You’re a charity. Perhaps a venerable institution – a university, college or school – rich in land and historic buildings but cash poor. Or perhaps a younger organisation, looking for ways to increase your impact using other illiquid assets.
Either way, you have a problem – or an opportunity – that’s common to many organisations in the sector. There is pressing need, or a chance to grow, but the financial means are tied up and out of reach. How can the value in substantial illiquid assets be set free? This is where charitable organisations are increasingly turning to a different way to raise cash: issuing bonds.
Bonds are obviously not new. This type of financial instrument has been around for hundreds of years. But charities, generally being relatively conservative organisations, have been slower to move into this space than others. This is perhaps understandable given charity trustees’ strict duties, including to protect their assets, but the path is now becoming quite well-trodden and making a bond issue can certainly be in a charity’s best interests in the right circumstances.
Essentially, issuing bonds or ‘notes’ is just turning to a different type of lender. Instead of a bank, the lender (or ‘purchaser’ of the bonds) can be a private organisation, fund, group of individuals… the list goes on. As you’d expect, in return for the cash, the issuer (or borrower) repays with interest at an agreed rate, also known as a ‘coupon’ rate. The advantage is that compared to bank lending, this rate can be lower and the repayment period can be very long.
By issuing bonds, institutions have been able to develop their premises, free up cash for short and medium term expenses, and protect their undertakings for the future. In this article we’ll touch on some of the issues to think about if you’re considering your own issue.
Understanding your structure
Where a charity is issuing bonds, the identity of the issuer is the first point to work out. This is not always as straightforward as you might expect. With an unincorporated charity – such as a trust – the issuer will be the trustee(s). Sometimes (though rarely), that will mean individual people, sometimes it will be a corporate trustee or trustees. In other cases, the charity itself will be the issuer, if it is a corporate body like a royal charter corporation or a charitable company limited by guarantee.
Here you will also need to think about the specific assets that give strength to the issuer’s covenant and/or that are proposed to be charged in connection with the issue. It may be, for example, that the issuer is a corporate charity but that the relevant underlying assets are held on trust. The right legal advice will help you to structure the transaction in the right way and to the satisfaction of the investor(s).
The charity’s powers
Crucial in these transactions, and sometimes overlooked until later in the process than is ideal, is ensuring that the issuing charity has the necessary powers. Investors will often require an express rather than implied power to borrow, and potentially also an express power to borrow for the purposes of investment, if that is what’s proposed. It may be necessary to amend the charity’s governing document so that suitable powers are available.
Investors will require a legal opinion as to the available powers, as well as (commonly) a range of other matters such as whether the charity is duly incorporated and that all necessary actions have been undertaken to authorise the transaction. This will mean very careful scrutiny by the relevant lawyers of the charity’s governing documents, board resolutions and any other relevant documents. With some charities this work can be highly complex, given the varied and sometimes historic structures that charities can have. We recommend paying close attention to governance and due authorisation early in the process, to avoid investors asking awkward questions about, say, the true extent of a bursar or CFO’s ability to approve and execute documents, when you’re deep in the transaction. It can be disruptive to have to call additional board meetings to perfect earlier authorisations but that can sometimes be necessary so that the issuer’s lawyers are able to give a ‘clean’ opinion. Early advice and good planning will help to avoid this.
Charity mortgage requirements
Bonds are issued on both a secured and unsecured basis. With a secured issue, where the underlying asset is land, charities need to remember that the Charities Act rules on mortgages over charity land will be engaged. These are fairly simple to follow, usually requiring suitable advice to be given to the trustees before the mortgage is entered into (covering a range of prescribed matters) or an Order from the Charity Commission. The mortgage will also need to include a certificate from the trustees that the requirements have been complied with.
Where the assets in question are held on trust or perhaps as permanent endowment, things can be a little more complex. It is often still possible for the relevant assets to be charged, but you would need to look closely at the trust instrument(s) that apply and understand what would happen in the event of enforcement. Investors would likely require this to be covered in the legal opinion.
Financial services regulation
Bond issuance is of course a regulated activity, with the regulatory and compliance requirements being significantly more involved for the issuance of public bonds to retail investors than with private ‘placements’ to sophisticated investors. With the former, the upfront costs and complexities can be much more significant, with issuers having to engage with, for example, the Prospectus Rules, so that individual retail investors are suitably protected. Whilst with private placements, things are simpler, a much greater portion of the potential investor pool is cut off, with only the more sophisticated institutional investors being in the game.
Whichever way you end up going, you will need to think about this regulatory context. A prospective issuer’s first step will usually be to speak to a capital markets intermediary who can help guide the process and make necessary introductions, but legal advice will certainly also be required.
Raising capital through bonds is just one of the ways that universities, schools and other charities are looking to leverage their assets and maximise their effectiveness. We have experience of advising on bond issues on both the investor and issuer side, for a range of different types of organisation.
If you would like to know more, please contact Philip Reed.
A version of this article appeared in the Spring 2022 issue of Bursar’s Review, published by the Independent Schools’ Bursars Association (ISBA). It is reproduced here with the permission of ISBA.