The Future Fund – A new kind of Angel Investor at your time of need or will the Devil be hiding in the detail?

The Future Fund is intended to assist those eligible by providing convertible loans to help companies fund their working capital requirements (the Government has been clear that the funding cannot be used to repay existing company debt, issue dividends or make payments to staff or advisers) at a time when they may be struggling.

The Government has allocated an initial sum of £250m to the Scheme which will be open for applications for an initial period of 5 months (from 1 May 2020 to the end of September 2020) and during which time eligible UK businesses can apply for convertible loans of between £125,000 and £5m if they can raise at least the same amount from private investors.

As with all financing offers, the devil will be in the detail and we expect this detail to be provided in the coming days. However, while the limited information currently available provides the broad terms only, it does provide a basis for assessing whether your business is eligible for the Scheme and if so, whether the terms are ones which you are willing to consider.

Eligibility

The basic eligibility criteria published by the Government states that your business will be eligible if it:

• is based in the UK;
• can attract the equivalent match funding from third-party private investors and institutions;
• has previously raised at least £250,000 in equity investment from third-party investors in the last 5 years.

The current eligibility criteria has led to criticism from some commentators that the Scheme will not offer assistance to the vast majority of UK start-ups. The eligibility criteria and limited time offer will prevent even those currently in discussions for their first round of funding from capitalising on the Scheme. Based on current information, it is likely that businesses in the later stages of their funding journey will be the likely beneficiaries of the Future Fund however the loan minimum of £125,000 (giving a total round of £250,000) does mean that Series A funding is (at least in principle) available.

EIS/SEIS

Arguably, the highest hurdle to climb for early-stage start-ups in order to successfully apply for funding under the Scheme is its apparent incompatibility with (S)EIS rules. The Scheme is a match-funding scheme which requires that the applicant business has raised an amount at least equal to the amount of the loan it is applying for on the same terms as those which are applied by the Government. (S)EIS is not available for convertible loans and so it follows that (S)EIS will not be available to investors providing match funding under the Scheme. For many early-stage start-ups who are raising funds from angel investors and EIS funds, this will likely render them unable to find that match-funding.

It is worth remembering however that the (S)EIS was set up to encourage investment in early-stage businesses. Noting that the purpose of the Future Fund initiative is aligned with that of (S)EIS has led some commentators to be cautiously optimistic that the Government will make changes to the (S)EIS rules to enable those investors providing match-funding in these circumstances to continue to benefit from (S)EIS. This of course remains to be seen and we would suggest that these changes may come later in the life of the scheme, depending on the uptake and the level of pressure applied on the Government by the angel investor and start-up community.

The Government has stated that full eligibility criteria will be published shortly however and while this will likely include some helpful clarification around the existing criteria; what is meant by “based in the UK” and what kind of historic funding will be counted in meeting the £250,000 previous funding requirement (will this include advanced subscription agreements or convertible loans?) for example, we do not anticipate that it will significantly widen the net to include very early stage businesses given that Government will  want to avoid being seen to be taking too much investment risk with taxpayer money or investing it in overseas businesses (the Government has already confirmed that the funding will be available to the ultimate parent company of a group and so if this is not UK based then such businesses will not be eligible).

Terms

Once you are satisfied that you are eligible to apply for funding under the Scheme, a look at the terms offered will inform your decision as to whether or not to submit your application. Again, full details are said to follow but as with all investments, companies should look carefully at the terms before rushing in.

It is worth noting that the basic terms outlined by the Government is the “worst-case” position that it, as an investor, is willing to accept. In the case that your matched investors demand more favourable investor terms, the Government will, in most cases, require the benefit of those more favourable terms.

Interest

The funding is provided in the form of a convertible loan meaning that when advanced, the funding is provided in the form of debt that will convert (automatically in some circumstances and at the option of the Government in others) into shares in your company on the occurrence of certain events. As is usual with debt financing, the amount advanced bears interest; in this case a non-compounding rate of 8% per annum to be repaid on maturity of the loan.

