21st April 2020

Many of our clients are high growth businesses who have found that they do not yet have sufficient historic levels of profitability or balance sheet strength to be able to access the Government’s Coronavirus Business Interruption Loan Scheme.

Yesterday (20/04/2020) the Treasury, in partnership with the British Business Bank, announced initial details of a new “Future Fund” which is an initiative targeted on providing financial support to innovative businesses in the UK. Through the Future Fund the Government will initially make £250m of convertible loans available to qualifying businesses on a match funded basis, and the scheme will remain open until September 2020.

Whilst the announcement of a matched funding scheme might, at first glance, look attractive to clients which have previous experience of matched funding schemes run on a regional basis with European funding, the initial details released suggest that the Future Fund will be significantly different. In particular, the convertible loans provided under the scheme will bear interest at a minimum rate of 8% per annum and will be able to convert into equity at a minimum discount of 20%. Therefore it is not cheap finance, particularly in comparison to bank loans under CBILS which are interest free for the first 12 months. That said, for qualifying businesses which have a funding requirement ​of between £250,000 and £10m (possibly more), the fund may provide a valuable source of bridging finance to support working capital needs.

The Future Fund will launch in May 2020 and further details about this scheme will be published by the Government shortly. The indicative headline terms published yesterday (which the Government has caveated as not being full or final) highlighted that this is likely to be quite a complex scheme through which the Government will share investment risk with other funders, and therefore help encourage investment into businesses who otherwise would be considered too risky in today’s climate. It is also structured to allow these investments to happen relatively quickly. This funding will be priced on a risk basis (i.e. it will be delivering the Government a good return in the event ​that the companies it supports are successful). Some key areas noted as part of this preliminary announcement are as follows:

Please note, the information below is a summary only. The full indicative term sheet (which is still not full or final) can be reviewed here.

Who is the scheme aimed at?

The Future Fund will be open to all unlisted UK registered companies that:

  • Can attract the equivalent match​ funding from third-party private investors and institutions;
  • Have previously raised at least £250,000 in equity investment from third-party investors in the last 5 years; and
  • Have substantive economic presence in the UK.

The above is likely to capture a range of business and include high growth companies that have received venture capital, angel or EIS/SEIS investment in the last five years.

What is a convertible loan?

Based on the information released by the Government yesterday, the Future Fund will be deploying match funded convertible loans. Much like standard loans, convertible loans are interest bearing and are repayable at some point in the future, except that convertible loans can convert into equity in certain circumstances. These circumstances may include the maturity of the loan, a future equity funding round or the sale/IPO of a company.

It is likely that the Government has decided to use convertible loans as they require less documentation and negotiation than a normal equity investment and therefore can be deployed more quickly, whilst it should also cut down the cost of the finance raise process. This support package is labelled as delivering “bridge funding” as, it should contribute to funding rounds being completed relatively quickly at a time of urgent need, the expectation is that the loan will be converted, or repaid, within three years depending on future events. These future events should hopefully crystallise when the market has stabilised.

What is match funding?

It is important to note that the Future Fund will only deliver unsecured bridge funding alongside other private third party match investor(s). This will provide an element of risk-share and funding leverage for the Government (and this should be considered as delivering the same benefit for the match funder) and also, when looked at holistically with the conversion parameters discussed below, provide the Government with a degree of third party validation of the quality of the investment being proposed, allowing it to deliver its support with more confidence.

The Future Fund loan shall constitute no more than 50% of the bridge funding being provided to the company, with the remaining amount provided by match investor(s). The guidance does not yet specify whether this match funding can be provided by current investors, new investors or both, but “both” is the most likely interpretation and it does suggest that the investment will need to be made in the same form as that made by the Government i.e. as a convertible bridging loan.

What are the indicative features of the Future Fund convertible loan?

The preliminary term sheet suggests that the Future Fund convertible loans will incorporate the following features (note there are other indicative terms not included in this briefing note):

  • The minimum Future Fund loan amount will be £125,000 and the maximum loan amount £5,000,000. The match funded round would therefore need to be over £250,000. Whilst the Future Fund contribution cap is £5,000,000 the overall round does not need to be limited to just £10,000,000. It is not yet clear what will determine the level of investment the Government is willing to make in each situation, or whether it will always just match the co-investment within these limits.
  • The funding can only be used for working capital purposes.
  • The Government shall receive a minimum of 8% per annum (non-compounding) interest to be paid on maturity of the loan. The interest rate shall be higher if a higher rate is agreed between the company and the matched investors.
  • The loan shall mature after a maximum of 36 months (see the “conversion” comments below).
  • The Government shall have limited corporate governance rights during the term of the loan and as a shareholder following conversion of the loan.
  • The company will only be required to provide limited warranties when raising the finance.
  • The company shall provide limited covenants to the Government during the term of the loan and as a shareholder following conversion of the loan, covenants will mainly be focused on achieving fair treatment with other funding round participants.

