20 April 2020
There was uproar when Rishi Sunak announced the Coronavirus Business Interruption Loan Scheme (CBILS) back in March. It was the poster boy of the Government’s support package. An “unprecedented” scheme designed to support businesses up and down the country.
But, there was a problem: it needed businesses to have had a “viable borrowing proposal” prior to the impact of Covid-19.
One particular sector, the tech and high growth sector, typically doesn’t have a viable borrowing proposal. Companies in this sector are loss-making. They have little to pledge as security. They burn money and would struggle to make repayments.
The poster boy scheme had failed an entire sector. Our fastest growing and most innovative companies weren’t getting the support they needed. They were going to collapse.
Well, things just changed…
Introducing the “Future Fund”
In response to the cries of help from an entire sector, the Government entered conversations on how they could best support venture backed start-ups. Here’s the plan:
- A loan of between £125k and £5m in value, which can either be repaid or converted into equity (more commonly called a convertible loan note)
- The loan funding provided by the Government must be matched by private investors
- The scheme will open in May.
This is great news for start-ups that can qualify – a cash injection which doesn’t need to be repaid.
How do I qualify?
Whilst the details are currently limited, this is what we know at the moment. The start-up must:
- be an unlisted UK company
- have raised at least £250k in total from private investors in the last 5 years
- have a “substantive economic presence in the UK” (that’s all we know – this will need to be defined further)
- Be able to match the funding
If a start-up is a member of a group, then only the UK registered parent company can apply for the loan.
What does it mean to match the funding?
The Government will only provide the loan (which they call “bridge funding”) if a company can get a private investor to match at least that amount.
The order of events is a little unclear – should the start-up raise funds now with the expectation that the Government will simply match it (between £125k and £5m), or will the Government decide a loan amount which will complete only when the start-up finds an investor to cough up the same amount?
How does the conversion to equity work?
This detail is what makes convertible loan notes popular with start-ups. In the most simplest of form, convertible loan notes are just like regular loans - but with no regular repayment. The loan can, at a particular date, convert into equity. That just means issuing shares worth up to the loan amount.
There are two dates to consider:
- The date of a “qualifying funding round”
“Qualifying” simply means a funding round that meets certain conditions – in the case of the Future Fund, it must be a funding round which raises at least the total amount of the bridge funding.
2. End of the loan term
Like a normal loan, there will be a time period on it – up to 36 months for the Future Fund.
Under the Future Fund, if a company raises a “qualifying funding round” (option (a) above), then the loan notes will automatically convert into equity.
The Government will be awarded the most senior class of shares at a 20% discount (at a minimum) to the qualifying funding round share price. This discount is fairly typical for convertible loan notes.
If the company doesn’t go through a funding round, then the loan will hit the end of the term (option (b) above). In this case, there are two options:
Option 1 – repay the loan
The Government can request for the loan to be repaid, or if the private investors decide to ask for their loan to be repaid, the Government loan must also be repaid.
This simply means that the company will pay off the debt and no equity has changed hands. Note there is a 100% redemption premium, though, which is designed to put startups off making the repayment (otherwise most of the well performing start-ups would repay the loan, leaving the Government with a portfolio of sub-par start-ups).
Option 2 – convert to equity
If the private investors decide to convert their half of the loan into equity, the Government loan will also convert. This will be at the same 20% discount mentioned above. The Government will then reside on the company cap table.
What else do I need to know?
Interest: the loan attracts an 8% interest rate which isn’t payable until maturity of the loan. If the loan is converted, then the interest amount converts too.
Covenants: they will be limited, but the main item being that the Government is treated fairly and in the same way that any other creditor and/or investor would be treated.
Terms: the issued terms are generally the minimum accepted levels. If the matched funding is on more favourable terms, the Government convertible loan will automatically adopt the favourable terms.
Decisions: the Government will have limited involvement in decision making. They’re more akin to a silent investor.
Transfer rights: here’s an interesting one. The Government will be entitled to transfer the loan and/or shares (if converted) to any other institutional investor, so long as that institutional investor acquires at least 10 different companies in the Future Fund.
This is odd because if a start-up takes this loan, they might find themselves with a different investor on the cap table later down the line. Normally in situations like this, transfers in shares must be approved by other shareholders. The “10 different companies” clause is likely to prevent an existing investor from easily buying the Governments stake to increase their own holding.
What about SEIS/EIS?
To be eligible for SEIS/EIS, shares must be paid for by cash at the time of issue. For convertible loan notes, the payment for shares issued is by way of converting the loan – this fact will disqualify the scheme from being eligible for SEIS/EIS.
This is clearly a great lifeline for any start-up which manages to jump through the hoops to get it.
It’s a little complicated, but working out a way to give the support has been a challenge from day 1.
Looking at the entry criteria and the general loan terms, there are a few points to note:
- It’s certainly not going to help the smallest of start-ups – we think the companies that will be most rewarded are those who have already raised Series A.
- The £250k hurdle is also likely to increase the funding gap for underprivileged founders who have struggled to raise in the past.
- The matching side of things is to protect the Government against being duped into uncommercial or unfavourable terms, and only to fund genuine businesses (otherwise investors wouldn’t match it).
- The automatic conversion and redemption premium are likely to prevent the need for start-ups to have to repay the loan. Whilst strange, the transfer rights seem reasonable because the Government need a way to sell without having to wait for an exit event.
Overall, we commend the Government on pulling together a rescue package for UK start-ups and hope this provides the vital funding needed to help start-ups pull through this turbulent time.
If you need any assistance understanding this scheme, or would like to know how to apply when it opens, please get in touch.