A bond is a form of loan agreement between an individual and an enterprise. Capital is loaned in small denominations, typically between £100 and £500, and evidenced by a bond or agreement that the society promises to pay interest and to repay the capital to the bondholder on a set date. Bonds are usually transferable between third parties. Bonds are widely used by public authorities, credit institutions and companies, but are rarely used by smaller community enterprises. Bonds do not confer ownership or voting rights.
Most societies prefer to issue shares rather than bonds. The reasons for this are fairly straightforward. Debt has to be repaid according to a pre-agreed schedule and normally carries a pre-arranged interest rate. Equity, particularly withdrawable share capital, is not subject to any pre-arranged repayment schedule or interest rates.
There are, of course, situations where bonds are appropriate. As they offer greater security and certainty, bonds may be a more attractive financial proposition for investors. Registered charities cannot issue equity that bears dividends, so bonds may be a good alternative. Other organisations, such as workers’ co-operatives, might like the idea of raising capital from their supporters without having to compromise their principles of workers’ control. Bonds provide a good solution to this problem because no voting rights are attached to them. Bonds may be attractive to members who have already invested the maximum £100,000 (£20,000 in Northern Ireland) allowable in withdrawable share capital but still wish to invest more, although societies should be cautious about being over-reliant upon members and should normally restrict any member investing more than 10% of the capital raised by a society. It is possible that some investors would prefer bonds with fixed interest rates and redemption periods.
Some larger co-operatives and housing associations have turned to the London Stock Exchange bonds market to raise capital, but as these issues are not targeted at the public, they cannot be considered a form of community finance.
Bonds do not provide for community engagement. Bondholders are not members, and they have no voting rights in the affairs of the society. There is not the same scope to engage bondholders in the business activities of the society as customers, volunteers or management committee members. Bonds do not give legal title to the enterprise or convey community ownership.
There are other disadvantages to bonds. They must be repaid by a fixed date, which means that profits will have to be made and set aside to fund these repayments. Although it may be possible to replace old bonds with a fresh issue, this means re-incurring the cost of raising capital, with the attendant risk that investors may not want to renew their bonds. Bonds can also be more expensive, especially if they are issued with a high fixed rate of interest that turns out to be more than the cost of commercial debt over the same period.
There are other ways of raising loan capital from the public, including the offer of loan stock or debenture stock: the former is fully at risk, while the latter is usually secured against a specific asset held by the enterprise. Selling any form of debt product to the public is a regulated activity, subject to the Financial Services and Markets Act 2000 and its associated Regulatory Orders, unless there are exemptions. Co-operative and community benefit societies are usually exempt.
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