Notes on the government's Future Fund scheme

The government has announced the £250m Future Fund aimed at helping start up, scale up and venture backed businesses impacted by coronavirus. We look at what it means.

The government has announced the £250m Future Fund aimed at helping start up, scale up and venture backed businesses impacted by coronavirus. We look at what it means.

The scheme applies to those aforementioned businesses that do not meet the traditional bank lending criteria and have therefore found themselves unable to access help under the previously announced government coronavirus funding packages.

The Future Fund will be delivered by the British Business Bank and will issue convertible loan notes between £125,000 and £5,000,000 (subject to matched funding being provided by private investors) to innovative companies which are facing financial difficulties due to the coronavirus outbreak.

At this stage limited eligibility criteria have been provided which state businesses are eligible if they:

• are based in the UK;
• can attract the equivalent match funding from third-party private investors and institutions; and
• has previously raised at least £250,000 in equity investment from third-party investors in the last five years.

An indicative term sheet has also been provided which is worth reading but the draft term sheet and the absence of the full eligibility criteria leave lots of questions to be answered.

We believe the following are the key areas to be considered:

Eligibility

1. Will all UK registered start up, scale up and venture backed businesses be eligible?  What is meant by substantive economic presence in the UK? It is relatively common for companies in this space to be founded in other jurisdictions and to continue significant operations in that jurisdiction, while using a UK holding company for fundraising purposes. Will such companies be able to participate?

2. Will there be a restriction for companies that have recently completed investment rounds?

3. Will companies have to demonstrate that they have applied and failed to access other coronavirus funding schemes such as CBILS?

Matching

4. What will the funding match?  Only new investment rounds?  What about rounds that have just closed or have staggered closes or where part of the round has been left open for investors who are yet to be identified?

5. Is the matching only available for bridging rounds that comprise convertible loan notes?  Or will the Future Fund match equity investment provided alongside the government’s convertible loan note? There are some provisions in the term sheet which indicate that the matched investment must be in the form of convertible notes so at this stage it appears that it must be matched convertible notes.

Terms

6. We’re assuming that the government’s terms cannot be amended (other than to make them more beneficial to match any better terms of a private sector investor – for example, a better interest rate or larger discount on conversion) because the term sheet refers to those terms being the minimum the government would accept but clarity is required.

7. There is a restriction on the use of proceeds for working capital. That looks generally fine (and akin to the existing EIS/VCT restriction on use of proceeds) but companies will need to make sure that they don’t trip up over any of these requirements. The reference to advisory fees not being payable from the government element is not clear – does it mean success fees or any professional advisory fees (although those fees could come out of the private element)?

8. Some of the terms would not be considered to be market terms in normal circumstances and would most likely be the subject of negotiation (but these are not normal times):

a. As regards conversion on Sale or IPO there is the lookback to the most recent non-qualifying round which could mean that the convertible unwinds into a significant number of shares for the holders (albeit that the discount rate would not apply where the last equity round is prior to the date of the bridge financing).

b. There is a 100% redemption premium if the loan is redeemed on maturity (although as with any convertible the intended outcome would be conversion to equity, and the 36-month term will assist with this as it is lengthy when compared to market norms).

c. If the loan converts and a further equity raise is undertaken within six months of conversion which results in an issue of shares which are senior to those issued on conversion, the former Future Fund noteholders are given the right to convert their shares into shares of the more senior class. It is unclear how investors on the round which triggers conversion of the notes will react to this right, but they may well ask for the same provision, although in practice the fact that it is relatively rare to issue further senior shares so quickly after a raise may manage this issue.

d. The term sheet includes a most favoured nation clause which provides for the Future Fund convertible notes to benefit from more favourable terms granted to investors on any subsequent issue of convertible notes, which could become relevant in practice given the lengthy term of the Future Fund convertible.

9. There is reference to government rights during the term of the loan and after conversion. More detail is needed on that to understand what restrictions companies will have to deal with and the practicalities of obtaining consent from the government to the restricted corporate actions will need to be made clear.

10. We assume the negative pledge will only apply in respect of new debt from existing shareholders or matched investors but this needs to be confirmed. It is unclear how any existing shareholder debt will be dealt with or whether such debt will have any impact on the ability of a company to take advantage of this scheme.

VCT / EIS

11. We’re reasonably certain that the government investment would constitute state aid risk capital for VCT purposes so would need to be taken into account in looking at the annual and lifetime limits, but this needs to be confirmed.

12. Convertible loan notes are not EIS eligible.  How does the government intend that EIS investors can participate in investment rounds where the Future Fund is participating (i.e. will the Future Fund match investments made by way of advanced subscription agreements)?

13. There are a number of terms which would not be VCT qualifying, for example, redemption premium of 100%, three-year term (rather than five years) and automatic conversion on a qualifying funding. As such we are assuming the government would need to have a separate loan note to any VCT qualifying loan note provided as part of the same round. This needs to be confirmed and the interplay between the two instruments resolved.

Documentation

14. What approach is going to be taken to the long form documentation? Will the parties be free to draft the convertible loan note based on the government’s term sheet? Or will the government provide a precedent long-form instrument for the parties to use?