The Future Fund: Credit where it’s due?

Startup funding
Marcus Young is partner and Layla D’Monte is an associate in King & Spalding’s London office, they have co-authored the below piece on what SMEs should expect from the Government’s Future Fund scheme…

Many SMEs will be looking at making an application to the UK government’s new Future Fund; a £250 million investment pot intended to support the country’s innovative new business ventures impacted by the COVID-19 pandemic.

The fund will match up to 100% of the amount provided by an investor/s, up to a maximum of £5 million and offer packages of between £125,000 to £5 million. It is delivered by the British Business Bank (BBB) and opened for applications on 20 May.
If it sounds like an attractive proposition for boosting SMEs then that’s because it is. The fund has a great many benefits but there are a number of key factors – and potential pitfalls – that SMEs should consider before filing any applications.

Try before you apply

First and foremost, the clock is ticking. The government has put in place a provisional deadline of 30 September for applications and the fund is operating on a “first come, first serve” basis. So once its gone, its gone (unless the Government extend the line of credit).
The scheme is an investor led scheme, and it is therefore the investor, or lead investor of a group of investors, who will need to apply. The key to accessing this fund is that it must be a qualifying individual investor in relation to an eligible company, not the company itself.

As such, companies need to find an investor willing to lead the process. Attracting funding of between £125,000 and £5 million (the amount required to be “matched” by the fund) is not going to be a straightforward task for many SMEs.
What is complicating this process is the unknowns. How much risk are the investors being asked – and willing – to take when making an application?

Willing lead investors may well look for certain guarantees from an SME itself to help mitigate the risk or even look at using the application as leverage for other aspects of the enterprise in future. Should an SME not give due care and attention to any agreements – or become too focused on accessing the fund – there is a risk they may enter into an agreement with an investor that has wider detrimental impact on the business. The initial short-term cash boost could be offset by losing control over aspects of your business in the long-term.

Gaining interest

It is also important to stress that these are not grants but loans. They will have to be paid back and carry a minimum of 8% per annum (non-compounding) interest rate; which is a huge margin on the current depleted Bank of England base rate. At this point, the interest will either be repaid or convert in equity. The loan will mature after 36 months. On top of this, the interest will be higher if the company and the investor(s) agree between themselves.

Unlike a typical bank loan, the interest is not payable on a monthly basis and instead will accrue until the loan converts. Rather similar to “interest-only mortgage”, that will require maintaining and managing a three-year “back-end” repayment schedule, especially as the loan cannot be repaid early by the company other than with the agreement of all of the investors. This too is a caveat that could lead to business disputes, with the loan being used as potential leverage.

The loans will convert into shares in the company in certain circumstances, including an exit or a new funding round. Investors and the Future Fund both invest using a convertible loan agreement, which is predefined and cannot be negotiated.

Tax (dis)advantaged?

There has already been a great deal of criticism on how the Future Fund is potentially incompatible with EIS and SEIS (tax schemes supporting individuals investing in startups, i.e. angel investors). It seems the government, rather than reviewing investment decks is relying on prospective applications having been pre-assessed by VC funds. It is important to stress that tax advice should be sought before accepting funding under the Future Fund.

Based on our analysis:

Past investments – may not be affected but there are no guarantees. The government has confirmed that previous EIS/SEIS investments will not be affected where the convertible loan converts into shares. Where the convertible loan note redeems, the British Business Bank states that government “intends” to make changes to the rules to clarify that this is compatible with such previous investments.

Current Future Fund loan note – is not compatible with EIS/SEIS. This means that the scheme will be highly unattractive to angle investors.

Private investment in the future – if you persuaded an angel investor to invest without SEIS/EIS for this investment to help your company in this time of need, the SEIS/EIS rules would preclude them from ever getting SEIS/EIS again in your company, so that investor is lost for future rounds.

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