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On 20 April 2020, the Chancellor of the Exchequer announced a scheme aimed at providing support to the UK's most innovative and fastest-growing companies. Below we provide an overview of the scheme and highlight some key questions being asked in respect of the scheme.
Future Fund and Innovate UK Funding
The Government has made up to £250 million of funding available by way of direct co-investment into certain UK start-up companies, as part of a new Future Fund. In addition, Innovate UK, the national innovation agency, is extending up to £750 million of loans and grant funding to innovation driven businesses focussed on research and development.
This package is a bold and unprecedented move from the UK Government. No direct investment equivalent has been provided by the US government, or in other technology hubs. France and Germany have provided €4 billion and €2 billion packages to support their start-up businesses, respectively, and the French Frontier Venture Scheme contains many similar elements to the UK scheme, although the size of their direct government investment packages is dwarfed by the UK's £250 million Future Fund (€80 million in France). This demonstrates the UK Government's strong backing for entrepreneurial capital and its belief in a post-Brexit economy, and also highlights the commercial and pragmatic approach being adopted by the UK Government to ensure a swift, decisive, and business-focussed response to this crisis. This approach is further demonstrated by the recent approval by the CMA of Amazon's investment in Deliveroo, where funding has been approved despite apparent initial competition concerns.
We expect that further details on the UK Government package will become available over the coming weeks, and we have set out a brief summary of the terms and key questions based on the current information (the headline terms of the Future Fund convertible loan note can be found here).
1. Does your business qualify for funding?
The Future Fund is available to companies which: (i) are unlisted and incorporated in the UK; (ii) have previously raised at least £250,000 over the past five years; and (iii) have a substantive economic presence in the UK. We understand that the substantive element is not intending to assess size or scale of companies, but mainly that a company is predominantly operating in the UK. If a member of a group of companies, the criteria will be applied to the parent company only, and so companies with a non-UK parent company will not be eligible for funding.
There is no upper limit on previous fund raises, and later stage business which have raised in excess of, e.g., £5 million previously are anticipated to be the most likely initial beneficiaries of the fund match from the Future Fund. However, the £250,000 minimum is intended to ensure that the scheme remains open to pre-Series A businesses who have previously raised large angel or family and friends rounds.
2. Does your business need to be suffering from a COVID downturn or experiencing a liquidity crisis to apply for funding?
No, there are no eligibility criteria related to being a business in distress, having limited runway, or having a revised business plan which shows how your business plans to survive for the next nine to 12 months. This contrasts with the French approach, which only extends financing to those companies which are unable to raise funds related to COVID difficulties. While COVID responses are not formal eligibility criteria, they are likely to be key focus areas for private investors, and so may be a de facto requirement for obtaining fund matching from Future Fund.
The UK Government has adopted the approach that all UK start-ups, as opposed to those currently in distress, should be able to benefit from the fund match provided they can raise external capital. However, future eligibility criteria have not been ruled out, which may include a more formal requirement around innovation, or alternatively, the scheme may only be made available to companies with limited runways.
3. How much funding is available and what can your business use it for?
The Future Fund will provide matched funding on a convertible loan note basis with a minimum amount of £125,000. While the amount of external funding is not limited, the maximum amount, which the Future Fund will match, will be £5 million. Use of these funds will be restricted to working capital purposes only, and will be expressly prohibited from being used to pay dividends, repay external debt, or make any bonus payments to staff, management, shareholders, or consultants. It would not be able to be used to pay advisory or placing fees or bonuses to external advisers assisting with the government funding.
Innovate UK is anticipated to allocate £200 million of grants and loans to their existing 2,500 customers on an opt-in basis, and we expect this to be in similar amounts to previous funding. A further £550 million is to be allocated to support a mix of existing customers and 1,200 new firms in an amount of £175,000. Further details are required from the Government on whether these grants and loans are only to be used for R&D funding or whether they can be used for broader working capital purposes.
In each case, regardless of the contractual restrictions on the use of funds, it is likely that any use of funds, for example any payments to existing shareholders (regardless of form of payment as a bonus, share buyback, or management fee) will be subject to political and media scrutiny, as highlighted by the backlash against Tesco's proposed dividend following its receipt of business rate relief in the amount of £585 million.
4. Will Future Fund match funds raised in rounds which have recently closed?
No. The Government is not currently proposing to provide matched funding in respect of recently closed financing rounds, and therefore, those companies who are currently raising funds and who wish to apply for matched funding should consider delaying entering into documentation until the Future Fund scheme opens in mid-May.
