In April, Chancellor Rishi Sunak, announced another form of financial support for businesses, as a result of the COVID-19 pandemic, in the form of the Future Fund. Following several other measures to support businesses financially, the government has partnered with the British Business Bank to support high growth start-ups with a new scheme. The Future Fund will see the government take equity shares in these types of UK businesses to support them, but only where private equity investment can be matched. We’ll outline the details of the Future Fund and whether your business is eligible below. This article will be updated if the Government provides any further guidance on the Scheme.
What is the Future Fund?
The Future Fund is part of the UK Government’s initiative to respond to the economic impact of the COVID-19 pandemic on businesses in the UK. So far we have seen the rollout of the Coronavirus Large Business Interruption Loan Scheme, the COVID-19 Corporate Financing Facility and the Coronavirus Business Interruption Loan Scheme, but not all companies, namely start-up businesses, may be eligible to benefit from these measures. The Government has indicated that the Future Fund, in partnership with the British Business Bank, is designed to reach those companies.
Available from 20 May 2020 until the end of September 2020 (though this time frame may be reviewed), the Government has billed the Future Fund scheme as one that will issue convertible loan notes between £125,000 to £5 million to innovative companies that are facing financing difficulties due to the COVID-19 outbreak. The Government has set aside £250 million for the scheme and will keep this figure under review. This article looks at the information that is out there and what the arrival of the Future Fund could mean for your business.
What is a convertible loan note?
A convertible loan note is a form of loan instrument that can be converted into shares (equity) at a specific point in time (that will be identified in the loan note instrument). This type of financing is often seen in start-up company funding because it gives investors the possibility of seeing their principal loan plus interest converted into shares in a company growing in value at a discounted rate.
Who is eligible for the Future Fund?
To be eligible for a Future Fund loan your business must have been incorporated since 31 December 2019 be an unlisted company that has raised at least £250,000 in total from private third-party investors in previous funding rounds in the last five years.
A company’s eligibility for the scheme will be also be affected by the type of investor(s) who are proposing to match the funding provided via the Future Fund scheme. Investors will need to fall into one of a number of categories set out in the Financial Promotions Order 2005.
To be eligible your business must also have a substantive economic presence in the UK. What ‘substantial economic presence’ means exactly is also not clear but the Government has given guidance that if the company applying for funding is a member of a corporate group, only the ultimate parent company, if a UK registered company, is eligible to receive the loan. In addition, the Government has stated that a business will only be eligible if it is able to say either (i) half or more of its employees are UK based, or (ii) half or more of its revenues are from UK sales.
And lastly, all eligible companies applying for funding will be subject to and will have to pass, customer fraud, money laundering and ‘know your customer’ checks before the loan will be granted.
How does the Future Fund work?
The way the Future Fund works is that the Government is essentially going offering eligible companies unsecured bridge funding. Bridge funding is widely understood to be a short term, quickly available funding plug until long-term funding is available. Unsecured bridge funding means that the funding is made without an asset or a guarantee given as security. Such funding therefore comes at a cost with certain conditions attached to it as the Government will be using UK taxpayer money to give companies loans without guarantees or other types of security and want to be seen to to be acting in the taxpayer’s interests and get a ‘good deal’. Details of the terms and conditions attached to the funding are set out in the key terms summary table below.
In terms of process, it must be an eligible investor who makes an initial investment application in connection with the company. The company is then required to certify the accuracy of the details provided in the initial investment application, before submitting a full application. Once an application is approved, a non-negotiable convertible loan agreement must be executed by all parties before the investment monies are paid into the bank account of the company’s solicitors.
But what does this mean? The table below sets out a summary of the key terms of the Future Fund.
|Provision||What is being offered?|
|Matched funding||The Future Fund Government loan can be no more than 50% of the total bridge funding being provided to the company (‘Bridge Funding’) and so the company has to find 50% or more funding from other investors (‘Matched Investors’). The Matched Investors can loan as much money as they want to the company and there isn’t a limit on the total Bridge Funding being provided, just on the Government’s portion of the funding. |
Previous funding rounds will not count towards the total amount of the Future Fund loan to be granted. This means the proposed investor loan from Matched Investors would have to be a newly raised amount.
|No SEIS/EIS relief for Matched Investors||Matched Investors will not be able to benefit from tax relief schemes such as the Enterprise Investment Scheme (‘EIS’) and the Seed Enterprise Investment Scheme (‘SEIS’) relief, as SEIS/EIS relief does not apply to convertible loans. This is because to be eligible for SEIS/EIS relief, the shares must be issued to raise funds for the purpose of business activity. The Government has published guidance that says that the issue of shares in consideration for the liquidation of a loan, or by the ‘conversion’ of loan stock, does not raise money for the company. Further, to be eligible for SEIS, a company must be raising no more than £150,000, which is below the eligibility threshold for the Future Fund.|
|Use of proceeds||The Bridge Funding can only be used for working capital purposes, which means not to repay any borrowings, make any dividends or bonus payments to staff, management, shareholders or consultants or (in respect of the portion paid by the Government) pay any advisory or placement fees or bonuses to external advisers.|
|Conversion||Unless the Matched Investors holding a majority of the principal amount of the total Bridge Funding or the Government choose to redeem their loans, the total Bridge Funding automatically converts into shares in your company on the company's next qualifying funding round at a minimum conversion discount of 20% (the ‘Discount Rate’) to the price set by that funding round, with a company repayment right in respect of the accrued interest. Matched Investors can negotiate an increase to the Discount Rate with the company (so that it is more than 20%). |
A qualifying funding round is a funding round that raises an amount equal to at least the total amount of the Bridge Funding (Government + investors), but this amount can’t include any shares issued on conversion of the Bridge Funding or any shares issued to employees/consultants on exercise of any share options.