Conversion & Repayment

Fundraising

The loan will automatically convert into equity on the company’s next qualifying funding round (a raise of not less than the amount raised under the Scheme (including the match-funding)) at a minimum conversion discount of at least 20% (the Discount Rate) (the Discount Rate will be higher if a higher rate is agreed between the company and the matched investors) to the price set by that funding round with a company repayment right in respect of the accrued interest.

On a non-qualifying funding round, at the election of the holders of a majority of the principal amount held by the matched investors (the Investor Majority), the funding will convert into equity at the Discount Rate to the price set by that funding round.

Exit

On a sale or IPO, the loan will either convert into equity at the Discount Rate to the price set by the most recent non-qualifying funding round (or if the last non- qualifying funding round took place prior to the advance of the loan, the price of that round without the discount applied) or it will need to be repaid with a redemption premium (being a premium equal to 100% of the principal of the bridge funding), whichever provides the best return for the investors.

Maturity

On maturity of the loan (3 years from advance), the Investor Majority will have the option to require that the loan is repaid by the company with a redemption premium (being a premium equal to 100% of the principal of the bridge funding); or converted into equity at the Discount Rate to the price set by the most recent funding round. The Government’s loan will convert unless it requests repayment in respect of its loan.

On conversion of the loan (in any circumstance), only the principal (and not any accrued interest) under the bridge funding  will convert at the Discount Rate.

Valuation cap

The Government has not sought to apply a cap on the value at which the loan will convert.

Conversion Equity

On a conversion event, the loan shall convert into the most senior class of shares in the company. If a further funding round is completed within six months of the relevant 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.

Decision-making

The Government shall have limited corporate governance rights during the term of the loan and as a shareholder following conversion of the loan. No further details are provided at this stage but we note that that the Government will require the same rights to company information as those offered to other investors.

Warranties & Covenants

Current details state that the company will be required to provide limited warranties (in relation to title and capacity, eligibility for the loan, compliance with law, borrowing, litigation and insolvency events) indicating that founders will not be required to provide warranties.

In addition, the company will be required to provide limited covenants to the Government during the term of the loan and as a shareholder following conversion of the loan, including undertaking to treat the lenders and the holders of the conversion equity fairly and equally as well as a negative pledge in respect of future indebtedness.

Transfer rights

The Government has broad transfer rights in relation to both the initial loan and any shares it acquires following any conversion enabling it to transfer to any institutional investor which is acquiring a portfolio of the Government’s interest in at least ten companies owned in respect of the Future Fund or to entities wholly owned by central government departments.

Whether or not the stated terms are acceptable to you will very much depend on your circumstances but these should be considered carefully before rushing to submit your application. This is the case with all investments of course but in this case (as against a more usual equity fundraising) there are additional factors to consider such as:

• the funding here initially takes the form of debt financing – can your business afford the repayment at the stated interest rate and might it be able to raise debt finance from institutional lenders which may be able to offer a lower interest rate?
• depending on what stage you’re at in your funding journey, terms such as the 20% discount rate and preferential return of 100% of the amount advanced may be regarded as onerous and may lead to difficulties in raising in funds in future rounds.
• very little detail is provided in relation to the Government’s expectations as regards decision-making but it will be important to consider the Government’s ability to make commercial decisions quickly should they be required to do so.
• while the implications of the Government’s transfer rights should not be exaggerated, this could have undesirable consequences.

Much of the detail of this Scheme is still awaited and so we must be cautious when evaluating its value to growing businesses at this stage. It is clear from the information provided to date that this Scheme will not be for everyone and that the Government has had to walk the very fine line between providing the start-up community with the support it needs in these difficult times while not placing too many high-risk bets with taxpayers’ money. This balance may well be reflected in the type of investor the Government shows itself to be – neither the high-risk-taking angel that swoops in to save your business in its hour of need nor the devil ready to take advantage in difficult circumstances but rather the cautious investor willing to take a calculated risk if other  investors are willing to do the same.