With many early-stage, high growth businesses facing economic upheaval and pressure on their cash flow as a result of COVID-19, the Chancellor of the Exchequer has announced a £1.25 billion support package to help innovative companies navigate the challenging economic environment.

The Government is mindful that the UK is home to many dynamic companies and that they are often susceptible to short term funding challenges through a focus on R&D as they forge a path to profitability.

The new support package is made up of two components:

• the “Future Fund”, a new £500 million convertible loan scheme; and
• an additional £750 million of “targeted support” for R&D-centred small and medium sized businesses, provided through Innovate UK.

Future Fund

The Future Fund is a partnership between the UK Government and the British Business Bank, which will offer convertible loans to UK-based companies of between £125,000 and £5 million at a (non-compounding) annual interest rate of at least 8%. The scheme is due to open in May 2020 and run through to the end of September.

Full details of the Future Fund are expected to be published shortly. For now, the Government has divulged only the “Headline Terms”.

While the Chancellor’s announcement suggests that this is a £500 million scheme, it appears that the Government has allocated £250 million, with the remainder of the scheme representing a matched funding component.

Eligibility: The Government has revealed that in order to be eligible, an applicant must:

• be based in the UK;
• receive at least equal matched funding from private third party investors (“Matched Investors”); and
• have raised at least £250,000 in equity funding from private third party investors in the last five years (“Prior Funding”).

The Headline Terms clarify that to be “based in the UK”, the applicant must be an unlisted company registered in the UK with “a substantive economic presence in the UK”. If the applicant is part of a corporate group, only the ultimate parent company, if a UK registered company, is eligible to receive the convertible loan. As expected, the Headline Terms also clarify that customer fraud, money laundering, and KYC checks will be carried out, which will place emphasis on good corporate housekeeping prior to submission of an application.

Use of proceeds: The convertible loan must be utilised for working capital purposes and cannot be applied to repayment of other debt or to make dividend or bonus payments to shareholders or employees. Any advisory or placement fees may only be paid out of the funding provided by Matched Investors.

Conversion: The loan is expected to be convertible into the most senior class of equity in the borrower on the earlier to occur of: (i) the next “qualifying funding round”; (ii) an exit by sale or IPO (an “Exit”); or (iii) maturity of the loan after a maximum term of three years:

• On a funding round: conversion will occur at a minimum discount of 20% to the price per share set by the funding round (the “Discount Rate”) either: (i) automatically on a “qualifying funding round” (described in the Headline Terms as an amount raised that is at least equal to the principal amount of the funding received from the Future Fund and the Matched Investors); or (ii) at the option of the Matched Investors holding a majority of the principal amount of matched funding on a “non-qualifying funding round” (described in the Headline Terms as an amount raised that is not a “qualifying funding round”). Note that on a “qualifying funding round” the borrower is expected to have a repayment right in respect of accrued interest.
• On an Exit: the finance providers will receive the most favourable of: (i) conversion at the Discount Rate to the price per share at the most recent “non-qualifying funding round”; or (ii) repayment of the convertible loan at a premium equal to 100% of the principal amount (the “Redemption Premium”).
• On maturity of the loan: at the option of the Matched Investors holding a majority of the principal amount of matched funding, the loan will either be: (i) repaid at the Redemption Premium; or (ii) converted into equity at the Discount Rate.

The Headline Terms also clarify that: (i) no discount will be applied to conversion on an Exit or on maturity if the most recent “non-qualifying funding round” occurred prior to the convertible loan; and (ii) the Discount Rate will not be applied to accrued interest.

Other terms: The Headline Terms contain a number of other provisions that provide protection to the Government vis-à-vis the Matched Investors and future investors. For example, the Government will benefit from any higher interest rate, valuation cap, or information rights agreed with the Matched Investors, as well as “limited corporate governance rights”, both before and after conversion of the loan.

Most favoured nation and negative pledge provisions have also been incorporated in the Headline Terms, although it is worth noting that bona fide senior debt can be raised from outside of the existing pool of shareholders or Matched Investors.

Potential applicants may also be concerned that the Government is entitled to transfer the convertible loan and any of its shares (post-conversion) to an institutional investor acquiring a portfolio of the Government’s interests as well as freely within the Government and its departments.

