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Future Fund – Another Flawed Government Funding Scheme?1st May 2020 Corporate
The Government has announced that it will introduce the £250,000,000 Future Fund to assist start-up businesses, following complaints that start-up companies were not able to access its existing support schemes such as CBILS. However, as was initially the case with CBILS the rules of the scheme are so tightly drawn it appears many companies who would hope to use it will not be able to. Key problems with the scheme are:
1. Not S/EIS Compatible
Most equity fundraisings by start-ups in the UK take advantage of the tax reliefs offered by the Enterprise Investment Scheme and See Enterprise Investment Scheme. The rules of these schemes require that shares acquired must be wholly subscribed for in cash. The Future Fund investments are structure as convertible loans, and repayment of a loan is not subscription in cash.
This is probably the most significant issue with the scheme, as without the tax relief it is likely to be very hard to raise match funding from private investors – which is required to at least match the Government’s contribution. The Government is aware of this issue, but has stated that changing the S/EIS rules to address it would require legislation which they do not consider practical in the timescale.
2. Nature of Matched Funding
The Future Fund investment will be structured as a convertible bridge loan – and any match funding needs to be contributed in the same way. This means that it is not possible to raise pure equity (which might qualify for EIS treatment) and then use the scheme for the balance of the raise.
Additionally, the company will need to raise at least £125,000 of its own funds to be able to access the scheme. This may not be possible for smaller companies.
3. Size of the Pot
£250,000,000 sounds like a lot of money. However, the Government has set a minimum contribution on its side of £125,000 and a maximum of £5,000,000. This implies that no more than 2,000 companies will be funded – and it could be as few as 50. Even the higher level is not a lot in the context of the UK’s highly developed start-up culture.
4. Previous Fundraising Requirement
A company must have raised at least £250,000 in aggregate from private investors in the past five years to be eligible for the scheme. While this should not be an issue for more developed companies, smaller and newer start-ups may struggle to satisfy this criteria
5. Use of Proceeds
The funds raised can only be used for working capital, and an evidential trail will need to be maintained for this. A particular problem is that companies are expressly forbidden from using the proceeds to pay advisory or placement fees or bonuses to external advisors. Companies often instruct external advisors to help them raise money, and to ensure regulatory compliance such as financial promotions approvals for private placement memoranda. Some companies may struggle to meet these costs from their existing resources.
6. Discount on Conversion
If the loans covert into shares on a “qualifying fundraising”, then they will do so at a discount to the price on the set by that funding round and interest is payable in cash. This discount will be at least 20%, and will be higher if agreed between the match funders and company. This may well make it hard to raise further rounds of funding – which could be devastating should repayment be required (see below).
There is also a discount applicable for conversion on “non-qualifying” fundraisings and on repayment becoming due. This will be the same percentage as for qualifying fundraising but the percentage discount may differ.
7. Cost of Redemption
The loan will fall to be redeemed on a sale or IPO, or if matures (the term must be no longer than 36 months).
In some circumstances the loans will convert to shares, but if they do not then a redemption premium of 100% of the amount of the loan will be payable. This could well cripple a borrower by itself, and even before the risk crystallises may deter investors in future rounds.
8. Government Veto Rights
The Government will receive “limited” corporate governance rights both during the term of the loan and as a shareholder following it. It is not clear what these rights will be, or to what extent the government will be responsive to requests for consent. Again this could damage the prospects of future fundraisings, as investors may be deterred by slow or uncommercial government fundraisings and it may not even be possible to get consents required to the further issue of shares.
9. “Most Favoured Nation”
If the company decides to raise more money by way of issue of convertible shares with “more favourable terms” then those terms will apply to the funding provided under this scheme. This is easy to say in the short form the Government has used, but it is not clear how this will apply in practice – for example will the terms of the new funding need to be looked at as a whole, or will it be clause by clause. This could make a significant difference to the cost of new funding by a company going down the convertible route, and the practical effects are likely to be that either convertibles aren’t used or they end up being on the same terms as the Government funding.
10. Free Transfer
The Government must be free to transfer it’s the loan and following conversion any shares it holds without restriction to institutional investors acquiring a portfolio of at least 10 companies from the Future Fund. While this does seem reasonable on the surface, there is a danger that companies could end up being acquired, perhaps not even as a core target, by funds with significant interests in competitors.
Overall, the Future Funding scheme is a disappointment and seems unlikely provide significant help to start-ups. Industry organisations are already flagging up issues with the Government, and we can only hope that it makes adjustments to the rules so that start-ups can get the support they so desperately need.
JMW Solicitors LLP frequently advise on S/EIS issues and corporate fundraisings generally, including advising on structuring, advance assurances, fundraisings documents and applicable regulation. If you need any assistance in relation these or other legal issues relating to raising money for your business please contact please contact us.
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This note is for general guidance only and should not be used for any other purpose. It does not constitute, and should not be relied upon as legal advice. It relates to the position in England only.
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This note is correct as of 30 April 2020