Swingeing job cuts, slashed bonuses and vicious opprobrium from the general public – it’s fair to say that there have been better times to work in the Square Mile. As a result of this bewildering combination of factors and the growing anti-bank lobby it’s hardly surprising that more City workers than ever are re-evaluating their choice of career and planning their exit route from the financial rat race. But what about those masochistic individuals who love the day-to-day buzz of the money markets and steadfastly refuse to turn their back on the associated riches? If the banking behemoths aren’t employing fresh blood, where else could they turn to practice their wares?
The answer, increasingly, appears to be the burgeoning alternative finance market. As small investors have turned their backs on traditional banking products thanks to the perceived high risks and low returns, it’s heralded a new spirit of innovation, with business owners and dotcom-savvy entrepreneurs dreaming up financial models that promise to bring an end to the nation’s economic malaise. From interest paid in chocolate through to the combined financial wisdom of the crowd, what are the most innovative products to gain traction over the last couple of years?
Small Bond Market
Dividends paid in beer and shaving products with returns of circa 6%: the attractions of small bond issues to investors and those businesses seeking investment are many fold – especially at a time when raising finance for growth or working capital from traditional lending outlets has never been harder and returns have never been lower.
The first UK business to successfully get a small bond issue off the ground was King of Shaves (KoS), which launched its ‘Shaving Bond’ in 2009. The three-year non-transferable, non-convertible bond offered a return of 6% per annum in addition to free KoS products for the duration of the bond. The shaving bond sale raised more than £600,000 and KoS founder Will King says that the issue was a tremendous success thanks largely to the attractive financial package it promised investors, with the bonds offering 12 times the Bank of England base rate.
“It wasn’t just a case of give us X amount of money and we’ll give you some shaving products,” explains King. “You need to offer a genuine financial payback to the people who’ve allowed you to borrow their money and use it to advance your business. With this bond issue we did just that.”
KoS’s bond issue inspired a number of businesses to follow suit, including chocolate retailer Hotel Chocolat. Co-founder Angus Thirlwell says that the business had managed to grow its sales year-on-year without any equity dilution, but when it wanted to take the business to another level in 2010 it decided to approach the 100,000 members of its Chocolate Tasting Club for help.
Members were offered a three-year bond for a gross annual return of 6.72% if they invested £2,000 or 7.29% for £4,000. The return was paid out in chocolate with investors receiving six chocolate tasting boxes worth £18.95 a year (if they invested £2,000). Hotel Chocolat raised £3.7m through the issue and Thirlwell says it was a worthwhile exercise for the business and for the brand’s devotees.
“The return that we are paying out is approximately double the rate of interest you’d get from leaving money on deposit in a bank or building society at the moment,” claims Thirlwell. “But this is not just about the money. People want to feel that they’re getting a good deal but they also want to be reassured that their money is being used in a productive way. This is helping the economy and it’s helping a small business progress and create manufacturing jobs and grow exports. It’s the sort of thing that we should all be doing to get ourselves out of the economic malaise.”
Other businesses have heeded Thirlwell’s call to arms with green energy business Ecotricity issuing two EcoBonds since 2010 raising £15m and £16.2m, with both issues oversubscribed. And controversial Scottish brewing company BrewDog closed its £2.2m Equity for Punks bond issue early last December after it was heavily oversubscribed.
It’s clear from these examples that there’s investor appetite for these types of deals, and King – who thinks that more small bond issues will get off the ground in the coming months – is a firm believer that the small bond market could provide a vital funding lifeline to UK SMEs. It’s a view supported by the Confederation of British Industry (CBI) which, in a report published last year, stated that the use of bonds is far more widespread in the US and Germany, and that there was an opportunity to aid medium-sized UK businesses by opening up the bond market.
However, for the time being at least, there’s probably not going to be enough deals of this nature to justify the creation of a boutique practice specialising in small bonds, according to Chris Searle, corporate finance partner at BDO Stoy Hayward. Searle advised KoS and Hotel Chocolat on their bond issues and while he says that it was the right option for both of these businesses, it won’t work for everyone.
