DBS

26 financing sources dried up, the potential for a bond market for the larger segment of the SME sector is starting to be recognised by entrepreneurs and investors.” 39 The capital markets provide an obvious alternative to bank lending, but raising capital by issuing equity or debt based securities has historically been costly and subject to onerous listing requirements as well as complex legal and regulatory frameworks. Consequently, it has typically been the preserve of large firms 40 . However, the standard launch cost of a crowdfunded bond is now relatively low and does not usually exceed six figures 41 , although, when the raise amount could be £1 million or less, keeping this as efficient as possible is important so that the DBS model reduces the cost of capital for smaller companies and attracts SMEs looking for finance. SMEs are even more enthusiastic about DBS given the current low interest rates, as the coupon rates over the life of the bond can be set at a convenient rate, and still attract investors. The added bonus is that issuing bonds does not dilute ownership or the control of the company 42 . Subsequently, some very innovative, young companies are now giving investors routes to early involvement in potentially high yield opportunities in this sector, whilst small, but quite established firms are also accessible for investors. ASSET-BACKED BUSINESSES Whilst DBS might be secured on physical or financial assets and some may not be secured 43 , the range of collateral that backs SME fundraising is extremely diverse. Of course, asset backing can significantly lower the financial risk and some platforms only operate with companies that have existing operational assets. Obviously, looking at the adequacy of the assets for collateral purposes needs to be included in due diligence, but this can overcome the issue that crowdfunding has generally been associated with high risk equity investment. 44 This has contributed to the issuing of debt based securities across a wide range of sectors including: Commercial and Residential Real Estate, Medical, Food and Beverage, Leisure, Retail and Education. Not all of the DBS issued across the various sectors are asset backed but here is an example of one that is: Very young companies that are pre- trading and pre-profit are unlikely to have assets that can be used to provide unencumbered security to bond, loan note and debenture holders. Nor are they likely to have sufficient EBITDA to provide interest cover. Other companies use the asset they will be acquiring with the funding as the collateral for investors. For more information about how assets can be secured against debt based securities, see the Crowdfunded Bonds, Debentures and Loan Notes section of the Introduction to this report and the Due Diligence Considerations discussed in the How to Invest section. One of the most common assets used to back debt based security offers is land and buildings. With headlines continuing to bemoan the housing shortage and commercial property demand recovering after a Brexit wobble, property remains an interesting investment sector. And its value as a real asset is undisputed (property cycle permitting). As a result of this, there are numerous crowdfunded DBS offerings based on property development. The vast majority of loan notes in particular are for property related investments. However, it’s worth remembering that just because a project is in the property sector, it doesn’t guarantee that it will be backed by property assets or, in fact, secured at all. Property development can be very lucrative, but it is also a notoriously risky business with potential problems all too possible and experience is essential if returns are to be realised. Here is an example of a DBS offering in the property sector, with asset backing: So, there is a good spread of choice in the property sector for those looking to invest with debt based securities and some promising opportunities continue to be available. However, advisers should be asking the same questions as they would for a direct property investment, plus those specifically related to the DBS investment instrument. CARE HOME A Downing crowdfunded bond issued to finance Manor Grange Care home for Care Concern Group. They raised £3 million to fund the ongoing operation of a new, modern 83 bed care home, offering 5.5% p.a. at a 34% loan to value with the bond secured against all assets of the business. “With still more extensions to the ISA regime, ISAs could soon become the “only show in town” for those with modest amounts to save and invest.” – David Kilshaw, Ernst & Young PROPERTY DEVELOPMENT A Rockpool promoted loan note investment raised £2 million to finance the purchase of land for a building project to be undertaken by a company experienced in infrastructure projects for health and community care, with a focus on housing for vulnerable adults and surgeries for GP practices. The 9% return on offer reflected the recent profitability issues of the company, although it was well established, with significant assets, and the notes were secured against tangible net assets of £7.7 million, subject to bank priority of £2.1 million.