The Future Fund: summary of key terms

Why is this being done?

The Fund is intended to address a perceived market failure which has not been addressed by the other steps taken by the Government to assist businesses manage their cash positions during the Covid-19 pandemic.

For early stage companies which rely on equity investment to maintain their cash position and which are not profit making, access to schemes such as the Coronavirus Business Interruption Loan Scheme (“CBILS”) has proved difficult, if not impossible.

Rather than try to force CBILS lenders to adopt a more flexible lending criteria, the Government has taken inspiration from private investors and sought to address the funding issue by providing bridge funding in the form of a convertible loan to eligible businesses.

Who is eligible?

Full eligibility criteria will be published in due course, but at present the Government has specified the following:

• UK registered businesses - The business must be an unlisted, UK registered company with a substantive economic presence in the UK. If part of a wider group, the eligibility criteria will be assessed against the ultimate parent only.
   
• Prior fundraising - The business must have raised at least £250,000 from private third party investors in the last five years.
   
• The matching requirement - Private third party investors (referred to as “Matched Investors”) must at least match the amount of the funding provided under the convertible loan such that not more than 50% of the total funding is provided by the Fund. So, as an example, if the business was seeking a £1 milion loan from the Fund, it would need to raise at least a further £1 million from other investors.

What can the loan be used for?

The loan provided by the Fund can only be used for general working capital purposes. It cannot be used to repay any debt, make any dividends, pay any bonus or any advisory or placement fees to external advisors.

What are the key terms of any convertible loan?

The terms of the loan are as follows:

• Interest rate

  8 per cent. per annum (non-compounding) to roll up and be paid on maturity/conversion. If a higher rate is agreed with Matched Investors, the loan will be made at that higher rate.

• Maturity date

  Maximum of 36 months.

• When will the loan convert and at what price?

  The loan will convert as follows:

  • automatically on the next “qualifying funding round”, which is an equity funding where the business raises at least the amount of the bridge funding; and
     
  • at the election of a majority of the principal amount of the funding held by the Matched Investors, on any non-qualifying funding round.

  The conversion price will be set by reference to the price of the fund raising which triggered conversion with the discount rate (see below) applied.

• Discount rate

  20% to the price of the funding round or higher if agreed with the matched Investors.

  On conversion, only the principal of the loan will attract the discount rate, not any accrued interest element.

  The discount rate will not apply where this is a conversion on a sale, IPO or on maturity if most recent funding round occurred before the date of the loan.

• Valuation cap

  None, unless one is agreed with the Matched Investors;

• What does the loan convert into?

  Conversion is into the most senior class of equity.

  Where a further funding occurs within 6 months of conversion, the Fund may elect to convert their shares into the senior class of shares created by that later funding.

• What happens on a sale or IPO?

  On a sale or IPO the loan will either convert at a price by reference to the last non-qualifying funding round or it will be redeemed with a redemption premium of 100% of the principal of the loan, whichever will provide the higher amount to the Fund.

• Repayment

  On maturity, the loan shall, at the option of the holders of a majority of the principal amount held by the Matched Investors, either:

  • be repaid by the company with a redemption premium (being a premium equal to 100% of the principal of the bridge funding); or
  • convert into equity at the price set by the most recent funding round (with the discount rate applied).

  Any loan made by the Fund will convert unless the Fund specifically requests repayment in respect of its loan.

  The redemption premium is presumably designed to ensure that, where the equity value is high and the company elects to repay rather than convert, that the taxpayer is receiving a good return on its investment.

• Covenants in favour of the Fund

  The company will be expected to covenant the following to the Fund:

  • “limited corporate governance rights” during the term of the loan and as a shareholder following conversion of the loan. There are no details on the extent of these rights as yet;
     
  • undertaking to treat the lenders and the holders of the conversion equity “fairly and equally”;
     
  • to provide the same information rights as other investors in the company;
     
  • to comply with law;
     
  • that it will not take on any debt senior to the Loan other than bona-fide senior indebtedness from a person who is not an existing shareholder or Matched Investor, such as a high street bank; and
     
  • a ‘most favoured nation’ provision which would extend any more beneficial rights agreed by the company and other investors following the date of the Loan to the Fund.
• Transfer

  The Government is 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 Fund.

  This may be a particularly unwelcome provision for founders and existing investors, who will want to know who they are entering into business with at the outset.

Initial thoughts

The guidance is relatively preliminary and there are a number of questions left to be answered:

• Eligibility – as stated above, full eligibility criteria are still to be released. The suggestion is that the Fund may only invest in companies which show some form of ‘innovation’ or technological advancement – getting this assessment criteria right so as to be as inclusive as justifiable will be critical.
   
• Matched Funding – it is unclear as to the form of the matched funding (i.e. does it need to be the same convertible loan) and who will qualify as a ‘private third party’.

  Query also in the prevailing economic circumstances whether there is sufficient Matched Funder liquidity. The BVCA had originally lobbied for only a proportion of the Fund’s investment to be matched rather than on a £ for £ basis, which may have made the Fund a more attractive and viable option for existing investors.

• Interplay with EIS – if matched funding is to be made in the form of a convertible note, these will not qualify for EIS relief. Again, this may impact the willingness of private investors to match funding.
   
• How will they implement it – a practical question is how the British Business Bank will approach the administration, diligence and making of any convertible loans. Query whether implementation will need to be outsourced to fund managers in the same way CBILS have been with lending banks. The key is that loans need to be made quickly before further damage is done to the target companies.
   
• Attractive in only some cases? Whether the terms of the funding will be attractive will need to be assessed. The Government is under pressure to make sure it invests on commercial terms which are attractive to taxpayers, but this begs the question as to whether existing investors will only look to utilise the Fund where they see merit in leveraging their own investment £ for £ rather than taking the opportunity to invest the full sum themselves.
   
• Size of the fund – the BVCA had originally lobbied for a fund of £500 million rather than £250 million. The Government has stated that the size of the fund will be kept under review, suggesting that, if successful, the Future Fund may expand in future.