Private Equity and Venture Capital | The Future Fund takes off
Published on 21st Apr 2020
Despite the UK government putting billions into helping businesses cope with the financial impact of coronavirus, there has been concern that the initial Coronavirus Business Interruption Loan Scheme (CBILS) would not be available to many private equity or venture capital-backed businesses. As we explain in our other insight, the subsequently-announced Coronavirus Large Business Interruption Loan Scheme (CLBILS) addresses some of the issues, but will still be inaccessible to many businesses. However, there may now be some further help coming for those investor-backed businesses which remain ineligible for the CBILS or CLBILS.
On 20 April 2020 the UK government announced the May launch of its hotly-anticipated Future Fund, which is intended to provide innovative companies with sufficient capital to ensure that they can survive and (if possible) continue their growth trajectories during the current crisis.
In this insight, we consider the form and extent of additional support which the Future Fund and Innovate UK initiatives may make available to investee companies.
Which businesses qualify?
In order to be eligible for funding, businesses must be UK registered private companies, be in a position to secure enough private funding to match the government's investment and have raised at least £250,000 in private investment in the last five years. As a result, it could be of assistance to companies which have received venture capital investment and potentially also those within private equity portfolios, particularly those that are not eligible for CBILS or CLBILS. The Future Fund will be delivered in partnership with the British Business Bank and aims to ensure that the UK start-up and high-growth eco-system emerges from the shadow of coronavirus broadly intact.
In order to achieve this, the UK government is pledging a total of £250 million of funding with another £250 million to be sourced from private investors. Importantly, funding provided to companies by the Future Fund will not simply take the form of a loan but amounts of between £125,000 and £5 million will be made available to eligible recipients in the form of convertible loans which will convert to equity on companies' next funding rounds (the mechanism for which is set out in more detail in a headline term sheet that has been published). It is also important to note that the funding provided by the Future Fund must be used solely for working capital purposes.
Devil in the detail
Robert Dighero, Partner at Passion Capital, notes:
"It is very pleasing to see that the Treasury have announced such a supportive scheme for innovative UK companies and the British Business Bank is absolutely the right vehicle to administer the scheme given its existing close relationships to the UK's start-up ecosystem. However the finer detail of how it will work and be administered will of course be key."
The details of the Future Fund scheme are expected to follow in further guidance over the coming days, but clarity on the following points will be particularly important.
The government's announcement notes that the Future Fund is aimed at supporting "innovative companies". However there is not yet any guidance on how this will be interpreted and so which companies will be deemed to be eligible or not.
The published headline term sheet makes it clear that the Future Fund loans will only be deployed where companies have raised at least £250,000 in private investment in the last five years and also that other private investors are prepared to invest alongside the Government. The Future Fund loan cannot constitute more than 50% of the bridge funding being provided to the company, with the remaining amount needing to be provided by the matched investor.
This means that companies will need to be able to successfully source investment commitments from other investors in order to make use of the Future Fund scheme, which could provide practical challenges and timing issues. There may also be fund structuring limitations on existing investors which could present challenges. These concerns are expressed by Stephen Chandler, Managing Partner of Notion Capital, who comments:
"The Future Fund is a step in the right direction but does not go far enough to fully deal with the funding gaps in the venture capital ecosystem. The match funding is to be deployed on a 1:1 basis (50% matching) where further leverage by deploying on a 1:3 basis (25% matching) would have a much more significant impact. The risk is that this scheme just increases the size of bridging rounds that would happen anyway as opposed to genuinely helping companies without other options in the current liquidity squeeze. It is not currently clear whether anything will be on offer for companies backed by funds who don’t have dry powder to match fund cash investments. One way of doing that might be by underwriting investments in exchange for a top slice of future fund distributions."
Conversion to equity
The published term sheet makes it clear that any government bridge funding is to automatically convert into equity on the company's next qualifying funding round at a minimum conversion discount of 20% to the price set by that funding round with a company repayment right in respect of the accrued interest. If a qualifying round doesn’t occur before the maturity of the loan (a maximum of 36 months) then the government will also have the option to convert into equity at a 20% discount to the price set by the most recent funding round.
There has been some confusion (largely caused by early Treasury communications) around whether recipient companies will have the option to repay loans before they convert to equity but it now appears that this will only be possible in limited circumstances. Companies and their investors will therefore need to consider the implications of accepting the government on board as an additional shareholder.
As Stephen Chandler notes: "the mandatory conversion mechanic, rather than allowing for the redemption of loans, means that the Government will end up with loads of small equity interests in businesses. However, it may be that private investors will be encouraged to lead on managing these co-investments with a mechanism for those being bought out for cash at a later date."
We agree that private investors are likely to be encouraged to buy out the government's stake in later funding rounds. However, there is also reference in the published term sheet to the government reserving the right to be able to transfer its loans to an institutional investor acquiring a portfolio of the government’s interests in at least ten companies owned in respect of the Future Fund. This may present an alternative method for the government to exit its investments.
Innovate UK accelerates support for R&D
The Government has also announced that it will be offering additional support for small and medium size firms which are primarily focussed on research and development. There will be £750 million of targeted support made available through a grant and loan scheme. This scheme will be administered by Innovate UK, the national innovation agency. The first payments will be made by mid-May.
However, this support will mostly only be available to existing Innovate UK customers. The government's announcement notes that £200 million of payments will be accelerated to 2,500 existing Innovate UK customers and a further £550 million will be made available to increase support to those customers. Only £175,000 of support will be offered to around 1,200 firms not currently in receipt of Innovate UK funding.
As a result, this grant and loan scheme is likely to provide limited opportunities for firms requiring help but which re not already part of the Innovate UK programme, who will instead need to look into whether they can qualify for either the Future Fund or the CLBILS.
Osborne Clarke comment
Companies backed by private investors need access to support mechanisms even though many venture capital and private equity funds currently have considerable sums of un-deployed capital at their disposal (so-called "dry powder"). This is because many of these innovative companies have already attracted backing from investors through earlier vintages of those managers' funds which have fully drawn down from their limited partners. Later funds will also often be restricted contractually from investing in those earlier funds' portfolio companies or will be restrained from doing so by conflicts issues.
The recent announcements will therefore be welcomed by private equity and venture capital investors - and the businesses they back - across the UK economy, although there does remain some uncertainty resulting from the requirement for private match funding amongst other things as to whether the right businesses will ultimately be able to make use of the package.