24 Apr 2020

This week, we were pleased to welcome the government’s Future Fund Scheme, but pointed out that their announcement left several unresolved details. We’re now able to highlight where extra clarity is required, and make our recommendations.

To recap on our previous article, the Future Fund will provide government loans of £125,000 to £5 million to UK-based innovative companies, subject to at least equal match funding from private investors.

These convertible loans are intended to provide a further financing option for businesses that rely on equity investment, but are facing financing difficulties due to the COVID-19 outbreak and are unable to access the Coronavirus Business Interruption Loan Scheme.

The scheme will be delivered in partnership with the British Business Bank. An indicative term sheet is available here: Future Fund Headline Terms

However, many of our clients have contacted us asking for further details. Currently, many businesses hoping to plan their fundraising and business strategies around the scheme are not sure whether they are eligible.

More details should be available imminently, but in the meantime, here are some recommendations which we hope the government will adopt.

Timeline

We are told the Future Fund will launch in May 2020. Unfortunately, what is not clear is how long the application process will take following initial roll out, nor when companies hoping to benefit from the scheme can realistically expect to receive the money.

This is pertinent, because many companies are on a very short cash runway and need to understand how to plan and time their interim financing and matching funds so they can benefit from the Future Fund.

Our recommendations to the government for the Future Fund would be:

  • a realistic indicative timeline for (i) applications and (ii) funds flow should be published as soon as possible; and
  • “matching funding” for the purposes of the Future Fund should include any equity or convertible financing done from 20 April 2020 onwards.

What makes a successful application?

There is little specific detail on which companies will be successful in their application. Beyond the qualifying conditions indicated, we need more information on the nature of the process to understand who is eligible.

For example, will a business plan be required from the borrower? What will the process be for triage/assessment of investment cases? We know borrowers will need to provide limited warranties, but what exactly will these be and how will any potential disclosures against them be evaluated?

We can also see the opportunities for cynical valuation and other financing tactics from companies wishing to use the scheme arbitrarily, to artificially manipulate valuation/ conversion prices within the parameters that have been published.

Our recommendations to the government for the Future Fund would be:

  • further guidance and information on assessment criteria to be provided as soon as possible to understand evaluation process for applicants; and
  • anti-manipulation/ fair dealings provisions to be considered and made clear, so companies and their investors can understand what financing structures will be acceptable alongside any given Future Fund investment proposal.

Nature and timing of matched funding

The single question we are being asked more than anything else right now is “what constitutes “matched funding””?

The headline terms say:

“The Government shall make unsecured bridge funding available alongside other private third party matched investor(s). The loan shall constitute no more than 50% of the bridge funding being provided to the company, with the remaining amount provided by matched investor(s).”

This requirement has caused many of our companies to reconsider and even pause much-needed interim financing rounds, to assess how best to ensure that the funding they are lining up will count as matched funding.

Our recommendations for the Future Fund would be:

  • as above, we need to know if there can be a look-back for matched funding (i.e. in the last month or so). At present, many companies are in limbo, deciding whether to restructure, postpone or close urgently needed bridge rounds;
  • we need clarity on whether the matched funding needs to be on identical terms to the Future Fund instrument or whether it can be, for example, on ‘no more favourable terms’; and
  • we also need clarity on whether the matched funding can be by way of priced round/ advance subscription. This is particularly pertinent because it would be extremely helpful to companies if persons participating in the matched funding could be eligible for EIS relief.

Under the current EIS rules, we do not see how investors in convertible loans will be eligible on EIS relief on that investment, will not eligible for EIS relief on future investments in the company from when they take the CLN, and, we think, will be potentially at risk of clawback of EIS relief on previous investments in the company, if ‘value’ is returned to them under the CLN arrangements. Given the number of start-ups who have EIS investors, and the fact that existing investors will be the most likely source of matched funding, this is a big issue.

State aid analysis

We have not yet seen any clear guidance on the state aid implications of the Future Fund loans. In the meantime, the most likely expectation is that the Future Fund advances will count as state aid and therefore reduce the amount of other state-backed schemes available for companies.

For example, the limits on the money that can be raised under SEIS/EIS also include any money raised from any other ‘risk finance state aid’ schemes. State aid can take many different forms such as grants, tax breaks or loans, and you can see why a reasonable working presumption must be that Future Fund advances are very likely to be state aid.

To recap on the limits: an eligible company is allowed to raise a maximum of £5m a year (and a maximum of £12m over the Company’s lifetime) or a maximum of £10m a year (and a maximum of £20m over the Company’s lifetime), if it is knowledge-intensive company.

