In the early hours of Monday 20 April, the Government unveiled its Future Fund. In this matched funding scheme, launching in May 2020, the Government will use convertible loans to directly invest in innovative companies who face difficulties securing financing due to the coronavirus outbreak.
With the Government pledging matched funding of between £125,000 and £5,000,000, this is great news for emerging companies, and very welcome support for their investors too.
The scheme will start to operate in May, although it seems likely the first transactions to close under it will take another couple of weeks to complete. Companies without enough cash to last until at least the end of May would be well advised to continue to seek alternative sources of financing.
It is unclear what the qualifying criteria will be for companies to receive funding from the Future Fund, beyond the limited terms set out below. In particular, with the scheme stated to be for “innovative companies which are facing financing difficulties due to the coronavirus outbreak”, we do not know whether companies will be able to use funds raised using a compatible structure prior to the launch date in May as matched funding for the purposes of the scheme. In fact it is possible that companies having been able to raise those funds might make them ineligible, as it could be argued they demonstrate that the company is not facing financing difficulties.
Overall our initial reaction, together with those of some of our clients and contacts with whom we’ve had early discussions, is that the Future Fund is clearly a positive step from the Government. However, the initial heads of terms contain some unusual provisions worth noting, which will warrant closer examination when the details of the fund are released.
The Future Fund won’t be available for all companies. To qualify for the Future Fund, a company will need to:
- be UK based (or, if part of a group, be the UK-based parent company);
- have raised at least £250,000 in equity investment from third party investors over the past five years; and
- be able to attract at least the equivalent amount from third party investors (i.e. if the Government invests £250,000, the Company needs to find at least £250,000 from other investors, although it can take in more if it’s able to do so).
The requirement to match fund could prove tricky for some companies, as the Government’s investment is being made via a convertible loan, and the heads of terms appear to suggest that the matched funding also needs to be in the same form. This raises two points:
- companies who are raising a priced funding round now (perhaps at much reduced valuations due to the economic climate) will seemingly be unable to benefit from the Future Fund. To benefit from the fund, any incoming investors will need to be happy to take a convertible loan which leads to the question of whether such an investor prefers to invest via the convertible loan or a priced round at a currently low valuation. To succeed, the fund will need buy-in from the third-party investors; and
- convertible loans are not S/EIS-compliant, which is often a huge driving force for investors when considering early stage investments. Additionally, if an investor invests into a particular company through a convertible loan, any future investments they make in that company will not be eligible for S/EIS-relief. This means investors looking to claim S/EIS reliefs on their investment are unlikely to want to invest under this structure.
It would seem very strange, from a policy perspective, for the Government to effectively mandate that matched-funding cannot qualify for its flagship schemes, which are designed to encourage investment in the kind of companies that the Future Fund has been created to support. We eagerly await clarification on this point.
The investment would almost certainly be classed as State Aid, which can have implications for S/EIS and VCT purposes. However there is no mention yet on how this will interact with S/EIS and VCT reliefs. We will wait for further guidance from the Government.
The conditions attached to the note (including the discount rate of 20% on any conversion) are in line with market standard, and the terms note that the Government won’t set a valuation cap on the price at which the loan converts (although they will take the benefit of any cap agreed with the other investors).
However, it should be noted that rather than being rolled up and converted as part of the loan at the discounted rate, any interest (at 8% p/a) accrued on the loan at the time of the conversion, will need to either be repaid to the Government or converted into shares at the undiscounted rate (i.e. the price paid by investors in the fundraising that triggers the conversion).
If another funding round closes within six months of the one that triggers the conversion, the Government will be entitled to convert their shares into the senior class of shares issued by the company as part of that further round.
Whilst unusual, we expect this has been included as a form of ‘anti-avoidance’ type mechanism, protecting the Government in the event that a company raises funds by the issue of a certain class of share, only to then shortly raise further funds by issuing shares with superior rights. Given that the Government is investing what is essentially tax-payer money, we can see there are strong policy reasons for such a provision.
What remains to be seen, is whether future investors (i.e. those planning to invest in a company within six months of the Government’s loan converting as part of a legitimate fundraising) will be put off by such a right and will therefore be asking companies to delay any further fundraisings until the six month period has lapsed.
The loan amount (plus interest) may be repaid, at the choice of the Government, in the event:
- of a sale or IPO of the Company; or
- 36 months after the date of the loan (the maturity date).
On repayment, as well as repaying the principal amount of the loan plus interest, the Company will also need to pay a redemption premium equal to 100% of the loan.
There is no mention of any early repayment rights for the Company. Those companies who can maximise their current opportunities and, perhaps won’t require any further funding, will have no mechanism by which the loan converts nor will they have the option to repay the loan before the maturity date (which may be desirable for some companies wanting to limit the interest they will need to pay under the loan).
We expect this would only apply to a small proportion of the recipients. The nature of those companies who will apply for the Future Fund means many will require further funding. As the Government loans will be public money, there is a strong public interest in maximising the potential returns under the loans, through the redemption premium and the interest charge.
The Government will have (as yet unspecified) limited corporate governance rights. In addition, the Government will also reserve the right to package up and sell its investments in the future to such institutional investor(s) as it sees fit, without any restriction. This could mean that companies will be giving consent rights, information rights, and potentially other additional, currently unknown rights to unknown transferees of the Government. We will have to assess what these risks mean in practice, when we have more information about the proposed corporate governance rights.
We will continue to provide updates on the Future Fund as more details are released. In the meantime, if you have questions on any of the above, please get in touch.