continuing to pay interest in existing bonds or repaying bondholders’ original capital on their maturation could become increasingly difficult.

Preserving value

To protect the interests of all parties, it is important that all involved in the minibond transaction take proactive action and consider their full range of options to preserve and protect the lenders’ investment, or the value of the underlying businesses.

This includes the issuer, but also the security trustees – an independent third party that holds security against the lenders’ investment, with the duty of acting to serve the interests of the investors should the borrower fail to meet its financial obligations.

If issuers find themselves in distress and anticipate that they will be unable to meet their obligations to lenders, it is important that they communicate this as early as possible to the security trustee. It can be tempting – and understandable – for management teams in distressed companies to neglect to take action, in the hope that they can manage headwinds.

However, quick, proactive and honest communication with their stakeholders will mean that they and their partners have the appropriate amount of time to consider the full range of recovery options available, and give all involved an accurate understanding of the scope and nature of the challenges.

By the same token, security trustees should be taking the opportunity to start conversations with their issuers, assessing each business’ financial strength and their ability to service their bond, ensuring they discover shortfalls or areas of significant distress, whilst also considering what this could mean for their investors.

Where issuers are in distress, the right path forward will depend on their specific circumstances. In certain cases, the best option for all parties will be formal administration or insolvency proceedings. However, this won’t always be the case.

The interests of all parties could be best served by, for example, first considering how the issuing business can restructure or refinance existing debt; how it can drive efficiencies in its operations; or how it can make changes to its operating model or corporate structure to adapt to a new trading environment.

Additionally, with financial and legal advice in place and the agreement of the security trustee, minibond payments can be frozen and an issuer can work to agree a way forward with its creditors and investors, which could include accepting an equity stake in the business. This could give issuers vital headroom with which they can restructure and revitalise their operations.

Looking ahead

Considering the full range of recovery options available to issuers in distress will be key when financial challenges arise. Good, proactive, communication between issuers and trustees – from both sides – must underpin this process.

By working together and seeking advice and support where necessary, issuers and trustees each stand the best chance of finding a sustainable path forward to safeguard the future of the issuers’ businesses and of investors’ funds.

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David Hudson

David Hudson

  • Partner
  • Restructuring Advisory
  • London