DBS

19 “The market for traditional banking is failing, and debt based securities are part of the solution to bridge the gap.” – Rohin Modasia, Property Crowd However, if a P2P platform goes out of business, the regulations require that there is provision for administration of continuing repayments. This is not a specific regulatory requirement for platforms that facilitate crowdfunded bonds, debenture and loan note issues, but platforms promoting DBS capable of being held in an IFISA must receive and distribute payments in respect of the investment, treat the investor as their client and exercise rights under or in respect of the investment which could include appointing a security trustee, with a security agreement which allows the platform to step in to assist investors in the event of serious issues such as default. Without this, in terms of investor protections, if a DBS issuer defaults, unless there is some form of asset backing there is no protection, whereas a P2P platform may have additional protections in place such as a provision fund. Nevertheless, there is an ongoing debate about the real value of such funds. It is as a result of these differences that the FCA has different regulatory approaches in place for Loan Based Crowdfunding (including P2P lending) and Investment Based Crowdfunding (including equities and DBS); DBS are governed by Articles 25 and 77A of the Regulated Activities Order, whilst the lighter touch of Article 36H applies to P2P lending. For more information on the regulatory landscape for DBS, see the Legal and regulatory status section of this report. WHO ISSUES DBS? Crowdfunded bonds, debentures and loan notes tend to be issued by much smaller companies than those issuing, for example, retail bonds. Alternative funding channels for SMEs have opened up over the past five years and the issuer base has diversified. SME bonds are one of the new options. They tend to use the crowdfunded bond structure because the minimum bond sizes that most larger investors expect are typically too large for most SMEs. In addition, the cost of issuing wholesale debt securities can be a hurdle for smaller companies, while public reporting requirements can also be onerous 15 . These issues extend to retail bonds; in theory, the Order Book for Retail Bonds (ORB) is open to businesses of all sizes, but in practice, the fees and governance requirements associated with raising funds in this manner have effectively precluded small firms. In reality, ORB only makes sense for companies raising large sums of money – as a rule of thumb £25 million plus 16 . In fact, some say that bonds are a way for well-established businesses to borrow large sums of money from investors, and are considered to be a viable alternative to offering equity (and control) in the form of shares. But crowdfunded DBS, with a cheaper cost of capital than more traditional corporate bonds, have also given smaller, dynamic companies a route to this method of raising funds at lower cost, meaning potentially higher returns for investors. The British Business Bank certainly sees bonds as useful for SMEs for fund-raising purposes at most of their business stages. Some platforms have described their DBS investments as being at a later stage than EIS and VCT investment, but at an earlier stage than bank debt. This suggests that their risk profile may be lower than EIS and VCT and that the burden of bank debt, which is often prioritised over any other form of debt, may not yet be present. There are also some online platforms which publicise their ‘own’ crowdfunded bonds or debentures (although not loan notes) and offer them to investors. In fact, they are issued by separate, but associated entities, which then choose the underlying investment opportunities (usually not within the platforms’ own business, although this has happened). We discuss this further in the next section. RELATIONSHIP OF PLATFORM/ ISSUER AND UNDERLYING ASSETS The platforms which offer debt based securities are primarily conduits for the connection of crowdfunded bond, loan note and debenture issuers with lenders who wish to become holders of those securities. This means that they provide the service of promoting the issue, administer it by receiving and distributing investor money (used to purchase the DBS) and oversee the issuing and receiving and distribution of investor coupons from the issuer. The platform is also required to disclose what due diligence it has BUSINESS STAGE BOND PRE-TRADING PRE-PROFIT PROFITABLE GROWING BUSINESS ESTABLISHED& STEADILY GROWING ESTABLISHED STABLE BUSINESS LAUNCHING NEW PRODUCT/SERVICE/ BRAND MAKING ACQUISITIONS EXPANDING INTONEWTERRITORIES INVESTING IN NEW FACILITIES LOOKING TO REFINANCE IN NEED OF CAPITAL RESTRUCTURING SOURCE: BRITISH BUSINESS BANK DEBT FINANCE SUITABILITY OF BONDS AS SME FINANCE MECHANISM