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With the Future Fund having been announced by Chancellor, Rishi Sunak, almost a month prior on 20 April 2020 there has been considerable content delivered on the high level terms applying to the Future Fund; we do not seek to reiterate that content here. Instead, we will look at the most material and interesting clarifications and new information.
As a quick recap, the Future Fund is being made available through a Convertible Loan Note (CLN) structure (further detail on CLN investments can be found here).
The Future Fund will subscribe for CLNs in an investee company on the terms of a CLN instrument (the Instrument), matching third party investors (Other Investors) who shall also subscribe for CLNs using the same Instrument.
The Future Fund will be open for applications from Wednesday, 20 May 2020.
The British Business Bank’s expectation is that a Future Fund application will result in funding no sooner than 21 days after submission. As a result, the earliest it would appear possible for a Future Fund investment to complete would be the middle of June.
The application process will be investor-led, with the investor (or a lead investor if the investment is syndicated) being required to start an application. Investee companies will be required to check all information provided by that investor before submitting the application.
Applications will be reviewed on a “first come, first served” basis with no fast-tracking for certain investment amounts, businesses or sectors. The Future Fund will be initially open until 30 September 2020, although it is of course possible that this is extended.
Some clarity has been provided with regard to those who will be “eligible investors” for the purposes of the Future Fund agreeing to match fund and includes “Investment Professionals”, “High Net Worth Companies”, “Self-Certified/Certified Sophisticated Investors” and “Certified High Net Worth Individuals” among a limited number of others. These concepts flow from the exempt categories for “financial promotions”, aimed at ensuring that private individuals who may not have sufficient experience to understand the risks of direct investment in early stage companies are not pitched such opportunities. As a result, companies aiming to make up a syndicate of investors of individuals who do not fulfil the criteria of “High Net Worth” or “Sophisticated” investors will not be eligible for matched funding.
Also, some additional criteria for the investee company have been specified, requiring it to (i) have been incorporated before 31 December 2019 and (ii) for one of the following to apply:
Further, it has been clarified that the £250k of investment that proposed investee company must have previously raised to be eligible must have been raised between 1 April 2015 and 19 April 2020. This will stop any prospective investee companies that do not meet that threshold from carrying out a £250k funding now in order to qualify for a Future Fund CLN round.
It is well documented that to be eligible for Future Fund investment a company had to have received £250k in equity capital in the last 5 years. However, it was previously phrased that such investment had to come from “private investors” which caused concern amongst entities that have received otherwise qualifying investment solely from Government-backed equity funds. Whilst this change looks positive for such companies, we understand clarity is being sought to confirm the position and of course, State Aid rules (which restrict the amount of government support a private entity can receive) will remain relevant.
One of the key areas of concern when the Future Fund was announced was whether VC funds which benefit from investment from the British Business Bank itself could make a qualifying co-investment alongside the Future Fund. Such funds include the Enterprise Capital Fund programme, which constitutes a significant part of the early stage market in the UK, and also regional specific funds such as the Northern Powerhouse Investment Fund and the Midlands Engine Investment Fund. It appears that co-investment from such funds has been cleared from a State Aid perspective, which is very welcome news.
It was widely anticipated that the terms and documentation used to implement the Future Fund would be non-negotiable and that has turned out to be correct.
The only terms which can be tailored (and even then, only tailored in favour of the Future Fund/Other Investors) are the interest on the loans, the discount that will apply on conversion to shares (being a minimum of 8% and 20% respectively as previously published), the “Valuation Cap” which sets the maximum price per share at which loans can convert and the “Headroom Amount” which sets the amount of additional investment which can be made in to the company under the same Instrument after the initial Future Fund investment is made (which will both be set at £0 if nothing greater agreed with the matched investors).
It should be noted that, whilst the documentation provides for a “Headroom Amount”, any investment made by Other Investors after the initial Future Fund investment will not be matched by the Future Fund so it will be important to ensure the details of all investments that the investee company wishes to have matched are included on the application in the first instance.
We discuss some more of the detail of the terms of the Instrument below.
The previously published guidance and information on the Future Fund contained little detail on how the terms of the Instrument would work alongside an investee company’s existing shareholders’ agreements and articles of association.
Given the likelihood of existing arrangements applying and side agreements being put in place between Other Investors and investee companies, the Future Fund has sought to deal with them by including a number of covenants within the Instrument.
The covenants are given by both the investee company and (where applicable) the Other Investors, some of which we summarise as follows:
A number of the above covenants have the potential to require future actions be taken by an investee company which, without necessary shareholder/investor consents, could result in (i) a breach by that company of existing contractual arrangements (such as restrictions on share transfers or loan repayments) or (ii) a breach of the CLN instrument by the company and/or the Other Investors. To avoid that situation it would be prudent to deal with all of these issues (or as many as is possible) at the time of the Future Fund investment.
However, a positive development is that the Future Fund is not requiring more extensive consent rights with regard to key operational or other corporate matters within the business – this was an area of concern following the publication of the initial term sheet, which appears to have now been resolved as above.
In normal investments, investors would seek to include as full a suite of warranties as is sensible given the size and nature of the investment. These warranties contain statements about the investee company which, if they are not accurate at the time they are given, could give an investor an ability to recoup some of their investment from the investee company.
The Future Fund has taken a very light touch to warranties, requiring the investee company only (and not the founders) to warrant only fairly basic information (including its eligibility under the Future Fund scheme). It is possible that the Other Investors will want to bulk out those warranties with a fuller suite in a side agreement, in line with the fuller form subscription agreements we often see in convertible loan note financings. However, careful thought would need to be given to any such agreement to ensure it (i) does not constitute a side agreement with the potential to adversely affect the economic interest of the Future Fund or (ii) cannot be considered to be treating the Future Fund in a manner which is disproportionate to the manner Other Investors are treated. As noted above, this could give rise to a breach of the covenants in the Instrument which are given by both the investee company and the Other Investors so it is within both of their interests to get this right.
It is widely known that the CLN structure did not allow for S/E
IS qualifying investment and it would appear that the Government has not bowed to the demands of the S/EIS industry to amend the structure or legislate to allow for the Future Fund to be S/EIS compliant.
However, British Business Bank guidance now states that “the government has confirmed that existing EIS investments will not be affected where the convertible loan converts into shares. Where the convertible loan note redeems, we have been alerted that the government intends to make changes to the rules to clarify that this is compatible”. Of course, those changes have not yet been made so those looking to retain S/EIS compliance should tread carefully and will likely await further clarity from the Government as to what specific measures will be taken to protect their position.
In addition, whilst it is possible for Venture Capital Trusts (VCTs) to invest in convertible loan notes, the current rules prohibit a right of repayment within 5 years. On the basis that the Future Fund requires co-investment on exactly the same terms, with a 3 year long-stop date, we do not anticipate that VCTs will be in a position to provide qualifying co-investment.
Whilst clarity on the terms that will apply to a Future Fund investment is welcomed, what has become clear is that proposed investee companies will need to:
Further, investors that usually seek S/EIS qualifying investments will likely wait for further clarity on the changes to S/EIS legislation before committing to take part in a Future Fund investment.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at 19 May 2020. Specific advice should be sought for specific cases. For more information see our terms & conditions.
19 May 2020
Insights 14 SEPTEMBER 2021