Introduction to the package
The UK Government has today (20 April 2020) announced a scheme pledging £1 billion worth of support for start-ups struggling amidst the Coronavirus pandemic who are likely to be ineligible for the Government’s emergency loan scheme.
Summary of the scheme
The scheme funding comprises the following two pots of Government money:
- a £750 million expansion of Innovate UK’s funding for the most R&D intensive small and medium-sized businesses, comprised of grants and loans. Whilst the majority of this funding is reserved for businesses already receiving Innovate UK funding, it is understood that £210 million will be offered in £175,000 chunks to 1,200 companies who do not currently receive Innovate UK funds; and
- a new £250 million fund called the Future Fund to be administered by the British Business Bank, which will invest between £125,000 and £5 million in high-growth UK companies. The scheme will initially be open from May 2020 until the end of September 2020. The investment by the Government will take the form of a convertible loan, and the following eligibility criteria have so far been announced:
- the investment will be made on a 50:50 matched basis with private sector investment from one or more investors. I.e. companies will need to raise private sector money first before they are eligible for Government money (it is not yet clear whether a commitment from investors or cash in bank is required as evidence of this investment);
- in the past 5 years the company must have raised at least £250,000 in aggregate from third-party investors (excluding any funding being matched) and have a ‘substantive economic presence in the UK’; and
- the company must be an unlisted UK registered company. If the company is part of a group, only the UK parent company will be eligible to receive the loan, and the company shall be subject to customer fraud, money laundering and KYC checks prior to any loan being made.
Full eligibility requirements have not yet been published by the Government and these are expected to follow soon.
Future Fund investment terms
Whilst the terms of any investment made by the Future Fund will predominantly depend on the terms agreed with private investors, the Treasury has published a sample of headline terms here.
A snapshot of the key terms include:
- Investment will be by way of an unsecured convertible loan which must comprise no more than 50% of the total funding being provided to the company alongside the matched investor(s). There shall be no cap on the amount that the matched investor(s) may loan to the company.
- On a conversion event (see below), the loan shall convert into the most senior class of shares in the company at the time of conversion or if a further funding round is completed within six months of the conversion event, the lenders shall be entitled to convert their shares into the senior class of shares of the company in issue post that follow-on round (the “Lookback“).
- The Government shall receive a minimum of 8% per annum (non-compounding) interest to be paid on maturity of the loan.
- The Government shall have limited corporate governance rights during the term of the loan and as a shareholder following conversion.
- The bridge funding shall be used solely for working capital purposes.The bridge funding shall automatically convert into equity on the company’s next qualifying round at a minimum conversion discount of 20% to the price set by that funding (the “Discount Rate“)(or higher, if a higher rate is agreed with the matched investor(s)), with a company repayment right in respect of the accrued interest.
- A qualifying funding round shall take place where the company raises an amount in equity capital (excluding any shares issued on conversion of the bridge funding or to employees/consultants on exercise of any options) equal to at least the aggregate amount of the bridge funding (anything else shall be a non-qualifying funding round).
- On a Sale or IPO the loan shall either convert to equity at the Discount Rate to the price set by the most recent non-qualifying funding round or it shall be repaid with a redemption premium equal to 100% of the principal (the “Redemption Premium“), whichever shall provide a higher amount to the lenders.
- On maturity of the loan the loan shall, at the option of the holders of a majority of the principal amount held by the matched investors: (i) be repaid by the company with the Redemption Premium; or (ii) convert into equity at the Discount Rate to the price set by the most recent funding round provided that the Government’s loan shall convert unless it specifically requests repayment.
What does it mean?
When devising the terms of investment by the Future Fund, it would appear that the Government has taken into account concerns raised by a number of key figures in the UK start-up arena over recent weeks in response to the rumours of a Government support package being unveiled. Such critics flagged the risk of the scheme leading to adverse selection, resulting in the Government holding tax-payer funded equity stakes in failing start-ups.
It was initially feared that the Government loan would be repayable at any time, resulting in the (relatively small proportion of) successful start-up companies simply paying back the loan and the Government ending up with a low-value stake in the failing ones. It appears that these concerns have largely been addressed by: i) the requirement for any Government loan to be matched by private-sector investment, effectively meaning that the Government will only invest in any start-up companies able to show that VCs and other investors have ‘skin in the game’; and ii) the conversion terms, which provide for automatic conversion or costly repayment, the combination of which, it is hoped, will allow the Government to off-set loss-making investments against those generating higher returns.
Inevitably, some key questions around the detail of the Future Fund investment terms remain unanswered and will need to be bottomed-out in the coming weeks. For example, can the private sector matching investment come from a range of investors, or must this be limited to investment by VCs, thereby ruling out promising pre-VC stage companies? How does the investee company prove they have received the private sector matching investment (or will committed funds be sufficient) and what is the timing of this prior to the Government releasing funds? And, must the matching investment be made on identical terms, or will those investors looking to obtain EIS/SEIS relief be able to rely on the advance subscription agreement model in place of a traditional convertible loan note? Whilst these questions remain unanswered it is unclear what effect this announcement will have on current transactions and whether investee companies (and investors) may delay transactions, to the extent they are able, to ensure they are eligible to participate in the Government’s initiatives. Further, companies wishing to participate in the scheme – or who want to preserve their ability to participate – will likely have to offer any convertible debt (during this uncertain period) on the same terms as the Government is seeking, meaning the more aggressive terms (e.g. 8% interest, the Redemption Premium and the Lookback) will be required by VCs even where matched funding from the Government is not immediately sought.
To date, the UK Government’s start-up initiatives such as the EIS and SEIS schemes, R&D tax credits and Innovate UK have been transformational to the UK start-up ecosystem. Companies benefitting from such initiatives are now, more than ever, reliant on investors being willing to part with cash that often goes direct to the heart of the business, helping (predominantly loss-making) early-stage companies meet payroll and other outgoings that they would otherwise struggle to meet. The continued growth of the UK start-up scene amidst the Coronavirus pandemic is therefore reliant on VCs and other institutional investors continuing to reach into their pockets, and it seems that the Future Fund has been designed with that in mind by seeking to promote private investment at a time when the focus of many investors may understandably be elsewhere. Whilst this is certainly a welcome and exciting development for high-growth companies, the first Future Fund loan is unlikely to be made available until mid-May; it is also unclear whether any other complementary schemes may be requested by business or provided by government. In the meantime it is hoped that the Government will continue to audibly support those existing initiatives already mentioned in this article, as well as provide more clarity around the unanswered questions. And, when the Government does start making loans, it will need to act fast to be able to meet the accelerated investment timetables that VCs are so accustomed to and start-ups are so reliant on.