As well as SEIS/EIS/VCT interactions for the purposes of state-aid related eligibility, it will also be important to understand the aggregated effect of job retention scheme, investment from Enterprise Capital Funds, investment from European Investment Bank–backed VCs, Grants and Tax breaks.

We recommend that the Future Fund:

  • publishes clear guidance on how companies should assess their potential eligibility for the Future Fund in light of other state aid they may have received. This should be done as soon as possible, so companies who are contingency planning can understand their potential eligibility before they change any other interim funding plans or pathways they may be looking at.

Crowdfunding platforms

It is possible and potentially beneficial that “matched funding” can be raised via crowdfunding platforms. With the lead time required for a successful crowdfunding campaign, it is understandable that some companies want to start that campaign now.

Crowdfunding platforms and companies using them will need to develop standard mechanisms and explanation for any “matched funding” raised, which may need to be promoted in advance but closed once further details of the scheme are known.

We recommend that the Future Fund:

  • opens a direct line of communication with, and guidance for, crowdfunding platforms so they can play an appropriate part in the successful implementation of the scheme.

Nature of previous funding

The headline terms state that an eligible company must have raised at least £250,000 in aggregate from private third party investors in previous funding rounds in the last five years and have a substantive economic presence in the UK.

We recommend to the Future Fund that clarification is provided on what is meant by:

  • private third party investors, both in light of the above concerns regarding state aid and in terms of investor profile more generally; and
  • substantive economic presence in the UK.

Use of funds

The headline terms state that:

“The bridge funding shall be used solely for working capital purposes and shall not be used by the company to repay any borrowings, make any dividends or bonus payments to stathe Future Fund, management, shareholders or consultants or, in respect of the Government loan, pay any advisory or placement fees or bonuses to external advisers.”

In practice, this may well mean that Future Fund recipients open a specific separate bank account to demonstrate this use of funds. It also means that any professional advice on the funding may need to come out of other funds. We would hope that the money raised from the matching funds can be used, but it is not clear whether this is caught by the words “The bridge funding”.

We recommend to the Future Fund:

  • further detail be provided as to how this will work in practice; and
  • it should be made clear that a separate bank account (or some other proof of qualifying spending methodology) is advisable.

Negative pledge

The terms currently state:

“The company shall not permit the creation of 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.”

We recommend to the Future Fund:

  • it would be good to get confirmation that this does not preclude new or extended venture debt facilities (otherwise a commonly used source of finance); and
  • that, as we presume from the above, other customary arrangements will be excluded (preferably regardless of the counterparty provided they are on arm’s length terms) e.g. rent deposit, invoice discounting, overdraft.

Secondary arrangements

“The Government shall be entitled to transfer the loan and following conversion of the loan, any of its shares without restriction to an institutional investor which is acquiring a portfolio of the Government’s interest in at least ten companies owned in respect of the Future Fund.

In addition, the Government shall be entitled to transfer any of its shares without restriction within Government and to entities wholly owned by central government departments.”

We recommend to The Future Fund:

  • the Future Fund terms should build out reasonable safeguards for potential borrowers who might be concerned at the prospect of having a material investor whose identity and modus operandi it had not bargained for.

Loan terms

While the loan terms are not unusual for companies of the profile, the commercial terms of 8% interest rate/ 20% discount rate/ repayment with a 100% premium will be challenging for many borrowers.

This instrument is far from ‘soft money’ and is not a no-brainer for potential borrowers. It does merit some careful analysis, modelling and shopping around to ensure that these terms represent a good deal for any given company.

It is also worth noting that the preference attaching to this instrument has the potential to push junior classes of existing shareholders ‘underwater’. In most cases, shareholder approval (and therefore buy-in) will be required to create allotment authority and disapplication of existing shareholder pre-emption rights over the convertible loans and the shares arising from them.

Our conclusion

As a parting perspective, we recommend companies assessing the Future Fund as a source of finance should:

  • look first at the various other schemes the Government has introduced to address the effects of the pandemic on business;
  • monitor further news and announcements for further details of the Future Fund set-up;
  • if the Future Fund remains a preferred option and the company is potentially eligible, consult with their stakeholders to ensure they can deliver the necessary corporate approvals to put in place the funding;
  • consider the effect of these convertible loan terms on existing equity, including management/staff, and consider whether any alleviation measures will be required to address any reduced alignment or disquiet that could result; and
  • consider carefully the current unclearness around certain key features of the scheme and in particular the timing of funds flow under Future Fund investments.

We can’t guarantee, of course, that that government will take up our recommendations on clarifying the terms of the Future Fund, but we trust they will make this scheme more straightforward and attractive to the businesses it’s intended to support.

In the meantime, if you need advice on how the scheme could potentially affect your business, please get in touch.

Read the articles in the series