April 21, 2020

On Monday 20 April 2020 the government announced a £250 million ‘Future Fund’ to assist high-growth companies facing financial difficulties as a result of the Coronavirus outbreak.

The Future Fund is due to launch in May 2020 and will initially be open until the end of September, to be delivered in partnership with the British Business Bank. The investments are to be made through convertible loan notes (CLNs) which is a common form of bridge funding that can usually be deployed speedily (mainly because company valuations and long form equity documents do not need to be negotiated, as they would on an equity funding round). The government has published a term sheet setting out the key terms – available here – which appear to be in line with market trends in the main with some exceptions as set out below. In summary:

1. The investments shall be available to eligible companies in the form of CLNs of between £125,000 to £5 million.
2. To be eligible companies must:
   • be unlisted UK companies with a substantive economic presence in the UK;
   • have previously raised at least £250,000 in equity investment from third-party investors in the last five years; and
   • be able to attract the equivalent match funding from third party private investors. This is a key criterion because companies are likely to need the support of their existing shareholders or, even more difficult, new investors in order to access the funding. It is unclear exactly when this matched funding must be provided (i.e. whether it must be simultaneous with the government funding). It would appear from the term sheet that the matched investor(s) will have to invest under the same CLN and, importantly, this would preclude (S)EIS investors from providing the required matched funding.
3. The loan shall be an unsecured debt accruing 8% interest per annum (which rolls-up into the principal amount) to be converted into equity in the company in a future funding round – the conversion shall be into the most senior class of shares at a discount of at least 20% to the price paid by the investors on that round (though the interest element shall not benefit from the discounted price).
4. On maturity of the loan (3 years) or on a sale or IPO, if not already converted, the loan shall either be converted into shares or repaid with a significant premium of 100% of the principal plus accrued interest, at the option of the noteholders –  i.e. if the loan is repaid rather than converted, the government will receive more than a 2x return. This is one of the less familiar terms included in the pro forma term sheet and whilst it is quite possible that if a conversion event has not occurred by the maturity date, the company may not be in a position to repay the loan at all, the proposed repayment premium may place a substantial burden on some companies. There is no mention in the term sheet of an early repayment right for the company (which would enable companies to reduce the principal amount and interest paid under the CLN if in a position to do so).
5. The government shall be entitled to transfer its notes or 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. This does introduce some uncertainty for companies in terms of the identity of their investors in the medium term. That said, there must also be some concern for companies about having the government on their capitalisation tables and what complexities that might bring.
6. The government will not set a cap on the company valuation in relation to the price at which the loan converts into equity on the next funding round (although they will take the benefit of any cap agreed with the other investors) – a valuation cap can mean a significant dilution effect so this potentially benefits the existing shareholders.

The extent to which any of the above will be negotiable is currently unclear, but, given the potential for widescale uptake, it would seem unlikely that much negotiation will be possible. However, it is possible that the investors providing the matched funding will require more favourable terms than those in the term sheet, and the government is likely to benefit from such terms.

Further details, including how to apply, will be published in due course. If you think your company is eligible and may apply for funding under the Future Fund, the following preparatory steps would be prudent:

1. Consider your company’s balance sheet and capitalisation table and the level of funding you would be looking to apply for (bearing in mind the potential for dilution).
2. Identify and approach potential investors for the matched funding.
3. Consider the immediacy of your funding needs. Clarity on the Future Fund may be month or more away so companies with funding already lined up, or who have more urgent needs, may have a dilemma – whilst the term sheet isn’t explicit on this, presumably any funds invested prior to the launch of the Future Fund will not qualify as match funding.
4. Check your company’s existing equity documents for any consents, waivers, approvals or shareholder resolutions required to enter into the proposed CLN.
5. Consider the practicalities of taking investment in the current climate (e.g. how will the necessary due diligence be carried out).

The Future Fund will be welcome news for start-ups who find themselves in need of funding due to the Coronavirus crisis. Accessing funding can be a challenge for such businesses even in buoyant economic conditions but during periods of significant economic uncertainty, such as those currently being experienced, raising new funding is much more difficult, largely because:

• investor confidence is low and VCs, angels and corporate venturers are reluctant to make investments or require more advantageous investment terms to protect against the perceived increased risk of investing at this time. Our clients have experienced investors pulling out of investments after signing term sheets and over the course of Q1 2020 there was a 32% decrease in equity deals into private UK companies compared with Q4 2019; and
• traditional debt funding and the existing government bailout schemes are not available to most start-ups as they do not have sufficient predictable revenue streams or fixed assets.

It is hoped that the Future Fund will help maintain London’s pre-eminent position in terms of European start-up ecosystems or indeed start-up ecosystems outside of Silicon Valley. Whilst there are still a number of questions to be answered about how exactly investments from the Future Fund will be deployed and, in all likelihood, the funds will not actually be available until mid or late May (taking into account the process to agree the necessary legal documents), it should provide some confidence for start-ups, entrepreneurs and existing investors.

If you would like to discuss your funding requirements, please do get in touch with any member of the team.