Coronavirus - Government launches Future Fund for high-growth companies - UK

• Global
• United Kingdom

• Banking and finance
• Coronavirus - Country overview
• Corporate

27-04-2020

On 20^th April, the UK Government announced a £500m “Future Fund”, as part of its package of measures to support businesses in response to the coronavirus. 

What is the Future Fund?

The Future Fund is being set up with the aim of providing assistance to “innovative” companies – in other words high-growth, relatively early-stage firms with a focus on technology and development. It is targeted at those businesses which have been unable to access other government business support programmes, such as the Coronavirus Business Interruption Loan Scheme, because they are either pre-revenue or pre-profit and typically rely on equity, as opposed to debt investment. This fund is designed to leverage private sector investment, which appears to be a prudent approach.

When will the Future Fund launch?

The Future Fund will launch in May 2020, at which point we would expect further details to have been released around how the scheme will operate and how companies may apply. The government is committing an initial £250m in funding towards the scheme, which will initially be open until the end of September, although the scale of the fund will be kept under review. The Future Fund is being developed in collaboration with the British Business Bank.                                                                                                                                    

This note covers the eligibility requirements and key parameters of the Future Fund and sets out considerations and actions that potential applicants for the scheme should plan for now, along with some potential challenges and questions which remain unanswered at this stage.

We encourage you to visit our Coronavirus Hub for further up to date insight into the economic aid measures announced so far and the various other issues and challenges which businesses are facing in these unprecedented times.

Who is eligible for the Future Fund?

There is currently no indication as to how companies can demonstrate that they are suitable candidates for the Future Fund’s policy goal of investment in “innovative” firms. While more detailed eligibility criteria has been promised in due course, at present the scheme would appear to be open to a wide range of “innovative” sectors (for example fintech, IT, R&D, health and so on), including those sectors which have been specifically barred from applying for the Coronavirus Business Interruption Loan Schemes. In light of the government’s comment that the Future Fund is aimed at those businesses which cannot access other government business support programmes, an applicant may have to prove ineligibility in respect of the other government schemes in order to unlock Future Fund support.

In addition, while the Future Fund is explicitly part of the government’s package of Coronavirus support measures, at present there is no requirement for applicants to demonstrate that they are negatively affected by the ongoing pandemic, or to demonstrate a viable business plan (although such requirements may be announced in due course).

At present the only qualifying requirements are that the applicant must be:

(i)            an unlisted UK registered company;

(ii)           that has raised at least £250,000 in aggregate from private third party investors in previous funding rounds in the last five years; and

(iii)          have a substantive economic presence in the UK. If the applicant company is a member of a corporate group, only the ultimate parent company of the group, provided it is a UK registered company, is eligible to receive support.

The requirement for an applicant to have raised at least £250,000 of private investment in the recent past indicates that the Future Fund would be particularly appropriate to companies which have received venture/seed capital investment and potentially also private equity portfolio companies.

What support is being offered?

The government’s support under the Future Fund will be to provide funding by way of a convertible loan note issued by the successful applicant company. The funding will need to be ‘matched’,  meaning that the government loan will only be provided alongside funding provided by other third party investor(s), however, the government will not provide more than the amount advanced by the third party investor(s). A minimum amount of £125,000 has been set with a maximum amount of £5,000,000; there is no cap on the amount that the third party investor(s) can advance, but the government will only match up to £5,000,000 of investment. We assume that this criteria has been set in order to comply with State Aid rules and is similar to criteria for regional development funding which we have seen in the preceding years.

A detailed (but not exhaustive) term sheet setting out the key terms of the convertible loan can be found on the government’s website.

The funding provided by the government and the third party investor(s) must only be used for working capital purposes. It will be prohibited to use the loan to repay other borrowings, pay dividends or bonus payments or, in respect of the government’s part of the loan, pay any advisory fees or bonuses to external advisers.

The loan will bear interest at a minimum of 8% per annum (although the rate will be higher if a higher rate has been agreed between the company and the third party investor(s)) and have a maximum term of 36 months. However, the loan will be structured to automatically convert into the highest-ranking class of equity shares on the occurrence of the next “qualifying” funding round (a “qualifying” funding round being an equity capital raise at least equal to the aggregate amount of the convertible loan). In addition, the loan will also convert into the highest-ranking class of equity shares on the occurrence of a “non-qualifying” funding round, if a majority of the third party investor(s) elect. Conversion of the loan will be at a minimum discount of 20% to the price set in the subsequent funding round (and will be higher if a higher discount rate is agreed between the company and the third party investor(s)). If a further funding round is completed within six months of conversion, the lenders will be entitled to convert their shares into the highest-ranking class of shares of the company in issue post that round.

If the maturity date of the loan is reached without a funding round having occurred in the interim, the loan will, at the option of a majority of the third party investor(s), either convert at a 20% discount rate to the most recent funding round, or be repaid, but at a premium of 100% (i.e. the amount repaid will be double the original investment amount). However, the key terms provide that the government’s portion of the loan will convert on maturity, unless the government requests repayment. At present there is no ability for early repayment of the loan ahead of maturity, whether at the company’s option or not. On a sale or IPO of the company, the loan will either convert at a 20% discount rate or be repaid with a 100% premium, depending upon which alternative would return more funds to the lenders.