Points for clarification: When the final terms are released, it would be helpful to receive more information on the following points:

• The form of Prior Funding: We would ordinarily expect analysis of a company’s previous funding rounds to capture debt funding, but the Headline Terms refer to Prior Funding in the form of equity rather than debt, so it remains to be seen whether there will be any flexibility in this regard.
• The structuring options available to Matched Investors: While the Headline Terms suggest that Matched Investors will invest via a comparable instrument to the Government’s convertible loan, the scope for alternative funding arrangements (such as the use of advance subscription agreements for Enterprise Investment Scheme (“EIS”) purposes) will be a point of interest for potential Matched Investors.
• Timing of funding by Matched Investors: Funding rounds often take place over the course of several months. We expect the final terms to clarify whether the matched funding must be closed at the same time as the Government’s convertible loan or can be closed within a certain period of time (before or after) and still satisfy the eligibility criteria.
• Government’s options on maturity: It would be helpful to receive guidance on the circumstances in which the convertible loan may be subject to repayment at the Redemption Premium, although the Government has noted that its loan will convert on maturity unless it requests otherwise, enabling it to participate in borrowers that demonstrate particularly strong performance.

Tax Implications: As for any form of borrowing, the tax implications should be carefully considered. A company receiving a convertible loan under the Future Fund scheme may wish to consider the following:

• Preservation of “EIS” treatment: A company borrowing through the Future Fund may have other investors who are expecting “EIS” tax relief on their investment. As with any new funding, the borrowing company should bear in mind that a new investment may breach the “control and independence requirement” under the “EIS” legislation. Broadly, this may happen if the borrower becomes a 51% subsidiary of another company or comes under the control of another person, such as through the exercise of voting powers or other powers granted to the investor. While the Headline Terms state that the Government will have limited corporate governance rights, and our view is that it is unlikely that the Government would want such powers in any case, the terms on which the Matched Investors may invest are yet to be finalised.
• Conversion of debt to equity: The conversion of debt to equity is usually tax-neutral for the borrower. However, each convertible loan must be considered on a case-by-case basis.
• Withholding tax: UK borrowers are obligated to withhold tax at a rate of 20% on payments of yearly interest. However, the Headline Terms state that the Future Fund scheme will be delivered in partnership with the British Business Bank (although they do not identify the lending entity), so the borrower may be able to utilise the exemption for interest paid to a UK tax resident corporate, or the exemption for interest paid on advances from UK banks, for example. The borrower will also need to consider the withholding tax treatment that will apply to any payments of interest to the Matched Investors.

Innovate UK

At the same time as announcing the Future Fund, the Chancellor outlined the Government’s plan to make a further £750 million of “targeted support” available through Innovate UK’s grants and loan scheme.

Innovate UK describes itself as “the UK’s innovation agency” and is part of UK Research and Innovation, a public body funded by the Government. Its objectives include providing support and investment to innovative businesses and it currently works with 2,500 customers.

It is these customers that will primarily benefit from an acceleration of up to £200 million of grant and loan payments on an opt-in basis, with a further £550 million allocated to increasing support for them. However, £175,000 will be offered to around 1,200 businesses that are not currently benefiting from funding through Innovate UK.

Conclusion

In recent weeks, governments, central banks, and individual businesses worldwide have taken significant steps to mitigate the economic turmoil brought about by COVID-19. The UK Government is no exception, with this latest package of support building on previously announced measures relating to the pandemic, including the Coronavirus Job Retention Scheme, Coronavirus Business Interruption Loan Scheme and COVID-19 Corporate Financing Facility, as well as its existing initiatives for innovative early-stage companies, such as the £2.5 billion British Patient Capital fund and planned £200 million Life Sciences Investment Programme.

Clearly, early stage companies and their investors will be paying close attention to their funding requirements, and, while there are challenges presented by any requirement to arrange third party matched funding in the current climate, the Future Fund represents another resource available to innovative businesses to negotiate the extraordinary challenges presented by COVID-19.

Further details relating to the financial support available to businesses affected by COVID-19 can be found on the UK Government’s website at:
https://www.gov.uk/government/collections/financial-support-for-businesses-during-coronavirus-covid-19

The UK Government’s guidance page relating to the new Future Fund, which includes a copy of the Headline Terms, can be found at:
https://www.gov.uk/guidance/future-fund

For more information about Coronavirus (COVID-19) preparedness, please visit our Coronavirus (COVID-19) Resource Center for Europe.

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