In a move to support the UK’s most innovative and fast-growing companies during the COVID-19 pandemic, the Government last month (April 2020) announced its new, and unprecedented, £250 million ‘Future Fund’ scheme in partnership with the British Business Bank (“BBB”).
The scheme is due to launch this month (May 2020) and is expected to remain open until the end of September 2020.
With full details to be released imminently, we summarise what we know to date and the questions that are prompted by a review of the Government’s initial heads of terms (“Terms”).
Which companies can use the Fund?
The Future Fund is available to companies that:
- are unlisted and UK incorporated;
- have previously raised at least £250,000 in aggregate over the last 5 years; and
- have a substantive economic presence in the UK.
If the company is a member of a group, only the ultimate parent company (if it is a UK registered company) is eligible to receive the loan.
It is not entirely clear on the face of the Terms whether the Future Fund is intended for a wide pool of UK based, venture backed start-ups, or a more specific group. Further clarity on the eligibility criteria, and in particular on what constitutes “substantive economic presence” and what the Government determines are “innovative companies… facing financial difficulties”, could narrow the pool significantly.
Similarly, some loopholes are immediately visible in the limited information we have – for example, it is not unusual for companies in the space to have the vast majority of its business in the UK, but have a US or other jurisdiction parent company. Under the Terms these companies would not be eligible. While we assume this is led by some public policy issue, we would question its logic if the aim of the Future Fund is to protect UK jobs and businesses.
More practically, there is a question over how applications will be made to the Fund and by whom, with suggestion that it might be more suitable for private investors to make the application directly.
How much funding is available and how can it be used by companies?
The Government’s loans will range from £125,000 to £5 million in the form of convertible loan notes and must be matched by funding from third-party private investors and institutions. The amount of external funding is not limited, but the Government’s loan will constitute no more than 50% of the bridge funding to be provided.
Under the Terms, “the bridge funding shall be used solely for working capital purposes” and will not be used to repay borrowings, pay dividends or bonuses to staff, management, shareholders or consultants or, in respect of the Government’s loan, to pay any advisory or placement fees or bonuses to external advisors.
To receive this funding, businesses need private investors (whether that’s new or existing backers) to be willing to invest at least as much as the Government, so the Fund is less likely to support failing ventures. It is not yet known how the amount of funding per company is to be determined, or whether the matched funding also needs to be in the exact same form of convertible loan, but the Terms suggest it will be the latter (with perhaps with some flexibility for amendment). The BBB has suggested that the Government and private investors may have to sign up to the same convertible loan instrument.
Further detail is needed on the nature and timing of matched funding. It appears that the Government does not intend to match funding retrospectively, instead seeking to invest in new rounds, and there is a lack of detail on the closing process. As we wait for this information, companies in urgent need of funding find themselves in limbo: do they pull together and close funding as soon as possible, or do they wait to see if they can participate in the Future Fund? We know of several companies currently wrestling with this conundrum.
We also await further crucial guidance from the Government on the interplay between the scheme and the SEIS, EIS and VCT (“State Aid”) incentive schemes. If, as expected, exact or very similar matching is required, any such State Aid money raised will not be counted in the matched funds as the Terms are not compliant. We have heard it be said that the very early businesses, which SEIS and EIS investments often support, are perhaps not the focus of the Future Fund and, if we assume that the aim is to support the most jobs possible, we can see the rationale for focusing on later stage businesses. However, there are large businesses with EIS and VCT funds, and the £5 million cap on matched funds under the Terms is the same cap as the amount a company can raise in EIS funds each year (incidentally, the Future Fund is likely to constitute a form of state aid itself and therefore count towards the annual limit). If the focus of the Fund is on larger businesses, then the £5 million cap may be considered too low; for companies raising substantial sums, the additional £5 million will no doubt be welcome but may not have the impact the Government is hoping for.
On that note, if the focus is on bigger businesses raising larger funds, the Future Fund could be depleted incredibly quickly: only 50 companies would need to receive the maximum £5 million under the Terms to fully deploy the Future Fund. We have heard that the Fund will be deployed on a first come, first serve basis which makes the dilemma for companies currently considering whether to wait for the Fund to open all the more difficult.
