The Future Fund – good news for growth companies?

On 20 April the Treasury announced a £250m fund to support high growth companies who may not be eligible for funding under other Government schemes.

The Future Fund will be delivered in partnership with the British Business Bank and will be open for applications in May 2020. Investments will vary between £125,000 and £5,000,000.

Headline terms have been published by the Government but questions on the practical application of the scheme will need answering.

Eligible Companies

The main conditions include:

• The business must be an unlisted UK registered company with a substantive economic presence in the UK;
• The business must have raised at least £250,000 in equity investment from private third party investors in the last 5 years; and
• The business is able to attract match funding from third party investors and institutions – so the Government contribution shall comprise no more than 50% of the total funding.

If the business is part of a corporate group, only the ultimate parent company is eligible to receive the funding. 

Main Terms

Investment from the Future Fund will take the form of unsecured convertible loan notes (CLNs). High growth companies, their advisors and the world of venture capital are familiar with CLNs – the current climate requires a speedy, hassle-free approach and CLNs may provide just this. The CLN structure also keeps the investment on track by avoiding delays caused by discussions around the valuation of a company, allowing such debates to be deferred until a future significant equity funding round occurs.

Whilst the full terms of the CLNs will hopefully be published shortly, the headline terms require the following:

• Use of Proceeds – funding may be used for general working capital purposes, but not to repay borrowings, pay dividends, bonuses to staff or management, or in respect of the government loan, pay any advisory of placement fees or bonuses to external advisers.
• Interest – the interest rate shall be 8% per annum (non-compounding) to be paid on maturity of the loan, unless a higher rate is agreed between the company and the matched investors,  in which case the CLN interest rate will be the same as the higher rate agreed with the matched investors.
• Term – the loan has a maximum term of 36 months.
• Governance / other rights – the Government will have limited corporate governance rights during the term of the loan and as a shareholder following conversion of the loan. The company may not incur debt that is senior to the loan, although bona fide senior indebtedness from a person that is not an existing shareholder or matched investor is permitted.
• Transfer – the Government will be entitled to transfer the loan and (following conversion) any shares without restriction to an institutional investor who is acquiring the Government’s interest in at least 10 companies in respect of which the Future Fund has an interests.  The Government is also entitled to transfer without restriction within Government and to entities wholly owned by central government departments.
• Whilst there is a £5million cap on the Government investment, there is no requirement that any matched funding is similarly capped (thus the aggregate of the Government funding and matched investor funding is uncapped).
• The Future Fund scheme will initially be open until 30 September 2020, but will be kept under review and may be extended.

Conversion

Under the Future Fund the CLNs will automatically convert into equity in the next fundraising round of the company which raises an amount at least equal to the aggregate bridge funding (being a “qualifying funding round”).

The CLNs will convert into the most senior class of equity issued by the company. The principal will convert at a 20% discount (or higher if agreed between the company and the matching investors) (Discount Rate) to the price set by that funding round. Any unpaid interest will convert at the actual (non-discounted) price in the funding round.

If a further funding round is completed within 6 months of the CLNs converting, the Government may elect to convert its shares into any senior class of shares created by such subsequent funding round.

On a non-qualifying funding round (being a round which raises less than the aggregate bridge funding), at the election of the majority of the matched investors, the bridge funding shall convert into equity at the Discount Rate.

On a sale or IPO, the loan shall either convert into equity at the Discount Rate to the price set in the most recent non-qualifying funding round (unless it precedes the date of the Future Fund loan in which case the conversion shall take place at no discount) or shall be repaid together with a redemption premium of 100% of the principal of the bridge funding – whichever will provide the higher amount for the lenders.

Repayment

On maturity of the loan, after 3 years, the loan shall, at the election of the majority of the matched investors (i) be repaid by the company with a redemption premium of 100% of the principal of the Government-provided amount of the bridge funding; or (ii) convert into equity at the Discount Rate to the price set by the most recent funding round. The Government’s loan shall convert unless it requests repayment in respect of its loan. Accordingly, we would expect almost all of the Government loans provided to convert into equity at the Discount Rate, given the punitive redemption premium.