How is the “conversion” or “redemption” expected to work?

The rules around conversion and redemption are not particularly unusual, but they are likely to introduce complexity to the scheme. This funding is structured to deliver the Government a “risk-based” level of pricing i.e. the Government will expect the scheme to deliver a good level of return from the businesses it supports that go on to thrive.

The preliminary term sheet suggests that the bridge funding will automatically convert into equity on the company’s next qualifying funding round at a minimum conversion discount of 20% to the price set by that funding round, however there are various other scenarios and permutations around this that are also overviewed in the full document. On a sale or IPO, the loan will either by converted to equity (based on a formula) or be repaid with a redemption premium (being a premium equal to 100% of the principal of the bridge funding), whichever will provide the higher amount for the lenders.

If the loan matures (after a maximum term of the 36 months) then it can either be repaid by the company with a 100% redemption premium (i.e. if £500,000 is borrowed then £1,000,000 must be repaid excluding any accrued interest) or converted to equity at a discount to the price set by the most recent funding round. This will be determined by the holders of a majority of the principal amount held by the matched investors, but the Government may have some rights here too.

On a conversion event, the Future Fund loan (plus other match funds) shall convert into the most senior class of shares in the company. If a further funding round is completed within six months of this conversion event, the lenders shall be entitled to convert their shares into the senior class of shares of the company in issue post that round.

Other terms

There are a number of other terms muted in the indicative term sheet (and this list is not exhaustive), those referenced below are to illustrate that this scheme, whilst no doubt very welcome, is not a promise of “soft” funding support and therefore needs to be considered very carefully:

  • The Government shall not set a valuation cap on the price at which the loan converts into equity on the company’s next funding round. Where the match investors have agreed a valuation cap with the company, the Government shall be entitled to those same terms.
  • In the event that the company issues further convertible loan instruments to investors (including any new or existing investors which are not matched investors) with more favourable terms, those terms shall apply to the bridge funding provided under the scheme.
  • The company shall not permit the creation of any indebtedness that is senior to the loan other than any bona fide senior indebtedness from a person that is not an existing shareholder or match investor.

Overall

The Government has reacted to mounting pressure from high growth (and other) businesses who are not able to access its other funding initiatives. The Future Fund is designed to deliver measured support to this sector and is structured to give other funders confidence to back businesses in uncertain times. The terms are still to be confirmed, but those made available yesterday suggest that the scheme will serve a useful purpose. It is almost unavoidably complex in some areas (but could have been worse) and the pricing of the funding available is risk based and therefore not “cheap” if considered in a narrow context. There is a requirement for businesses to source matched funding and this can be time consuming and potentially expensive.

However, there is a lot at stake here for businesses. The ingredients of this funding include relatively expensive debt with conversion rights, a range of conversion trigger events and pricing mechanisms and the introduction of match funders (new or existing or both?). Whilst from a governance point of view the Government’s position appears light touch, this may not be the case with the match funder. The overall funding proposition is therefore likely to have quite a profound and long-term impact on the company it supports, its board and its existing shareholders, and not just from a financial perspective. This, of course, could be a really positive thing, and in many cases it will be, but it is certainly something that will need to be carefully considered and well understood before any capital is raised.

We will provide a more comprehensive update when more details of the scheme become available. In the meantime, if this is something you are considering and the requirement is urgent, there is likely to be a few weeks between now and the scheme being opened for businesses to prepare. We would recommend speaking to current funders (and potentially new funders if applicable) to assess their appetite, updating your business plan and financial projections (both of which are likely to be funder requirements). As always, we are happy to discuss this further.

If you would like to discuss this Future Fund further, please contact us:

John Healey (Corporate Finance Partner)
johnhealey@unw.co.uk or 07949 235813

Gareth Phillips (Corporate Finance Manager)
garethphillips@unw.co.uk

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