This page was last updated on 22 May 2020.
On 20 May 2020, applications opened for the Coronavirus Future Fund, the Government's scheme to help high-growth companies who are facing financing difficulties due to COVID-19. In partnership with the British Business Bank, the Government has made an initial £250 million available for investment through the scheme, although it will consider increasing this amount if needed.
The minimum investment amount per business will be £125,000, with a maximum of £5 million.
The funding is structured by way of convertible loan notes (CLNs), a tried and tested Venture Capital instrument which obviates the challenge of trying to value a young business in a pandemic.
Any investment from the Fund will need to be matched by the same amount from accredited private investors who meet the Government's criteria. This will presumably give the Government comfort as to quality of standard of these businesses, given the time it would otherwise take to carry out any meaningful due diligence and the fact that many businesses urgently need funding.
The private investors will be encouraged to sign the Treasury’s Investing in Women Code, which commits firms to improving female entrepreneurs’ access to tools, resources and finance. The Future Fund is a signatory of this.
In order to qualify for funding, a business must:
- Be a UK-incorporated limited company.
- Have raised £250,000 in aggregate from private third party investors in a previous funding round in the last five years.
- (If it is a member of a corporate group) Be the ultimate parent company.
- Have a 'substantive economic presence' in the UK.
Listed companies (including on AIM) and any companies incorporated after 31 December 2019 are not eligible for the scheme. The rules also mean that any UK start-ups which participated in US accelerator programmes (and therefore have a US parent company) will be excluded from the Fund, which has caused some complaints from some quarters within the community.
Perhaps critically, as things stand, the Fund is incompatible with the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS), which offer tax breaks to early-stage investors. Therefore the majority of start-ups, which are powered by EIS funding, may struggle to secure the matched funding from angels, private investors and family offices.
However, the Government has recently agreed to amend the rules of these schemes to protect Future Fund investors from losing relief on their previous investments made prior to any investment through the Future Fund. However, it remains to be seen whether any further revisions will enable the investments themselves to qualify for those reliefs.
Critics of the Future Fund maintain that it primarily caters to VC funds, who make up only a small part of the overall investment landscape. The reluctance to make the Fund EIS-compliant means VCs are better-placed to co-invest. And, given the lack of investor confidence in the current climate, many VCs have put the brakes on any new investments and are focusing instead on their existing investments. It seems likely that the Future Fund will be used by VCs to invest in their current portfolio companies and enables them to reduce risk.
And, where VCs are using the Fund to support new investments, some say that desperate start-ups will have little choice but to accept onerous terms.
However, since applications opened on 20 May 2020, the Fund has been massively oversubscribed which has come as something of a surprise to many within the start-up community. As at 21 May 2020, more than 1,500 businesses have applied for over £750m of funding in total. The extraordinary level of demand from growth companies in technology and life sciences in particular suggests that the Future Fund will ultimately dwarf original expectations.
Given the exceptional take-up already, it seems likely that the pot will be increased from the relatively modest £250 million – but even so, it is likely to support only a small proportion of UK start-ups and mainly those with VC backers. Ultimately, the purpose of the Fund is to extend the runway for existing businesses, not to fund new start-ups, so this is support for businesses with a relatively robust track record already.
The Government will need to tread a fine line between supporting early-stage businesses in difficult times and speculating with tax payers' money in high-risk investments. That said, the Government is expending far greater sums to businesses under the furlough scheme, many of whom unfortunately may not survive this crisis.
Given the stated intention to support high-growth young businesses, it leads to question whether this was a missed opportunity for the Government to focus on purpose-driven/ESG businesses for example, given reports from investment markets which indicate greater resilience in this crisis by companies run along sustainable lines. A much larger pot could have been committed, perhaps with fewer strings attached, as a way of kick-starting this exciting and rapidly growing sector of the start-up ecosystem.