Commentary

• The Future Fund is a bold and unprecedented package of support for start-ups, being the first direct investment by Government in to local start-ups and demonstrates a strong backing for high growth companies and perhaps evidence that the Government is listening and responding to recent suggested proposals from prominent venture capitalists as to the support the Government should be providing in this sector.
• Companies will be keen to understand the timescale for the funds being made available. The Government’s current guidance notes that the scheme will be available from May 2020. In response to concerns from start-ups that the loans will be slow to be advanced, given the current speed of loans being advanced under the Coronavirus Business Interruption Loan Scheme, the Chancellor, Rishi Sunak has given assurances that companies should be “confident that this [Future Fund] will be up and running in May and then we’ll be there ready to provide the capital to drive your growth in the future.”
• Companies likely to be eligible who think they may wish to benefit from the Future Fund should start liaising with investors as soon as possible as the matched funding is required to be completed at the same time as the Government CLNs are advanced. The Future Fund will not match funding rounds recently closed.
• The Government has the unenviable challenge of providing a funding package which balances the needs of the company with the burden on the taxpayer. Furthermore the Government will presumably not want private investors to benefit disproportionately from Future Fund backed businesses – the 100% redemption premium demonstrates some off market thinking which seeks to achieve this balance.
• At first blush the Government’s transfer rights look unattractive. Founders and investors usually expect strict controls over share transfers. However, the Government cannot afford to lock funds up in potentially illiquid assets and the fact that any transferee must be acquiring the Government’s interest in at least 10 Future Fund backed companies suggests the Government’s equity stake may in the future be managed by venture capital funds or similar investors. It seems unlikely that the Future Fund will be selling down to investors who are not familiar to the growth company community. Perhaps founders and existing investors can take some comfort in this.
• The eligibility criteria doesn’t require a company to be in distress, so as things stand, even if a company has no immediate runway concerns, it can still apply. It remains to be seen whether the eligibility criteria will be further tightened. 
• The impact on S/EIS is not clear. If matched funding is structured through CLNs the matched investors investment will not qualify for the relief. Given the significance of S/EIS for high growth companies, one might expect the funding structures to preserve these tax reliefs, for example to allow the matched investment to be by way of equity providing the quantum of the funding is the same as the amount of the Government CLN. Similarly, there are initial concerns around state aid funding which, for companies with investors who have restrictions on receiving state aid funding, will need to be considered carefully.
• The Government is not proposing to match funding on recently closed investment rounds which raises the interesting prospect of current fundraisings being delayed whilst the Future Funding scheme comes online, or to an acceleration of funding to ensure the £250,000 threshold is met depending on when the 5 year period ends for assessing the total funds raised prior to an application to the Future Fund. 
• The prospect of the Government/British Business Bank appearing on a company’s loan note / share register is an interesting one. Whilst the expectation is that the Future Fund will be a passive economic investor, it remains to be seen what information rights will be required.  Currently the Government guidance indicates that the Government will be provided with the same information rights as other investors in the company.
• The Government’s current guidance refers to business needing to have a “substantive economic presence in the UK”. It will be interesting to see what quantitative measures will apply to access whether a business meets the test of having a “substantive economic presence” although our current understanding is that the test will be focused on the company predominantly operating in the UK rather than focusing on the size or scale of the company.
• We anticipate further Government guidance will clarify this, but it is likely that companies with a non-UK parent will not qualify for the Future Fund.
• The concept of the Future Fund is positive and suggests the Government is fully supportive of fast paced early stage companies that have delivered significant growth to the UK economy. Swift but measured deployment of the Future Fund may ensure that our fast-growth companies will thrive during and post-COVID- 19 and post-Brexit Britain.
• More generally, it is also worth noting that Companies can complete a questionnaire on the Government’s website which is found here, to ascertain which of the financial relief packages may apply to them.

For more information, please contact David Coates or Rebecca Burford.