Venture Capital | Future Fund: further guidance released but questions remain

On Monday 18 May 2020, the British Business Bank published final details for the UK government's hotly anticipated Future Fund, which is intended to provide UK-based innovative companies with sufficient capital to cope with the financial impact of the coronavirus pandemic by advancing funding via convertible loans. Applications will open on Wednesday 20 May 2020.

In this insight, we consider what the final guidance means for companies and investors, what still remains to be confirmed and what actions companies should be taking next.

1. What did we already know?

As explained in our insight when the scheme was first announced, the headline features of the scheme are as follows:

Eligibility: Businesses must:

• be UK-registered private companies with a substantive economic presence in the UK;
• have raised at least £250,000 in private investment in the last five years (from 1 April 2015 to 19 April 2020 inclusive); and
• be in a position to secure enough private funding to match the government’s investment.

Amount and form of funding: Amounts of between £125,000 and £5 million will be made available by the government to eligible recipients in the form of unsecured convertible loans and matched by private investors on the same terms.

Conversion: The capital of the loans will convert on the company's next qualifying funding round into the most senior share class issued in such round at a minimum discount of 20% of the round price.

Interest: The loans will attract interest at a rate of at least 8% per annum to be cash paid on maturity of the loan, after a maximum of 36 months. On conversion of the principal, the company can elect to repay the accrued interest rather than have it convert. Any interest not repaid will convert into equity but without a discount.

Repayment: The loan is repayable in certain circumstances (including at maturity or on a sale or IPO) with a 100% redemption premium. The loan cannot be repaid early without the consent of all lenders.

2. What has now been confirmed in the final guidance?

Assessment criteria

To satisfy the eligibility requirement of having a "substantive economic presence in the UK" companies must either have:

• half or more of their employees being based in the UK; or
• half or more of their revenues being from UK sales.

There will generally be a "first-come, first-served" approach taken when processing applications. Applications will not be screened or prioritised based on the amount applied for, the location of the company's business or the diversity of its management team, though the government is collecting data on the diversity of companies for monitoring and reporting purposes and is encouraging all match funding investors to sign up to its Investing in Women Code.

There will be some limits on how applications from investors with multiple investee companies will be treated: if a lead investor submits multiple applications on the same day and there are a high number of other applications on that day then only one application made by that lead investor may be processed on that day.

Restrictions on use of funding

The final guidance clarifies that the loans advanced under the convertible loan agreement cannot be used by the company to:

• repay any borrowings from a shareholder or a shareholder related party (other than the repayment of any borrowings pursuant to any bank or venture debt facilities);
• pay any dividends or other distributions;
• for a period of 12 months from the date of the agreement, make any bonus or other discretionary payments to any employee, consultant or director of the company other than as contracted prior to the date of the agreement and as paid by the company in the ordinary course of business; or
• in relation to monies advanced by the Future Fund, pay any advisory or placement fees or bonuses to any corporate finance entity or investment bank or similar service provider.

No EIS/SEIS relief

As has been much discussed since the scheme was first announced, convertible loans do not meet current Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) qualifying requirements. This suggested that the match funding from private investors would not entitle them to the relevant tax relief that would be applicable on an EIS or SEIS qualifying investment.

A number of voices within the investment community expressed concern that this would make access to the Future Fund scheme more challenging for earlier stage start-ups, who often rely on funding from angel investors and early stage investment funds making EIS or SEIS-qualifying investments. Despite this, the final guidance confirms that the match funding must be advanced in the form of a convertible loan and so will not be EIS or SEIS qualifying based on the current rules.

If there are investors that want to invest in an EIS or SEIS qualifying manner, it would be possible for them to invest in a different form alongside the Future Fund and matched funding convertible loan. For example, they could make a straight equity investment or invest via an advance subscription agreement. However, this funding would not count towards the match-funding requirement for the Future Fund, so to access the government funding the company would need to be able to also obtain match-funding commitments in the form of convertible loans from non-EIS and non-SEIS investors.

There were also many voices of concern that entering into the convertible loan will affect the EIS or SEIS compatibility of previous investments. The final guidance confirms that existing EIS investments will not be affected where the convertible loan converts into shares. Where the convertible loan note redeems, the government intends to make changes to the rules to clarify that this is compatible. The compatibility of future investments, however, does not have this assurance.