“In the wake of the KoS and Hotel Chocolat deals I was contacted by a number of other companies looking to do a similar thing but I told all of them that unless you have a large database of existing customers and potential customers to whom you can market the issue, it’s no good,” explains Searle. “You can’t just go out and discuss it with the general public because you just wouldn’t raise the money that way. Small bonds are only right for a small minority of companies.”
The crowdfunding concept has been around for a number of years with one of the most successful examples being Kickstarter, which offered musicians and artists a platform to gain funding for personal projects from their followers – to cut an album, for example. But it didn’t take long before canny tech entrepreneurs cottoned onto the fact that the concept could offer SMEs a viable alternative to venture capital and business angels.
One of the first crowdfunding enterprises out of the blocks in the UK was Crowdcube, which launched in February last year. Crowdcube co-founder Luke Lang says there are two core principles behind the business: to democratise investment and empower ordinary people. Entrepreneurs with an idea place their business proposal and prospectus on the website and then members of the public can invest in that business in exchange for equity, with a minimum cash investment starting at just £10. Deals funded so far range from £12,500 to £1m – Crowdcube raised £300,000 from investors over five days late last year to fund the next stage of the site’s growth.
Lang says that the company’s meteoric rise reinforces his belief that it’s only just scratched the surface of what’s possible in this market. “There are lots of other methodologies that we could introduce to what we’re doing to develop the idea further,” he explains. “People who work in the City understand that there’s a funding gap at the lower end of the market but also to a certain extent there’s an issue around raising finance through VCs and business angels because it can take too long. It’s over engineered and over complicated.”
Niggling drawbacks such as those outlined by Lang also helped to shape Jason Scott’s crowdfunded business idea. The co-founder of civilisedmoney originally intended to create a financial product that helped people with mortgage arrears avoid defaulting, but his efforts were ultimately thwarted by the bank bailouts. Undeterred by the setback Scott launched civilisedmoney late last year with the aim of “giving people the opportunity to come together to create a fresh financial future. One that is fair, transparent and without the expense of branches and big bonuses or the dangers of banks gambling with your money. It is simply people connecting directly, fairly and transparently”.
It does this through a range of products, including equity-based and rewards-based crowdfunding for businesses. Civilisedmoney’s next product will be a personal loans facility that taps into the rapid growth of peer-to-peer (P2P) lending websites. The new facility will provide welcome competition to Zopa, the UK’s first P2P personal loan lender, which launched in 2005. Zopa co-founder Giles Andrews says that the idea behind the site was to “combine the spirit of collaboration of people working with other people to get a better deal, as they do with eBay, with a superior economic model called a bond market for consumers”.
The business model is breathtakingly simple. Zopa matches people with money to invest with borrowers who need a loan and because it cuts out the middleman it can offer competitive rates to both parties. It’s certainly a strategy that has paid off in spades with the business completing just under £200m of loans since its creation, with 70,000 people now lending through Zopa. Andrews says that the business’s growth accelerated with the onset of the recession in 2008.
“People had lost faith and trust in bankers and we were able to tell an interesting story,” he explains. “For some people we became anti-bank – we were an alternative to a hated industry – to other people we were a pretty sensible option because we’d done a better job of lending people money than these enormous, prehistoric corporations.”
Andrews says that the best endorsement of Zopa is that many City workers are clients. “Quite a lot of our lenders are City folk,” he explains. “Even with the wage squeeze and pressure on bonuses they’re not badly paid so they tend to have money to invest. Quite a lot of our borrower applicants are also employed by the banks. They recognise that our loans are really good value and for people with lumpy cash flows who rely on bonuses they’re a pretty good product.”
Andrews adds that the business has already captured 1-2% of the UK personal loans market and he thinks that the company could grow by 10-15 times its current size in the future – Zopa is already eyeing up a move into the mortgage market. Civilisedmoney’s Scott concurs with Andrews’s assessment that the potential for growth of P2P lending in the UK is enormous, with these online operators increasingly considered a viable alternative to the products offered by retail banks.
“The banks are fully aware that there’s a P2P lending market out there that’s kinda doing OK,” says Scott. “But it’s our belief that at some point somebody is going to come along and take that percentage of the personal loan market from 2% to 10% or even 20%. It’s at that point that things will really begin to change.”
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