... it would make working capital loans available to innovative companies facing difficulties securing financing due to coronavirus (COVID-19).
As from 20 May 2020, applications for this scheme are now open.
Given that start-ups and scale-ups were not eligible for CBILS, this announcement - on the face of it - provides welcome news to early stage science and technology companies.
The government-owned British Business Bank (the BBB) will make loans in amounts from £125,000 to £5,000,000, but only to the extent that private 'third parties' make loans at the same time in at least an equivalent amount (Matched Investors). These Matched Investors can be existing shareholders. These three-year loans will charge a minimum of 8% interest (non-compounded) and be mandatorily converted to equity in many situations at a 20%+ discount rate. This £250 million “Future Fund” will launch in May and be open until the end of September.
The government has already published indicative heads of terms for its loans (Terms), promising to provide additional details about eligibility soon. Founders, investors and advisers alike will be waiting with bated breath for confirmation of these additional criteria, given that the limited terms published by the government suggest that there are likely to be significant numbers of UK startups and scaleups who will find themselves unable to take advantage of the Future Fund (see further below). There will also be plenty of state aid and tax considerations given the provenance of the funds and the fact that many of the target companies will have already taken advantage of schemes such as S/EIS and R&D Tax Credits - and will be looking to do so again in the future.
As is the case with CBILS, not every company will be eligible and this scheme has been specifically targeted at early stage companies. The headline criteria are that the company:
- Must be registered in UK, unquoted and have a substantive UK presence
- Must have raised at least £250,000 from private third parties in the past five years
- Has secured at least an equal amount from Matched Investors
So what does this mean for UK startups and scaleups keen to take advantage of this new scheme?
- The second requirement listed above means that no new start-ups will be eligible, as they will not have raised existing capital prior to this announcement. It also means that companies who have only raised SEIS and were now seeking EIS or VC funding will not be eligible either. It strikes us that this is an opportunity lost.
- Secondly, our review of the Terms suggests that there are other, less obvious criteria that, unless revisited, will have a significant impact on the take up of the scheme:
- it seems that the matched funding will be required to take the same form as the Future Fund / BBB investment - ie a convertible loan note. If this remains the case then EIS investors (either angel investors or EIS venture capital funds) are unlikely to be able to use this new scheme as convertible loans are not S/EIS compliant.
- Furthermore, if the company were successful in persuading an S/EIS investor to subscribe for convertible loan notes in this round, existing S/EIS rules would preclude them from making a future S/EIS investment in the company. As such, it seems unlikely that S/EIS investors will be persuaded to match fund the Future Fund / BBB investment.
- The Terms suggest that a company currently negotiating a conventional investment round (ie one based on an agreed valuation) would need to persuade those investors to re-structure their investment as a convertible loan note. This will not be without its challenges, particularly if the investor has successfully negotiated a significant discount on the valuation (as many investors are bound to attempt in the current climate). If the investor has agreed a valuation and headline deal terms that it is happy with, then they may not be willing to revisit those terms. Instead, they may well seek to encourage the founders to look away from the Future Fund and accept their investment (which could also mean the company having to take more money from that investor - potentially at a heavily discounted valuation - than they would ideally like at this time). Companies with existing VC investors may find themselves in a particularly tough spot as investors will often have investment veto rights that mean that they are in a commanding position and, conversely, founders will find themselves in a much weakened one.
- As always when agreeing to issue shares in the future at a discount, directors should consider the impact that the dilution may have on the company's attractiveness to future investors. The three-year term of the loan and the different conversion rates applicable to principal and accrued interest will make it difficult to model hypothetical capitalisation tables under various scenarios. A reasonable future investor would take into account the fact that the BBB investment was made at an uncertain time and that, in those circumstances, the discount structure was fair and should have little impact on the market value of the shares at the time of the future investment. However, a less reasonable future investor may seek to use the discount as an opportunity to drive a much harder bargain on other terms (eg participating liquidation / exit preferences, anti-dilution rights and ratchets) which - based on the Terms - the government / BBB would also then benefit from.
Summary of the Terms
Use of Proceeds
As is the case for S/EIS investments, the funds may only be used for working capital purposes and, specifically, it cannot be used for:
- Dividends or bonuses; or
- Advisers’ fees
- 8% non-compounding, unless a higher rate is agreed with Matched Investors (in which case, the BBB investment would attract the higher rate)
- The loan will convert at the company's next investment round and the precise terms will depend on whether that subsequent investment is a "qualifying funding round" (one where an amount of equity raised is at least equal to the bridge funding in which BBB participates), or a "non-qualifying funding round" (one where the amount raised on the subsequent investment is less than the amount of the BBB funding)
- On a qualifying funding round - the principal amount of the loan will automatically convert, at a discount of 20% (unless a higher figure is agreed with Matched Investors, in which case BBB would also secure the higher percentage discount) (the “Discount Rate”) to the value set at that round
- On a non-qualifying funding round - if elected by majority of Matched Investors, the principal amount of the loan will convert at the Discount Rate to the value set at that round (in other words, conversion is not automatic if the subsequent round is "non-qualifying")
- There is some good news when it comes to interest in that the Company has the right to repay accrued interest, and if it does not do so, the accrual converts without discount.
