Hitting up the customer

VISIT an outlet of Chilango, a Mexican food chain in London, and you will be invited to “become part of the story”, not just by eating a burrito but by buying a “burrito bond”. These are four-year loans to the firm of at least £500 ($835), paying annual interest of 8%, along with a variable number of free burritos, depending on how much an individual lends. Helped by Crowdcube, a crowdfunding website, Chilango has already raised £1.8m in this way—80% more than its initial goal—from 585 bond-buyers.

In Britain “mini-bonds” are more loans than bonds, in that they are not tradable (elsewhere they are a less regulated version of conventional bonds). They let individuals lend money directly to small, unlisted businesses. They tend to pay well, albeit with lots of risks and quirks. Hotel Chocolat, a confectioner, issued its first bonds in 2010, which paid interest in chocolate. Will King of the King of Shaves, which makes razors, toyed with offering 7% interest on the mini-bond it issued in 2009, so he could use the phrase “007” to market it (in the end he opted to pay 6% and forgo the gag). Naked Wines, an online wine retailer, offered a mini-bond that paid 10% in wine or 7% in cash. Borrowing without the expense of a proper bond issue or the frustration of dealing with banks also appeals to mainstream brands: John Lewis, a British retailer, raised £58m via a mini-bond in 2011.

Many peer-to-peer websites funnel small loans to businesses; the mini-bond simply replicates the process on a slightly grander scale. Whereas Crowdcube raises equity mainly for startups, its debt-raisings are aimed at more established businesses, which are supposed to be more creditworthy. But mini-bonds are not only not tradable, leaving investors’ money locked up until the bond matures, but also unsecured, giving them little recourse if the loan sours. They are cheaper to issue than a normal bond, which involves much more paperwork. But the paperwork is designed in part to help potential investors assess the risks.

That said, the average investor puts in a only a few thousand pounds. There have been no dramatic defaults so far. Mr King, who is keen to emphasise that he is no Bernie Madoff, says that the fear of “granny emptying out her life savings” made him cap individual investments in his first round of bonds at £5,000.

Whether the bonds are a good deal is another matter. They involve many of the downsides of equity without the upsides. Bondholders could probably get comparable returns for less risk in normal junk bonds, and credible issuers could probably find cheaper loans.

Both parties have other interests, however. “We now have hundreds of extra brand ambassadors,” says Eric Partaker of Chilango (pictured above, left). “People want an emotional bond with the place they invest in,” says Mr King. The question is whether that bond is strong enough to survive when interest rates start to rise.