Ever since the UK government announced its series of financial support schemes to combat the economic effects of the COVID-19 pandemic, there has been concern amongst some that:
- there was a lack of support for earlier stage businesses that may not be eligible for the proposed support schemes; and
- a large number of medium-sized and larger enterprises would fall into a gap between measures and would struggle to access liquidity support.
In particular, the government's Coronavirus Business Interruption Loan Scheme (CBILS) – a key lifeline for SMEs - received a lukewarm reception among venture capital and private equity investors.
Now, further government schemes have been announced which potentially change how venture capital and private equity investee companies are able to access UK government guaranteed funding:
- the revised UK Government's Coronavirus Large Business Interruption Loan Scheme (CLBILS);
- the 'Future Fund' convertible loan scheme; and
- an enhanced grant and loan scheme to be delivered via Innovate UK.
In this insight, we examine why private equity-backed businesses have so far struggled to access CBILS, and to what extent CLBILS offers hope for those businesses. We discuss the Future Fund and Innovate UK initiatives in our other insight.
CBILS: access denied?
Companies with majority private equity investors on their books have so far been overwhelmingly unsuccessful in accessing CBILS. This is for two principal reasons. First, for the purposes of calculating the applicant's annual turnover (which can be no more than £45 million), approved lenders have been aggregating turnover across the whole of the private equity investor's portfolio. In some cases, lenders have been aggregating turnover across multiple portfolios managed by the same fund manager. Unsurprisingly, when using this method, the numbers stack up very quickly.
Second, according to the guidelines laid down by the Treasury, many private equity backed business are not "viable". In order to qualify for loans, borrowers must have retained earnings on their balance sheets, with no more than 50% of the invested equity eroded by retained losses (in EU State Aid terms, they must not be "undertakings in difficulty"). In many cases, these requirements pose insurmountable hurdles for companies at the early stages of an investment cycle (or "J Curve"), where the company is delivering negative returns but with strong growth prospects. This will include a large proportion of venture capital-backed businesses, which are often pre-revenue.
While some private equity backed businesses are technically able to access the CBILS, meeting the eligibility criteria has been described by BVCA representatives as like "threading a needle". The BVCA, among other private equity stakeholders and interest groups, have therefore been pressing the Treasury since CBILS's launch to modify its eligibility criteria to acknowledge that companies within a private equity portfolio tend to act independently of each other with no ability to access common resources, and to provide greater flexibility for healthy, growing companies with relatively high debt to equity ratios.
Introducing CLBILS: access granted?
The launch of the CLBILS has offered a glimmer of hope for private equity investors and their portfolio companies in need of financial support. However, it's clear that some key regulatory and practical impediments remain.
Like CBILS, CLBILS applicants must also:
- be UK-based in their business activity
- have a borrowing proposal which the lender would consider viable, were it not for the current pandemic, and for which the lender believes the provision of finance will enable the business to trade out of any short-term to medium-term difficulty,
- self-certify that they have been adversely impacted by the coronavirus (COVID-19)
- not have received a facility under the Bank of England’s Covid Corporate Financing Facility (CCFF).
Unlike CBILS, however, there is no upper limit on the applicant's annual turnover. On the face of it, this appears to address one key obstacle faced by portfolio companies under CBILS, and may open up applications to private equity-backed businesses of all sizes.
- CLBILS applicants can access funding of up to £50 million with the UK Government guaranteeing 80% of this funding. For funding above £250,000, personal guarantees may still be required but the liability of these guarantees cannot exceed 20% of the total funding. It is therefore foreseeable that lenders will require parent entities or subsidiaries of the CLBILS applicants to provide the required guarantees for 20% of the total funding.
- The CLBILS funding can take the form of: term loans, revolving credit facilities (including overdrafts), invoice finance or asset finance. The tenor can be from three months to three years.
Applicants with an annual turnover (tested on a 12 month lookback basis) of more than £45 million will now be able to apply for up to £25 million of CLBILS finance, and applicants with an annual turnover of more than £250 million will be able to apply for up to £50 million.