5. Will third party investors receive S/EIS relief on their matched investment?
Although it may appear that the package does not currently benefit from S/EIS relief due to the form of investment, given that these reliefs are key government policies for encouraging investment in fast-growth companies, our expectation is that the package will be refined to ensure such reliefs are available to private investors.
6. Will your business need to repay the amount?
Repayment will be included in the terms of the loan notes (with an 8% interest rate p.a. on a non-compounding basis, unless a higher rate is agreed with the new investors). However, the expectation is that the investments will convert into securities prior to the repayment date, which will be three years from the date of borrowing. Typical conversion rights will be included, permitting for automatic conversion on a qualifying funding round (for an amount at least equal to the matched funding) and optional conversion on a non-qualifying funding round, in each case at a 20% discount rate, unless a higher rate is agreed with the new investors. Investments will convert into the most senior class of shares in issue or issued in any more senior financing round in the following six months.
To the extent that the investors and Future Fund elect for the investment to be repaid at maturity, the amount to be repaid will be double the original investment amount. Currently there are no permitted repayment rights for companies in connection with the funding from the Future Fund, and further clarity should be provided to determine whether companies can repay the funding ahead of the next funding round, and therefore treat the funds as bridge financing only. Further, on a sale or listing of the business, the investment will either convert or be repaid depending upon which alternative would return more funds to the investors.
Repayments under the Innovate UK schemes will be dependent upon the form of financing – grant payments will not be required to be repaid, and loans will be repaid in accordance with their terms.
7. What rights will the Government expect for its investment?
As an investor, the Future Fund will require:
- limited corporate governance rights, likely intended to be limited to customary minority shareholder economic protections only;
- customary fundamental warranties (and business warranties on areas including borrowing, litigation, and insolvency);
- customary covenants (including compliance with laws and fair treatment of lenders);
- a general "most favoured nation" right, ensuring that the Future Fund will benefit from any terms given to investors on any subsequent CLNs which are more favourable than its terms;
- a negative pledge restricting the creation of any senior indebtedness (save for bona fide third party indebtedness); and
- the same information rights as other investors in the company.
The intention of such rights is for the Future Fund to act as a passive economic investor, rather than an active party with a board seat and control over day-to-day business decisions. The Government is therefore not intending that the Future Fund will act as a fully fledged sovereign wealth fund focussed on start-ups, although this cannot be precluded for future funds.
The extent of information rights to be given to the Future Fund requires further clarification – the Government will need to confirm whether it will be satisfied with receiving audited accounts and business plans on an annual basis, or whether it will require more detailed monthly management accounts. We would not expect that the Future Fund will require material information rights – doing so would result in an unprecedented aggregation of sensitive business information on private companies in the public sector and pose questions on any potential sale of a Future Fund portfolio to a private investor.
8. Can the Government transfer their interests in your business?
The Future Fund will be permitted to transfer its investments (both as loan notes, and once converted into shares) to other government departments or wholly owned governmental entities, and more unusually, to any institutional investor seeking to acquire a portfolio of ten investments or more held by the Future Fund.
While most companies may be used to a traditional lock-up/restriction on transfer or pre-emption rights over transfers, the balance struck here seems sensible. There is a clear policy objective in avoiding government funds being locked-up in illiquid assets, and the restriction on transfer to only institutional investors willing to acquire a portfolio of 10 interests or more will practically require a transfer to a material venture capital fund or similar investor. Such investors would likely be potential investors in any event, and so businesses can be comforted that the Future Fund will not dispose of its interests to unusual or unlikely investors.
9. How and when can your business access these funds?
The application process has not yet been set out, although it is likely that the British Business Bank will administer the scheme and the application process. Applicants will need to provide customary fraud, anti-money laundering and KYC information to be considered. The application date has not yet been released, although this is anticipated to open shortly, given that the first payments are anticipated to be made in mid-May.
The UK Government has had to tread a difficult line with this package. The terms are required to be sufficiently company-friendly as to make a positive difference without resulting in a taxpayer-funded bailout for failing companies or permitting private investors to disproportionately benefit from successful businesses which receive funds from the Future Fund. This balancing act helps to explain some of the terms which would not currently be considered market standard, such as the 100% redemption premium. These terms increase upside to the taxpayer in the event that the business thrives following the COVID hurricane and so work to balance out the potential downside to the taxpayer of propping up a failing business.
Key details of this scheme are still to be refined but, in our view, it is a positive step and a clear indication that the Government understands the importance of innovative and fast-growth companies to the economy of post-Brexit Britain.
Helen Pantelides (Associate, White & Case, London) and Cassy Raby (Trainee Solicitor, White & Case, London) contributed to the development of this publication.
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