- If there is a Sale or an IPO before maturity of the loan, the principal amount of the loan will either:
- be converted at the Discount Rate to the value set at the most recent intervening non-qualifying round with accrued interest converting without the discount; or
- be required to be repaid, with principal amount being subject to a 100% redemption premium (ie the investor would be entitled to twice their initial investment),
whichever route offers the lenders the best return on its investment.
- If the loan reaches maturity without having already converted into equity then, at the option of majority of the Matched Investors:
- the loan will either be repayable, with the principal amount again being subject to a 100% redemption premium; or
- the principal would convert at the Discount Rate to the value set at the most recent funding round, and accrued interest would convert without the discount
However, note that the default position will be that the BBB will convert unless it specifically requests repayment.
- Interestingly, the Terms state that the government will not require a valuation cap, unless one is agreed with Matched Investors.
- It is worth noting that the loan converts into the most senior class of preferred shares existing at the date of conversion and the lender has a further right to convert its shares into any more senior class of shares that is issued under a further funding round within 6 months of the conversion event.
Protection Against Subsequent Convertible Note Issuance
- The loan will attracted "Most Favoured Nation" rights - in other words, should the company subsequently issue further convertible loan notes on even more favourable or investor-friendly terms, then those terms would be retrospectively applied to the BBB loan.
Negative Pledge, Warranties, Covenants, and Lender Governance
- The company would be entitled to borrow at a more senior level only from a someone that is not an existing shareholder or Matched Investor. Presumably, this means that the company could still raise further funding via a secured bank loan.
- The Terms make reference to a requirement on the company to give limited warranties and covenants, and also state that the government / BBB will expect limited corporate governance rights.
- The Terms also provide limited details of the government's right to (a) transfer the loan and equity to an institutional investor (subject to limitations) and to (b) transfer its equity in the company within government and to other companies owned by central government.
Whilst the government should be applauded for seeking to find a way to support the UK's innovative early stage companies, there is some concern that the initial terms miss the mark. Based on the initial terms published on 20 April, too many of the UK's most exciting companies (including those at the forefront of vaccine development and other equally important scientific and technological advances) will find themselves precluded from applying. We await further details as to eligibility and, in particular, whether government will permit EIS investors to match fund through an Advance Subscription Agreement (which has many similar characteristics to a convertible loan note).
Those who are (or believe themselves to be) eligible should get in touch with advisers soon and ideally before any term sheets are signed. Advice will be required in a number of areas including:
- complying with the company's existing corporate governance terms, including pre-emption rights and investor vetoes / consent requirements
- the terms of the convertible loan note and subscription agreement that will be required (in relation to the BBB investment and the Matched Funding)
- what changes may be required to the existing investment/ shareholders agreement and the articles of association
- whether any disclosures would need to be made against even the limited warranties (noting that the Terms reference to a "compliance with laws" warranty, which is very broad and therefore potentially risky) and
- state aid, tax and accounting /valuation advice.
Investors should also seek advice as to:
- whether their investee companies are eligible for the Future Fund investment (given their existing investment) and whether any proposed new investment could be structured / restructured to benefit from this scheme (taking into account restrictions that it may be subject to on the structure of its investment deals);
- the detailed legal terms of the convertible notes, because bridge financings such as this must be evaluated independently of tax benefits;
- the terms of converting principal and accrued interest under various scenarios, to support the economic modelling of conversion consequences; and
- how the investment negotiations should be carried out (which, from the company's perspective, would ideally see the investors' lawyer and the BBB lawyers working collaboratively, so as to help the company keep its legal costs to a minimum).
Finally, the nature of the proposed terms and the matched funding requirement mean that getting from successful application to completion of the investment is likely to take some time, which companies struggling for cash will need to take into account. Those who are about to run out of cash should be in urgent discussions with their existing investors and, if they are approaching the end of their funding runway, seeking the advice of an insolvency practitioner.
For specialist legal advice on how your organisation could benefit from the government's Future Fund, please contact Nathan Guest, Emma Cameron or Thomas Dick in our Corporate Law team, or complete the form below.