The removal of the upper limit on annual turnover criteria for CLBILS seemingly avoids the issue of turnover aggregation across investment portfolios seen with the CBILS, allowing more private equity sponsor portfolio companies to be able to access the CLBILS funding. However, discussions with the British Business Bank are on-going as private equity sponsors and lenders seek confirmation of eligibility criteria.
Potential issues with CLBILS
Crucially, the UK government has ceded power to the lenders to determine eligibility to the CLBILS. Most are likely to take a cautious approach to making such a determination, especially during the infancy of the scheme, which is likely to cause a bottleneck of applicants waiting for approval. Lenders are positively looking at ways to support private equity portfolio companies through UK government schemes, but there are many conditions to meet and these conditions have not been fully explored by the guidelines. A challenge for lenders is that they do not know that the 80% UK government guarantee is valid until it comes to time to make a claim and unless the CLBILS guidelines are very clear, lenders cannot be sure whether they are taking 20% or a 100% risk for their liability management purposes and risk assessment.
Another issue is that the CLBILS fails to use the participating lender as a pass-through agent for the UK government, but instead leaves the lender: (a) to do the credit assessment and (b) with credit risk (albeit this risk is limited to 20%). The quantity of demand for the CLBILS, plus the pre-existing debt/security that applies to most sponsor-backed companies, means that in practice the existing lender for the applicant is the only option and is being asked do a credit assessment on the applicant at a time when doing so is operationally and technically difficult.
There is also a fundamental point that an applicant's existing lender (especially if not a UK clearing bank) may not be a registered and approved lender for the CLBILS. If so, access to the funding will not be forthcoming without engaging a new lender which would present intercreditor relationship issues. Any existing lender that is not an approved CLBILS lender would be concerned that such UK Government backed funding, if utilised by a borrower, might prejudice their credit position given that a CLBILS loan would likely be senior to any existing debt. Therefore, some existing lenders (in particular direct lending funds) may consider amending existing terms, seeking fees or resetting interest rates before providing their consent to such funding coming into the debt structure, if such consent is required under the loan documentation.
The lender's credit assessment is further complicated by the fact that the CLBILS is to be superimposed on a pre-existing debt structure of the applicant. In some cases, lenders may find it easier to help existing customers by way of conventional channels and increased flexibility under existing documentation though execution of short-term waivers.
In addition, the CLBILS loans (being bilateral and typically based on standard form documents) are likely to be difficult to dovetail with Loan Market Association (LMA) based facilities. We have already seen this tested on CBILS funding that we are putting in place for clients who have LMA-based facilities and so are able to transfer lessons learnt to the implementation of CLBILS funding.
There is also a question for private equity investors around whether now is the right time to access the CLBILS funding or whether such funding would be better accessed once the lockdown restrictions are lifted and businesses are seeking to return to normal. Accessing the CLBILS now would not only result in incurring fees and interest accruing, but would also result in them being at the vanguard of the negotiation of the types of restrictive terms that lenders are offering as part of the CLBILS financing. Private equity investors will likely want to have a better understanding of what terms lenders are attaching to the CLBILS financing packages, especially when access to the CLBILS is not absolutely necessary.
Our expectation is that the bulk of new money requests will come in a couple of months, or even further down the line. This is when a possible liquidity crunch is anticipated for those businesses that have successfully managed their cost base to date, but which subsequently have to meet the cost of kick starting their business again at a time when they’ve already collected all cash and reduced debtors.
From the details of CLBILS released to date, there has not been any change to the lending criteria concerning the viability of the applicant's business. While portfolio companies may now be able to get around the turnover requirement under CBILS, this will not change the ratios on their balance sheets, and it seems likely that many applicants will be rejected as "undertakings in difficult" on the same grounds as under CBILS. These businesses should consider the Future Fund or grants or loans from Innovate UK which we discuss here.
Osborne Clarke comment
Osborne Clarke has considerable experience advising private equity sponsors and their portfolio businesses. For further information or advice on accessing the UK government's COVID-19 support mechanisms, please contact your usual Osborne Clarke contact or one of the experts listed below.