Investor eligibility

All of the investors will need to fall within specific investor categorisations in order to be eligible. This effectively means that friends and family will not be able to provide the match funding. There is however no jurisdictional limit on where the investors are based.

Application process

An application for the Future Fund will need to be completed via an online portal. The government will be relying on the investors, the company and the company's solicitors to carry out many of the necessary process steps and to then provide various written confirmations that these have been completed appropriately.

3. What questions remain?

Is £250 million of funding a hard cap?

The final guidance has reconfirmed that the government will initially make up to £250 million of funding available in total for the scheme. Based on the amounts advanced in each case being between £125,000 and £5 million, this would equate to providing support for between 50 and 2,000 companies. We would anticipate that demand for the scheme will be high and so the number of applications may exceed these numbers, which would suggest that some companies could miss out.

However, the final guidance does note that the government will keep the funding amount under review. Francis Evans, head of business finance at the Department for Business, Energy and Industrial Strategy, has been quoted as encouraging companies not to "look at it as if once it’s gone it’s gone" and in response to questions in the House of Commons on 18 May 2020 the chancellor of the exchequer said that if the demand was there the government would be "more than happy to expand the scheme".

How long will the deployment of funding take?

Companies considering applying for the Future Fund scheme will be keen to understand how long the application process will take and when they can realistically expect to receive the money. Companies may be particularly concerned by numerous media reports following the initial roll out of the Coronavirus Business Interruption Loan Scheme (CBILS) and the Coronavirus Large Business Interruption Loan Scheme (CLBILS) that some companies experienced a significant lead time under those schemes between an application being made, the application being processed and confirmed as successful and the loan monies being advanced.

The final guidance does note that applications are expected to take "a minimum of 21 days" from initial application to funding being awarded, but it is not yet clear how long this process will take on average in practice.

Does the Future Fund constitute state aid?

Our understanding is that the government views the Future Fund loans as not constituting state aid due to being advanced on commercial terms. If that is the case, there are two main consequences:

• "Undertaking in difficulty" rule won’t be a problem for access to the Future Fund: As noted in our previous insight on the CBILS and CLBILS, in order to qualify for loans under these schemes, companies must not be "undertakings in difficulty" for the EU state aid purposes (meaning they must have retained earnings on their balance sheets with no more than 50% of the invested equity eroded by retained losses). This prevents most companies at the early stages of investment cycles (who may have strong growth prospects but currently be delivering negative returns) from being able to access the CBILS or CLBILS.
• Utilising the Future Fund scheme will not reduce the amount of other state-backed schemes available for companies: A number of state aid initiatives (for example, the EIS and SEIS schemes) place limits on the amount of money that companies can raise under any other state aid schemes. If the Future Fund will not constitute state aid, it should not erode these allowances.

4. What should companies do now?

If you are eligible and want to apply for the Future Fund scheme:

• Consult with a solicitor on the detailed effect of the convertible loan terms on your existing capitalisation table and the specific documentation that will be required, as well as appointing them to act on the settlement of the investment.
• Consult with your existing investors to obtain the necessary corporate approvals for the funding and commitments to provide the necessary matched funding, as well as identifying a lead investor that is willing to progress the initial stage of the application.
• Start preparing and collating the information that will need to be supplied as part of the application.

If you are not eligible or are not sure whether to apply for the Future Fund scheme:

• Review the other state-backed schemes that have been introduced to support businesses during the current pandemic. Osborne Clarke has prepared an international guide to the government schemes across a number of jurisdictions.
• Consider other options for proceeding with fundraising from non-state-backed sources (such as private investors who may be seeking to make investments in an EIS or SEIS-qualifying manner).

For further guidance on raising funding (whether via the Future Fund or otherwise) please do connect with one of Osborne Clarke's experts using the details below. Osborne Clarke is deeply engrained in key venture and growth capital markets with recognised expertise in providing fundraising advice. With sector specialists across Europe, Asia and the US we advise both investors and companies on the full range of investment activity, from early stage venture capital financings through later stage and growth capital funding, including venture debt and senior debt facilities.