(COVID-19) - UK Government confirms "Future Fund" support for start-ups
UPDATE – the Future Fund is now live. Please see our latest article for more information.
On 20 April 2020 Chancellor Rishi Sunak announced the introduction of two major initiatives to support and sustain the growth and development of the start-up economy through the Coronavirus pandemic.
There has been growing pressure on the Government to respond to a coordinated plea from the start-up and scale-up community to "Save Our Startups", with over 6,000 signatories (including this author) putting their names to a letter urging critical support for our 30,000 start-ups which employ an estimated 3 million people.
The £1bn support package is designed to help early-stage and growth companies which do not qualify for the Government's Coronavirus Business Interruption Loan Scheme (CBILS) – typically because they are not yet profitable and/or are unable to secure funds through commercial borrowing. £750m of this will take the form of R&D grants to be distributed through Innovate UK (with £200m earmarked for 1,200 companies which are not currently receiving Innovate funding to apply for up £175k each), with up to £250m to be invested in start-ups via convertible loans.
In this article we will focus on summarising and explaining some of the key terms of the Future Fund (i.e. the loan aspect of the support package). We will also identify some of the circumstances where companies will not currently qualify for Government support, and consider some of the areas that need further clarification or action from the Government.
The Future Fund: up to £250m of convertible loan funding
The "Future Fund" is an initial £250m Government investment fund (which with matched funding is designed to release £500m into UK start-ups) which will be made available to certain qualifying high-growth companies. Qualifying companies must be unlisted UK registered companies which have raised at least £250k in third-party equity investment within the last 5 years. The scheme will not therefore be suitable for companies which have raised less than £250k, or (on the face of current guidance) where funds have been raised from the founders and family/friends rather than third parties.
Companies are invited to apply for between £125k and £5m from the fund, but must have lined up matched funding from co-investors (i.e. you must be looking to raise between at least £250k and £10m in total to be eligible for the Government support). Funds raised from the Future Fund are to be used for working capital, and not repayment of loans or distribution to shareholders (familiar concepts to those who have previously raised funds under EIS (Enterprise Investment Scheme) or VCT (Venture Capital Trust) rules).
The Government investment will be structured as a convertible loan note, which is effectively an interest-bearing loan (in this case bearing simple interest at 8%, repayable on maturity of the loan) which will either convert into equity or be repaid as follows:
The loan will automatically convert into equity (at a minimum discount of 20%) in the next qualifying funding round (i.e. a funding round which raises at least the total aggregate amount raised from the Future Fund and co-investors).
The loan may be converted on a non-qualifying funding round at the discretion of the matching investors (at a minimum discount of 20%).
On a sale or IPO, the loan notes shall either (i) be repaid with a 100% redemption premium (i.e. 2 x the amount borrowed, plus interest) or (ii) convert into equity at a minimum discount of 20% to the most recent non-qualifying funding round (post-drawing down from the Future Fund) – whichever provides the lender with the better return.
On expiry of the loan term (which must not be more than 36 months) the loan shall either (i) be repaid with a 100% redemption premium (i.e. 2 x the amount borrowed, plus interest) or (ii) convert into equity at a minimum discount of 20% to the most recent funding round – provided that the Government element of the loan shall convert into equity unless it requests repayment.
There is a full Future Fund term sheet which sets out the minimum terms which must apply to the fundraising round (including how this will relate to the matched funding element) and which should be reviewed carefully by companies which are considering applying for the scheme. We are happy to advise on any aspects of this term sheet which are unclear or need further explanation.
Which companies will the Future Fund be suitable for?
On the basis of the initial information provided, companies may wish to apply immediately to the Future Fund where:
They have raised more than £250k in third-party equity funding in the last 5 years.
There are existing investors in a position to proceed quickly with matched funding (it is unclear whether the Government scheme will require cash subscriptions to have been received by the company before the Future Fund element is released).
The company and matching investors are comfortable with investment being structured as a convertible loan in accordance with the Government's required deal terms.
Matched funding has been lined up from investors who do not (and will not) be eligible for EIS relief.
What questions has the Future Fund scheme left unanswered?
The Future Fund has been well received by many in the start-up and scale-up community, with the Chancellor being praised for following the lead of France and Germany in making financial provision available for growth companies.
However, at this stage there are various outstanding questions which need to be answered if the Future Fund scheme is to fully achieve its stated aim of supporting innovative companies which have been affected by the Coronavirus outbreak.
Some of the current concerns and/or unanswered questions relating to the Future Fund proposals are:
The immediate ineligibility of companies that have raised less than £250k in third-party equity funding, perhaps because the founders (and family/friends) have funded the business, or because the company has until now been sufficiently revenue-generative and therefore has chosen not to raise third-party investment.
The ineligibility of companies that otherwise qualify, and need an injection of working capital, but wish to raise less than £250k at this stage (and will not currently qualify for the Future Fund).
The position where a company wishes to raise funds from matching investors under EIS. Until now, convertible loans have not been an EIS-qualifying investment structure, which would mean that either (i) matching investors will not qualify for EIS relief on this or any future investment, (ii) convertible loans need now to be recognised by HMRC as EIS-compatible instruments or (iii) the matching investment could take the form of an EIS-qualifying non-interest bearing advance subscription agreement which closely (but not exactly) mirrors the terms of the convertible loans issued to the Government under the Future Fund.
The question of timing. One of the primary criticisms of the CBILS has been the perceived slowness with which mainstream lenders have been making funding available to businesses. The reality of coordinating a funding round with multiple third-party investors (including the UK Government) and the negotiation of a convertible loan note structure is that this is unlikely to be a quick process – and we do not currently know when Future Fund cash will be available for participating companies to draw down. Many start-up and scale-up companies are burning through cash quickly with a rapidly diminishing runway.
There is already concern that £250m of Government support will quickly be consumed – as this only makes provision for 2,000 companies (best case) or 50 companies (worst case) to participate in the scheme. It has been estimated that 15,000 UK companies have raised £250k in a single fundraising in the last 5 years, so it may be that demand far outstrips supply unless additional funding is released.
The concern that start-ups and scale-ups are being offered a much less attractive funding proposition than larger businesses which qualify for the CBILS scheme (for example because of terms such as the 8% interest rate and 100% redemption premium).
The Government's ability to transfer any shares in companies that it acquires to an institutional investor which is prepared to acquire a portfolio of at least 10 such companies. In other words, struggling companies might start out dealing with the Government but end up with an institutional shareholder further down the line.
There have been calls for HMRC to enhance EIS relief as a measure to increase private investment in high-growth companies at this unprecedented time. To date there have been no indications that the Government is planning to make such changes.
The future of the Future Fund
The Government has been widely praised for moving quickly to introduce the Future Fund, and we hope that for many of our start-up and scale-up clients this announcement will be welcome news. Interested companies should be encouraged to move quickly to sign up for the scheme, which will launch in May 2020.
However, it is also clear that some further work is required to ensure that innovative UK companies get the support they need to survive the Coronavirus (COVID-19) crisis.
If you would like to discuss any of the issues raised in this article, or have other concerns about the impact of Coronavirus, please contact Dan Partridge or Harry Trick in Michelmores' Corporate team.
All information correct as at 22 April 2020.
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This article is for information purposes only and is not a substitute for legal advice and should not be relied upon as such. Please contact our specialist lawyers to discuss any issues you are facing.