What are the terms of repayment or conversion?
Briefly, the Future Fund loan will convert at a 20% discount automatically on the next qualifying fundraising, or at the election of a majority of the investors on a non-qualifying fundraising. It will mature after 36 months and will carry an interest rate of 8% p.a. (non-compounding). The loan will either be repayable on maturity (with a redemption premium equal to 100% of the principle of the loan) or it will convert into equity at discount of 20% to the most recent fundraising.
On a conversion event, the loan will convert into the most senior class of shares in the company. If a further funding round is completed within six months of the relevant conversion event, the lenders will be entitled to convert their shares into the senior class of shares of the company in issue post-round.
Though the terms of repayment and conversion are not particularly unusual, care should be taken by companies to consider the potential costs of any interest or redemption premium (being 2X the loan) payable, as well as the potential costs of a 20% discount on a future round. Pre Covid-19 we would have considered some of the terms such as the redemption premium and 8% interest rate relatively investor-friendly (although not unheard of) for a non-distressed business, but of course these terms are designed for those companies in a difficult situation. The 3-year term makes it relatively unlikely that the terms on maturity will ever be relevant. The question companies will have to ask is whether they could get better terms from private investors and, if so, are the additional funds which the Government match worth the more onerous terms?
What rights will the Government seek for its investment?
As part of its investment, the Government will require the following:
- Decision-making: limited corporate governance rights.
- Warranties and Covenants: limited warranties and covenants from the company.
- Most favoured nation: that, should the company issue further convertible loan note instruments with more favourable terms, those terms will apply to the Future Fund Loan.
- Negative pledge: that the company will not create any indebtedness that is senior to the loan other than any bona fide senior indebtedness from a person that is not an existing shareholder or matched investor.
- Transfer Rights: the ability to transfer its interests in the company without restriction to an institutional investor that is acquiring a portfolio of the UK Government’s interest in at least 10 companies owned in respect of the scheme. In addition, the Government will be entitled to transfer any of its shares, without restriction, within Government and to entities wholly owned by central government departments.
These terms are generally fairly typical. Worth noting, we would expect that the negative pledge would not prevent the company from taking venture debt or the like and we would usually expect there to be a right of the majority of the noteholders to approve any debt.
Similarly, whilst the ability to transfer to wholly owned entities is not unusual for institutional investors, we would expect that this would be subject to certain protections for the company (like the Government not being able to transfer shares to competitors of the company). Companies should be mindful that this is an unprecedented Government intervention and we don’t yet know how it will act as a minority shareholder in a portfolio of high growth, risky investments. One must assume that the intention will be to sell their stakes as soon as possible and, based on the wide freedom to transfer in the Terms, that could lead to unknown or unwanted shareholders on the cap table.
It is important to recognise that the scheme is not designed to be a preferred choice, instead, its aim is to extend a helping hand as an emergency measure to struggling start-ups. The Terms of the Government’s loan are robust, presumably to balance the sheer number of businesses that are facing difficulties in the current economic climate, and the fact that the scheme is funded by the taxpayer. In our view, the Future Fund is not a silver bullet for companies currently struggling, but should be seen as extra support for businesses to lengthen their cashflow runway to the next fundraising, and as an incentive to investors to deploy what would otherwise be dry powder.
Further assistance for start-ups will also be available in the form of £750 million of grants and loans from Innovate UK, also expected to launch this month (May 2020), and we will wait to see if the Government plans any additional assistance for earlier stage State Aid backed businesses.
Updates will follow as soon as further information is published by the Government. You can find regular updates on Covid-19 related matters: here.
This article is current as of the date of its publication. The information and any commentary contained in this article is for general information purposes only and does not constitute legal or any other type of professional advice. Marriott Harrison LLP does not accept and, to the extent permitted by law, excludes liability to any person for any loss which may arise from relying upon or otherwise using the information contained in this article.