On a non-qualifying funding round which raises at least 25% of the amount raised under the Future Fund scheme, the Matched Investors holding a majority of the principal amount of the total Bridge Funding can elect for the loan to be converted into shares in the company at the Discount Rate to the price set by that funding round. A non-qualifying funding is a funding round that raises less in equity capital than the total amount of the Bridge Funding (Government + investors), and also can’t include any shares issued on conversion of the Bridge Funding or any shares issued to employees/consultants on exercise of any share options.
On conversion of the Bridge Funding, only the principal amount (and not any accrued interest) shall convert at the Discount Rate and any accrued interest not repaid by a company shall convert at the relevant price without the Discount Rate.
On a sale or initial public offering, the Bridge Funding will either convert into shares at the lowest price paid by investors at the company's most recent equity financing or it can be repaid with a redemption premium (which is a premium equal to 100% of the principal amount of the Bridge Funding – so 2x), whichever will provide the higher amount for the lenders. The Discount Rate will not be applied to the Conversion Price.
When the Bridge Funding matures, the investor portion of the loan can either, at the option of the Matched Investors holding a majority of the principal amount of the Bridge Funding, be repaid with a redemption premium (which is a premium equal to 100% of the principal of the Bridge Funding) or convert into shares in the company at a price equal to the lowest price paid per share paid by investors in the company's most recent equity funding round. No Discount Rate will be applied to the conversion price. Similarly, when the Bridge Funding matures the Government’s portion of the Bridge Funding can either, at the option of the government, be repaid with a redemption premium or convert in shares.
|Valuation cap||There is no valuation cap set on the price at which the Bridge Funding converts into shares on the company's next funding round. But the Matched Investors can set a cap if they wish and that cap will apply to the Government’s portion of the Bridge Funding as well.|
|Conversion equity||On a conversion event, the Bridge Funding will convert into the most senior class of shares in the company. If another funding round is completed within six months of the relevant conversion event, the Bridge Funding lenders are entitled to convert their shares into the most senior class of shares of the company in issue following that funding round.|
|Interest rate||8% per annum (non-compounding) interest to be paid on maturity of the Bridge Funding to the Government. The interest rate may be higher if a higher rate is agreed between the company and the Matched Investors.|
|Term||The Bridge Funding matures after a maximum of 36 months.|
|Decision-making||After the Government has received notice of a conversion event from the Company, the Government can request a meeting to discuss the corporate governance rights that it wishes to be granted once it is a shareholder. The Company is require to act in good faith when discussing the rights to be provided to the Government, but it is under no obligation to to provide any specific rights.|
|Warranties||The company is obliged to provide standard warranties to the Government and the Matched Investors, including in respect of title and ownership, capacity, its loan eligibility in accordance with the Government eligibility criteria, compliance with law, the borrowing facilities of the company, litigation and insolvency events to the Bridge Funding lenders on closing of the Bridge Funding. |
The Matched Investors are required to provide warranties to the Future Fund in respect of their professional status and capacity and authority.
|Covenants||The company is obliged to provide covenants to the Government during the term of the Bridge Funding and as a shareholder following conversion of the Bridge Funding, including undertaking to (i) treat the Bridge Funding lenders and the holders of the conversion shares fairly and equally (ii) provide the Government with certain information (iii) provide the Government with the same information rights as other investors in the company (iv) and comply with all legal obligations.|
|Most favoured nation||In the event that the company issues further convertible loan instruments to investors (including any new or existing investors which are not Matched Investors) with more favourable terms, those terms shall apply to the Bridge Funding.|
|Negative pledge||Unless consent has been obtained, the company cannot permit the creation of any indebtedness that is senior to the Bridge Funding other than any bona fide senior indebtedness from a person that is not an existing shareholder or Matched Investor.|
|Transfer rights||The Government is entitled to transfer any converted shares without restriction to an institutional investor who is acquiring a portfolio of the Government’s interest in at least ten companies owned in connection with the Future Fund. The Government is also entitled to transfer its Bridge Financing and any of its shares without restriction within Government and to entities wholly owned by central Government departments. |
Prior to conversion of the Bridge Financing, the Government is entitled to transfer its loan, but is subject to the same restrictions as those transfer restrictions imposed on the most senior class of shareholders in the company.
Will this actually benefit UK companies?
Whether an application to the Future Fund will benefit your company will depend on the specific facts and circumstances of your company. A lot will depend on the financial standing and established trajectory of your business. It is important to remember that the Future Fund bridge financing is meant to be an emergency measure made necessary by the occurrence of an out of the ordinary event that has had far-reaching detrimental economic consequences on many businesses in the UK. It is arguably not surprising that given the amount of businesses that are currently facing unprecedented difficulties and that the scheme uses taxpayer money, the Future Fund is not designed to prop up or top up already struggling businesses.
The robust conversion terms we have seen so far however do suggest that companies could give a lot away in return for the funding, and that businesses will in all likelihood need to be fairly established with a strong investor base to take part successfully in the scheme. This also serves to further emphasise that this Future Fund is most suitable for growth businesses with viable business models and a supportive investment community (that has come to terms with any potential tax implications) and that have now hit hard times as a consequence of the current lockdown and pandemic-related brave new world.
Do you need a solicitor?
Yes, a solicitor is required to facilitate the settlement of the loan, holding and releasing the completion monies to the investee company on execution of the convertible loan agreement and upon confirmation from the Future Fund via the Future Fund portal.
It is also recommended to instruct a solicitor to advise on the scheme, your eligibility and the associated documentation.