The Corporate team at Mishcon de Reya has significant experience of advising investors and early-stage businesses on a wide range of investments and fundraisings, including CLNs of this nature, so by all means get in touch if you have any questions or you are considering applying for the Fund.
What is a convertible loan note (CLN)?
A CLN is a debt instrument, with a mechanism for the principal amount to convert into equity in certain circumstances. CLNs are a tried and tested VC tool, and have become an increasingly popular method of investment over recent years where it is difficult to place a meaningful valuation on early-stage companies. Conversion occurs on a “qualified financing”, generally being an issue of equity, sale or IPO, each usually at a threshold valuation. As a debt instrument, CLNs will rank ahead of equity upon a liquidation and therefore offer investors additional comfort prior to conversion of the CLNs into equity. Furthermore, by converting at a discount to the valuation of the company at the time of a future financing, CLNs sidestep the problem of valuing a company and offer their holders a reward (by way of discount) for participating in the bridge financing. CLNs are also typically simpler to draft and quicker to negotiate than more traditional equity financings, but in our experience legal advice is required to ensure that CLNs are structured in a way to suit the existing share capital of a company.
Who should be considering this new scheme?
The Fund may be a suitable option for businesses that traditionally rely on equity investment and are unable to access the existing Coronavirus Business Interruption Loan Scheme.
In order to qualify for funding, a business must:
- Be a UK-incorporated limited company.
- Have raised £250,000 in aggregate from private third party investors in a previous funding round in the last five years.
- (If it is a member of a corporate group) Be the ultimate parent company.
- Have either half or more of its employees based on the UK or half or more of its revenues from UK sales.
The scheme is therefore primarily catering for those companies who have already successfully raised funds privately and will likely leave earlier stage companies, or those companies without a proven track record of private investment, out in the cold. Notably, it is these companies, perhaps with products and concepts conceived and developed in these extraordinary circumstances, who may be most in need of financial support and whose growth will help kick-start the economy when the clouds begin to clear.
What details do we have at this stage?
The Government has published the CLN instrument here.
The terms are relatively typical for a CLN funding of this nature, albeit in our experience they are at the slightly more aggressive end of the scale. Important points to note at this stage include:
- The interest rate on the CLNs is 8% per annum, which is on the high side although the justification will no doubt be the high-risk nature of these investments.
- The Government contribution to the CLNs shall not be more than 50% of the total CLNs issued as part of this bridge financing, but there is no cap on the amount that the matched investor(s) may loan to the company – meaning that the scheme is not suitable for those companies that have little or no interest from private investors.
- As is typical with CLNs, a future fundraising of an amount no less than the total principal amount of the CLNs shall be a "qualifying financing". Upon a "qualifying financing" the CLNs shall automatically convert into equity on the company’s next qualifying funding round at a minimum conversion discount of 20% to the price set in that funding round.
- A future fundraising that raises less than the total principal amount of the CLNs shall be a "non-qualifying financing". Upon a "non-qualifying financing", the CLNs shall convert into equity at a minimum conversion discount of 20% to the price set in that funding round, but only at the election of a majority of the principal amount held by the matched investors. Interestingly, the matched investors retain an upper hand over the Government investment here.
- Alternatively, if conversion has not occurred prior to the third anniversary of the CLNs, the CLNs shall, at the election of the holders of a majority of the principal amount held by the matched investors (i) be repaid by the company with a redemption premium (being a premium equal to 100% of the principal of the bridge funding), or (ii) convert into equity at the 20% discount rate. The redemption premium is very high and appears to be an attempt by the Government to encourage conversion rather than repayment.
- The conversion will not apply to the accrued interest, which may either be repaid by the company or converted into equity without the 20% discount.
How can companies apply?
Applications can be made through the British Business Bank: https://www.uk-futurefund.co.uk/s/.
The Future Fund is an investor-led scheme, and the initial stages of the application will involve the provision of information by only the lead investor with the investee company subsequently providing further information.
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