Out-Law News | 21 Apr 2020 | 4:03 pm | 4 min. read
The £500m 'Future Fund' initiative is part a broader new £1.25 billion package of support for start-up and innovative companies impacted by the coronavirus. The package also includes £750m of targeted support for SMEs focused on research and development.
Charles Waddell of Pinsent Masons, the law firm behind Out-Law, welcomed the development.
Waddell said: "The government's 'Future Fund' plans are essentially to co-invest with venture capital and private investors in innovative businesses through the use of convertible loan notes (CLNs). The terms of the arrangements outlined are broadly industry-standard and should be attractive to venture capital and private investors. Interestingly, the government is effectively sub-contracting due diligence in the investment to investors, trusting their judgment as to which innovative companies to invest in. This should hopefully speed up the investment process. The terms are 'covenant light', indicating that the government has no desire to interfere in the operation of those companies. The exit strategy is clear – the government plans to bundle up portfolios of 'Future Fund' companies and divest in deals with secondary investors."
Totis Kotsonis, also of Pinsent Masons, said that the government appears to have factored rules on state aid into the way it has designed its support under the Future Fund.
“Whilst the government has yet to publish the full detail of the terms and conditions which will apply in gaining access to bridge finance under this Fund, it is clear that these would need to be consistent with state aid law requirements," Kotsonis said. "This is on the basis that, in principle, government support in this context can distort competition in that the funding arrangements won’t benefit the whole market but only companies meeting certain criteria."
"At the same time, there are a number of options available to the government in this context that avoid the need to notify the proposed arrangements for state aid authorisation. First, it can impose terms and conditions which ensure that funding is made available on market terms. If that is the case, then the funding won’t qualify as state aid and won’t require pre-notification to the European Commission for clearance. Another alternative that would avoid having to get prior authorisation for the arrangements would be to ensure that funding is made available strictly on conditions that ensure that it benefits from an available exemption," he said.
"We await further clarity on this point but the information that has been made available suggests that the government is pursuing the first option," Kotsonis said.
The Future Fund is set to launch in May and will be delivered in partnership with the British Business Bank. Companies will be able to access between £125,000 and £5m of government loans with private investors matching or exceeding the government’s commitment. There is no cap on the amount that matched investors can provide, and therefore no cap on aggregate bridge funding.
According to the fund’s headline terms (3 page / 38.6KB PDF), loans will automatically convert into equity on the company’s next qualifying funding round at a minimum conversion discount of 20%, or at the end of the loan if they are not repaid.
In the event that the company is sold or listed, the loan will either convert into equity at the discount rate to the price set by the most recent non-qualifying funding round, or be repaid with a redemption premium equal to 100% of the principal of the bridge funding, whichever will provide the higher amount for the lenders.
Loans will mature after a maximum of 36 months and the government will receive interest of at least 8% a year to be paid on maturity.
To be eligible, a business must be an unlisted UK registered company that has previously raised at least £250,000 in equity investment from third-party investors in the last five years. Firms will only be able to use the loans for working capital purposes.
The government will be entitled to transfer the loan, or following conversion, any of its shares, to an institutional investor acquiring a portfolio of the government’s interest in at least 10 companies owned in respect of the Future Fund. It will also be able to transfer any shares within the government or to entities wholly owned by central government departments.
The government said it had committed an initial £250m towards the scheme, but the scale of the funding would be kept under review. The scheme will initially be open until the end of September.
Charles Waddell said: "Companies funded by private investors are eligible for support through the scheme. Private investors typically want Enterprise Investment Scheme (EIS) reliefs. EIS relief is available only where the investor subscribes for shares which meet certain requirements. Investments in CLNs are not EIS eligible. I have worked on lots of bridge deals where the EIS investors have subscribed for EIS eligible ordinary shares and the non-EIS investors take CLNs. What is not clear from today’s announcement is whether a company could raise monies on this mix and match basis, i.e. issue EIS eligible equity to those who want EIS reliefs and CLNs to HM Treasury. It would be great if they could."
The announcement follows calls earlier this month from the British Private Equity & Venture Capital Association (BVCA) for the government to make financing available for early stage companies in the digital, biotech and life sciences sector companies during the Covid-19 pandemic.
BVCA director-general Michael Moore welcomed the announcement of the Future Fund and said the association would work with government to ensure that the finance achieved its objective of sustaining the sector.
Under the government's £750m support scheme for SMEs involved in research and development, funding will be made available through innovation agency Innovate UK’s grants and loan scheme. The agency will accelerate up to £200m of grant and loan payments for existing customers on an opt-in basis, with an extra £550m to increase support for the same firms. A further £175,000 will be offered to around 1,200 firms not currently in receipt of Innovate UK funding. The first payments will be made by mid-May.
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