In terms of ongoing governance and control rights for the government as part of their investment, it is currently stated that the government will have limited corporate governance rights so long as it is a lender or shareholder in the company. It remains to be seen what rights are envisaged here,  although the government will receive the same information rights as other investors in the company. The government will also benefit from a negative pledge whereby the company agrees not to incur any indebtedness senior to the convertible loan (other than bona fide investment from a party who is not a shareholder or matched third party investor under the convertible loan), and a most favoured nation clause, which provides that the Future Fund lenders will benefit from the terms of any subsequent convertible loan, if those terms are more favourable than the Future Fund loan.

Finally, the government will be entitled to transfer the loan and any shares it receives on conversion of the loan, without restriction, to an institutional investor which is acquiring the government’s interest in not less than 10 Future Fund companies.

Actions, points to consider and potential challenges

• Clearly, further details around the operation and the specific terms of the Future Fund will need to be provided. In particular, additional clarity would be welcomed as to how applicants can be expected to meet the requirement of being a suitably “innovative” company. Potential applicants are therefore advised to monitor developments (for example on the British Business Bank and government websites) in the coming weeks, ahead of formal launch of the scheme.
• The Future Fund scheme is currently limited in scale; only £250m of government money has been committed initially (although there is the possibility for the scheme to be scaled up). As demand for the scheme may be high (particularly at the outset), in addition to aligning the timing of future funding rounds to the availability of Future Fund support (discussed below), potential applicants should ensure they have collated the documentary evidence required to pass the government’s fraud/AML/KYC checks to avoid unnecessary delays. If the fund proves popular we may see an extension in time and amount.
• The Future Fund scheme will only match third party investments made in the future; it will not apply retrospectively to past fundraisings. For this reason potential applicants should consider delaying any planned fundraisings (if possible) until such time as they are able to benefit from the Future Fund.
• Conversely, if no such fundraisings are planned, companies should look to initiate discussions with existing shareholders and potential third party investors as soon as possible about a fundraising in the coming months if they wish benefit from the additional matching investment provided under the Future Fund. However, because of the requirement that the Future Fund support must match funding provided by third party investor(s) (i.e. the government will not fund on a standalone basis), the support offered under the Future Fund will be of no benefit to companies which are unable to successfully source third party finance during the life of the Future Fund.
• The key terms of the Future Fund would appear to mandate that in order for the government to match the funding provided by third party investor(s), such investor(s) must provide funding on the same terms as the government, by way of a convertible loan. Many private investments are structured in order to benefit from Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) reliefs, or to secure other favourable tax treatment. As convertible loan notes are not EIS- or SEIS-eligible, it seems there is a risk that the Future Fund could deter or preclude third party investments that would otherwise be made. It is hoped that additional clarity on this point will be provided in due course, particularly as precluding EIS- and SEIS-eligible investments from the Future Fund would go against the similar policy aims of these schemes to encourage and stimulate investment in fast-growing companies.
• Although there is a lack of detail on certain aspects of the Future Fund, the government should be commended for providing a relatively detailed term sheet for the convertible loans at this stage. The term sheet provides comfort that Future Fund support will be provided on a basis which is familiar to many early-stage businesses (and their investors) and on terms which are (in large part) relatively market standard. The key terms will assist the framing of discussions with potential third party investors and minimise the time taken in negotiating the investment, allowing the company to access funding in short order. In particular, investing via the convertible loan will defer questions of the company’s valuation (which are often contentious in the context of fundraisings) until future funding rounds.
• It is important to note that the convertible loans are being provided on the expectation that they will convert into shares. There is no option for the company to repay a loan ahead of its maturity date. If the loan proceeds to maturity without a funding round having occurred in the interim, there is the possibility that, if the convertible lenders so elect, the loan must be repaid along with a premium of 100%. In this respect the Future Fund is most suitable for companies which will require future funding – the matched funding provided by the government providing an enhanced bridge to the next funding opportunity, allowing the company to invest and grow more intensively in the meantime. In this sense the 8% interest rate and 100% premium payable on any redemption act as a deterrent to any company looking to treat the government support as simply an additional working capital facility.
• Being convertible loans, applicants will need to consider pre-emption rights of existing shareholders, which will need to be satisfied or waived, as well as consents required from existing shareholders or third party funders.
• As the investee needs to be the ultimate parent company and UK registered, certain companies may need to effect a corporate reorganisation prior to being funded or even before application.  For example, a number of “innovative” companies are registered in the Channel Islands.
• Given the expectation that the convertible loans will convert into shares, the government is likely to end up with equity stakes in a large number of relatively small, privately-owned companies. The government is unlikely to want to hold on to such illiquid investments as a largely passive investor, so has built in the provision that it can transfer its investment to any institutional investor which is acquiring the government’s interest in not less than 10 Future Fund companies. This opens up a secondary market for the government’s Future Fund investments and creates interesting future opportunities for institutional investors to acquire a portfolio of interests in early-stage firms within (or across) sectors. Private sector investors may be particularly interested if the investee companies can be grouped into coherent portfolios based on sector or geographic area. Alternative, the investments may be transferred to regional public sector bodies which already hold a portfolio of similar investments; for example, the Development Bank for Wales. For the company itself, it should be aware that this provision means that new third party investors may be brought in by the government with the company having no say (and limited visibility) as to the identity and intentions of such future investors.

If you have any questions regarding the Future Fund, or any of the wider packages of government support, please contact us.