Jenny Tooth shares her thoughts on the new Future Fund
I do hope that you are keeping well. As you know we have been pressing Government and British Business Bank for some weeks now to address the funding needs of the early stage innovating businesses that our community is supporting through the crisis and that do not qualify for the CBILS scheme. So we were relieved this week to see that the Government had come up with a new set of measures for innovating small businesses amounting to £1.25bn. This includes the new Future Fund offering £250m of convertible loans between £125k and £5m for business that have already received a minimum of £250k equity in the past 5 years to be matched by equity investment, either angels or VCs.
However, it became immediately clear that this new Fund is not adapted to the Angel and early stage market. The most obvious challenge is that the Convertible Loan Note structure is totally incompatible for Angels using the EIS tax reliefs to mitigate their risks in investing in high growth, very early stage businesses. Indeed, the latest BBB-UKBAA Angel Market Research 2019 has shown that 86% of Angel Investors have used the EIS scheme for their investments during tax year 2018-19. Thus businesses who are early stage and high risk and seeking angel investment are unlikely to be able to attract angel match funding and thus misses out a huge pool of potential co-investment.
The key issue is also that Government would need to make a legislative change to eligibility rules to allow Angels to access tax relief when they use CLNs in EIS eligible deals for these specific co-investment deals under the Future Fund. However, this is potentially too difficult to implement at short notice. Alternatively, it may be possible for Angels to match the deal and co-invest separately through an equity investment, not on the same terms, but where the equity investment is EIS eligible and the equity co-investment comes directly and contemporaneously alongside the Convertible loan as direct match to the Government.
Nevertheless, we know that Convertible Loan Notes are far from ideal for Angel Investors who take equity shares as their normal model and who are closely aligned through ordinary shares to the entrepreneurs that they back. Whilst the structure around the conversion of loan notes into equity and the implications for future rounds are also challenging for the investee businesses. It is also useful to note that the scheme does not fit well with VCTs who are also caught by EIS legislation which is incompatible with CLNs , whilst the Enterprise Capital Funds, heavily supported by BBB funding, are also excluded from co-investing with the scheme.
It is important to recognise that the Future Fund in its current model will directly reinforce the existing imbalances in the Equity ecosystem across the UK. Since there is a need to have raised £250k equity, this precludes many highly investable innovating businesses that have not raised this level of equity to date. This specifically excludes those that have only raised SEIS to date which is at a maximum of £150k, but also many in the regions where there is much less capacity for angel investment and where deal sizes are lower and equity investment is harder to build. The same challenges exist for female led teams, since women founders have had significantly less access to early stage investment and at a much lower level than their male counterparts.
There could be potential to lower the bar to say £100k investment minimum.
However there is an undeniable imperative to incentivize much more angel and early stage investment to address the funding needs of the early stage innovators here in the UK and we need to attract many more individuals to back great entrepreneurs. Thus we will continue to press Treasury to consider a time-limited increase in EIS and SEIS tax relief to act as an important catalyst in the market and to boost overall angel capacity across the UK.
There is nevertheless a need to consider the opportunity to bring further co-investment into the market to directly support Angel and early stage investors. This includes the opportunity for an enhanced and expanded version of the BBI Regional Angels Programme, bringing more Co Investment pots for angel groups across the UK. This should rapidly follow on from the already announced new co-investment funds to be operated by Par Equity and Start Up Funding Club, announced by BBB this week. We also could extend the Angel CoFund’s remit to enable the Fund to bring co-investment to existing angel backed portfolio businesses to support next stage growth.
Innovate UK’s announcement this week of a further £750m to back innovation and R&D projects is valuable ,but will principally focus on existing projects. There are a further 1,200 businesses that will be able to benefit from grants up to £175k, but it will be important to ensure these grants deployed quickly and with an accessible process without too many hoops, offering the potential to act as undiluted grant alongside Angel investment.
We urgently need appropriate measures from Government to leverage the power of angel and early stage investment at this time and we will continue to press for rapid and effective solutions.
Thank you for all that you are doing at this time to support our entrepreneurs. I will continue to work on your behalf and do keep in touch with your ideas and comments.
Meanwhile stay safe and well.