The Future Fund: 10 terms and what to do next

On 20 April the Government announced the launch of a £250m Future Fund to provide matched funding using a Convertible Loan Note (CLN) to high growth companies that may be pre-revenue or pre-profit.

A business is considered eligible for the fund if:

• it is UK-incorporated – if your business is part of a corporate group, only the parent company is eligible
• it has raised at least £250,000 in equity investment from third-party investors in the last five years (from 1 April 2015 to 19 April 2020 inclusive)
• none of its shares are traded on a regulated market, multilateral trading facility or another listing venue
• it was incorporated in the UK on or before 31 December 2019
• at least one of the following is true:
  1. half or more employees are UK-based
  2. half or more revenues are from UK sales

The British Business Bank (BBB) is an administrator of the scheme, which opened for applications on 20 May 2020.

The key terms:

1. The convertible loan is at most equal to the funding provided by private third parties at exactly the same terms – this means that the funding from the third parties cannot be issued as equity.
2. The size of the government cheque will be at least £125,000 and at most £5m.
3. This is bridge funding for working capital purposes only – no dividends, bonus’, adviser fees, consultant fees etc. The Government was very clear about the purpose of this loan being a bridging loan with commercial terms. Thus, the founders should keep this in mind when considering this option as it is not intended to be seen as state aid rather another funding option available.
4. Like for like terms, it is very important to note that the third party investment needs to match the terms and conditions of the government loan. Therefore, it is not eligible for EIS relief. This was a big shock to the start-up community and Angel Investors since it narrowed the pool of the companies that could benefit from the Future Fund even more.
5. The CLN turns into the most senior class of shares when:
   1. In the future, the business raises further capital that is equal to the whole bridge funding round;
   2. On sale or IPO;
   3. After 36 months, the loan will likely turn into shares, or, be repaid with a premium. From the conversation with the government agencies, it was indicated that the government expectations are to convert the loan into shares rather than be repaid. It seems that the Government is taking a VC approach to this loan and hopes for some winners.
6. Conversion will be at a 20% discount to the conversion event’s share price. In English, this means, when the loan converts to equity, the Government get a 20% share price discount (i.e. more shares). This is similar to most CLNs or Advance Subscription Agreements (ASA).
7. The interest rate on the loan is 8% pa unless investors lend at a higher rate. The interest does not compound and does not convert into equity.
8. The company will have to provide limited warranties including in respect of title and ownership, capacity, its loan eligibility in accordance with the government eligibility criteria, the borrowing facilities of the company, compliance with the law, litigation and insolvency events to the lenders on closing of the loan.
9. Covenants look quite light though there is a Most Favoured Nation clause which means that if someone else invests and gets better terms than the Government, then their terms must be improved to match.
10. The ability to raise further debt that is more senior (and in reality, this CLN is very junior, so most new debt will be more senior) is restricted to new external stakeholders only.

What does this mean:

1. Turning to existing shareholders – the Future Fund is a Government initiative that is clearly not there as a solution for all the early-stage companies affected by Covid-19. If you don’t meet the criteria or you are not willing to accept the commercial terms set by the Future Fund, then it might be a good time to reach out to your current investors with a rights issue offer. They are collective owners of the business; thus, it is in their interest to help business to weather this period. Our advice is to ignore preference shares and quirky instruments of the past to avoid mismanaging the point on the most senior class of share and instead focus on the ‘real’ ordinary shares in the business.
2. Alternatives for new investors – to reach out to the new set of investors might be an appropriate next step for the majority of the companies but in these circumstances, a new arrangement and deal structures might be used by investors to hedge their risks. For examples, a private investor wants a discounted share price, and EIS relief too. In this case, you could run an Advance Subscription Agreement that provides cash now in exchange for shares issued later at the same 20% discount to a future event’s share price (but without any interest paid along the way). ASAs don’t always comply with EIS rules, though. They can be argued to be a loan and, with newer ‘Risk to Capital’ tests, the 20% share price discount may be viewed less favourably. There will still probably be a way to get EIS compliant ASAs agreed for many businesses, but it will take longer, cost more in adviser fees and all sides – including the investor – will have to be happy with the risks.
3. New fundraising activity – new fundraising activity is happening and considering the limited number of companies that are eligible for the Future Fund majority of the companies will be increasingly looking at this option. This suggests that it can continue and, indeed, continue with some success. However, the investors are taking longer to evaluate the companies and are much pickier when making their investment decisions. Therefore, it is more important than ever to show how the business is adapting to the circumstances accompanied by a proper financial model, a fully diluted ownership table in different scenarios and have valuation research. This will allow and support investors in conducting thorough diligence.
4. £250m won’t go far – the Future Fund is far smaller than other Government initiatives, and already 58% (as of 14/6) of its funds have been allocated since the applications opened, and applications are only open until the end of September 2020. Worth keeping an eye on various initiatives that are being considered, such as expanding Regional Angels Programme (administered by BBB) in order to address the funding gap that remains for the majority of the early-stage companies.

If you need advice on structuring the ASA, a rights issue or assistance with equity fundraising, then please contact us on the form below.