On 20 April 2020 the Government announced measures targeted directly at high-growth companies such as start-ups. One of these two measures is a £500m fund dubbed Future Fund, half of which will be funded by the UK Government, with investors in the private sector contributing to the remaining £250m.
Who is eligible
In order to be eligible for Convertible Loans from the Future Fund, companies must:
- have raised at least £250,000 in equity from third-party investors in the last five years (from 1 April 2015 to 19 April 2020, inclusive);
- not be listed on any kind of public market or stock exchange;
- be a UK incorporated limited company as of 31 December 2019
- have, at least.
- Half employees based in UK; OR
- Half of revenues from UK sales
- be the ultimate parent company of their corporate group, if they are part of one.
It must also be noted that the proceeds of the Convertible Loan cannot be used to repay any borrowings from a shareholder, bonuses, dividends or advisory fees for the next 12 months.
An eligible company shall also be subject to customer fraud, money laundering and KYC checks prior to any loan being made.
The British Business Bank specifies that eligible investors must fall within one of the following categories
- an “investment professional” within the meaning given to that term in article 19 of the FPO;
- a high net worth company, unincorporated associated or high value trust falling within article 49(2) of the FPO;
- a “certified sophisticated investor” or a “self-certified sophisticated investor” within the meaning given in articles 50 and 50A respectively of the FPO;
- a “certified high net worth individual” within the meaning of article 48 of the FPO;
- an equivalent professional, high-net worth, institutional or sophisticated investor in accordance with applicable law and regulation in such investor’s home jurisdiction;
- an association of high net-worth or sophisticated investors within the meaning of article 51 of the FPO;
- capable of being classified as a “professional client” within the meaning given in the glossary to the FCA Rules
Note that all other investors must fall within one of the above categories in order for them to be eligible to invest in the convertible loan agreement. It is the responsibility of other investors to ensure they are eligible.
How it works
The Scheme will be delivered in partnership with the British Business Bank starting on Wednesday 20 May 2020, in the form of Convertible Loans.
It will initially be open until the end of September 2020.
A Convertible Loan is an investment tool that allows companies to raise finance from one or more investors, who agree to provide the funding that can either be repaid at a premium or convert into equity at a later date, at a discount rate.
Specifically to the Future Fund, Convertible Loans under the scheme will work as follows:
- The Government will loan between £125,000 and £5m over a maximum term of 36 months as long as this is matched by a private investor on a pound-for-pound basis.
- The Loan will automatically convert into equity at at least a 20% discount rate at the next qualifying funding round. It will automatically convert into the most senior class of shares in the company.
- If there is no qualifying round, it is up to the investors and the government whether to seek repayment with a 100% premium or to convert the loan into equity at at least a 20% discount rate.
The government is committing an initial £250 million in funding towards the scheme, which will initially be open until the end of September. The funds will be provided on a first-come-first-served basis, which means it’s a good idea to apply as soon as possible if eligible.
The Government has specified that while investment within the Scheme won’t be EIS-eligible, investors who previously invested under EIS or SEIS won’t jeopardise their eligibility by participating in the Scheme.
How to apply
In the words of the British Business Bank, the Scheme is “investor-led”, meaning that the Lead Investor is responsible for ensuring eligibility and applying for the Government Funding.
This is how the process will look like:
- Investors looking to obtain match-funding from the Government under the Scheme will create an account on the dedicated website;
- There, they will certify that they meet the eligibility criteria and provide information about the investment, including:
- Information on the individual completing the application, including an upload of the individual’s photo ID;
- Information on the investor making the match funding application;
- Information on all other investors who will be making up the match funding, if any;
- The amount of proposed funding;
- Information on the company receiving the loan and contact details of a director or secretary.
- The company will confirm that all the details submitted are accurate;
- Provided that the investment meets all the eligibility criteria, the match funding will be provided under a Convertible Loan Agreement;
- The Agreement template, available on the Government’s website allows the investors and the company to agree details such as the discount rate (which has to be at least 20%), the interest rate (which has to be at least 8%), and – optionally – a valuation cap and headroom amount. Other than these details, the Agreement doesn’t leave any room for negotiation.
How much you can raise
The amount of the loan provided by the Government is set between a minimum of £125,000 and £5,000,000 – as long as this amount is matched by a private investor.
There is no limit to the amount that the matched investor(s) may loan to the company and therefore no cap on the aggregate funding being provided.
Repayment & Conversion
One of the key aspects to keep in mind when considering this option is that the loan will automatically convert into equity upon the company’s “next qualifying funding round”.
When the conversion occurs, the Government and the matched investor(s) will acquire shares in the company for the original value of the loans at a share price discounted by at least 20%.
When converted, the loan automatically turns into the most senior class of shares in the company. If more ‘senior’ shares are issued within 6 months from the conversions, the holders can still convert their shares into the most senior class.
A funding round successive to the loan is “qualifying” as long as the amount raised is equal or higher than the aggregate amount of the loan.
Even when a round is not in itself “qualifying”, the investors and the government can still opt to convert the loan into equity at the share price set by the funding round, discounted by at least 20%.
If the company exits
If the company is sold or goes public before a qualifying funding round, the loan will either
- be converted at the Discount Rate to the price set by the most recent non-qualifying funding round; OR
- be repaid with a redemption premium of 100% of the principal of the bridge funding.
Whichever will provide the higher amount for the lenders.
Note that in this case, if the most recent funding round took place before the loan was issued, then the Discount Rate will not be applied.
If the loan matures before a qualifying round
If the loan reaches the end of its term before a qualifying round, it is up to the holders (the government and matched investors) to choose whether to:
- seek repayment with a redemption premium equal to 100% of the principal of the loan; or
- convert into equity at the Discount Rate to the price set by the most recent funding round.
The small print
According to the Convertible Loan Agreement of the Fund published on 18 May 2020, these are some of the additional clauses and terms that come with the funding.
Valuation Cap: Although the Government itself won’t set a valuation cap at which the loan automatically converts, but the private investors may choose to do so, and if they do then the Government will have a right to benefit from the same terms.
Interest Rate: 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.
Reporting: The company must provide the Government with historical financial information, detailed in the Agreement, within 90 days from signing the agreement. Additionally, the company must provide a quarterly report including financial and investment information, which is detailed on Schedule 4 of the Agreement.
Corporate Governance: The Government will have limited corporate governance rights during the term of the loan and will only gain full shareholder rights following conversion of the loan. There is a good faith obligation to discuss governance rights for the Future Fund upon a conversion. Although this doesn’t imply any obligation to agree on these rights, we advise to take this into consideration, especially given the Transfer Rights (see below) that the Fund holds per the Agreement.
Warranties: The company shall provide limited warranties, including in respect of title and ownership, capacity, its loan eligibility in accordance with the Government eligibility criteria, compliance with law, the borrowing facilities of the company, litigation and insolvency events to the lenders on closing of the loan.
Covenants: The company needs to underwrite to essentially treat the lenders and holders of the loan fairly and equally, providing them with the same information as other investors.
Most favoured nation: If the companies issues any more convertible loan facilities under more favourable terms, the Government and the matched investors have a right to benefit from those same terms.
This also applies in terms of the share class: if – within the first six months after conversion – any superior classes of shares are issued, the Lender have a right to convert their shares to the most senior class.
Negative pledge: 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 matched investor.
Transfer rights: The Government shall be entitled to transfer the loan and following conversion of the loan, any of its shares without restriction to an institutional investor which is acquiring a portfolio of the Government’s interest in at least ten companies owned in respect of the Future Fund.