What is the Future Fund and how will it affect our community? Jenny Tooth answers your questions
Last week we held a roundtable to discuss the new £250m Future Fund, which was recently announced by the Government to help innovative equity-backed companies that are facing financial difficulties because of the COVID-19 pandemic.
Chaired by UKBAA CEO Jenny Tooth, it was an opportunity to explain more about the Future Fund and for Jenny to answer any questions that our community has around it.
We’ve put together this Q&A from the roundtable so you can see what was discussed.
What are the main aspects of the Future Fund?
The Future Fund will provide government funded loans to equity backed UK-based innovative companies ranging from £125,000 to £5 million, subject to at least equal match funding from private investors.
To be eligible, the company must have raised a minimum of £250k equity from third party investors over the last 5 years and must be able to attract equivalent match funding form third party private investors.
The loans will be made in the form of Convertible Loan Notes on commercial terms. These will automatically convert on a qualifying round but also can convert in a non-qualifying round, or at the end of the loan term which will be maximum of 3 years. The loan may also convert into equity on sale or IPO.
When it converts there is a minimum conversion discount rate of 20% to the price set at the qualifying round, or the most recent non-qualifying round. It converts into the most senior class of shares and that will always be the case. There is no valuation cap on conversion and the government is entitled to those same terms
There is interest to be repaid on the loan of 8% but it is not compounding. That will be paid on the maturity of the loan or it will convert into equity at that point, although the discount rate is not taken into account with the interest rate.
The loan has a 36-month maturity rate attached to it. If it has not already been repaid by converting into equity or repaid earlier, there will be a redemption premium at 36 months.
Are convertible loan notes compatible with EIS?
Under the current EIS rules, a convertible loan note is not eligible as match in an EIS deal. Given that the majority of angels and EIS funds are going to be very dependent on that eligibility, this is a fundamental issue. The same applies to VCTs whose rules would not permit CLNs on the same terms. Treasury has informed us that in order to make CLNs compatible with EIS rules , it would require legislative change and that is unlikely to be undertaken in the short term. Thus the current Future Fund scheme as proposed will leave out a huge swathe of angels and other early stage investors.
Can equity be separated from a convertible loan note?
We have proposed to government to completely separate out the equity part of the deal from a convertible loan note. So that an EIS eligible investment can be made, by angels and early stage investors and EIS funds as a co-investment if it goes in simultaneously as match with a loan. However, there is no indication as yet that this would be acceptable.
Can Advanced Subscription Agreement be used as an alternative mechanism?.
Again, this has been proposed to Treasury for consideration, but the ASA must also convert within a fixed term of between 6-12 months into equity to be EIS eligible and this also therefore alongside a CLN would make the EIS deal ineligible. There is also always the chance of claw back of earlier claimed tax reliefs if the EIS investment is found to be ineligible.
Do third party investors include existing shareholders?
It is not clear how far this would require new investors. A big part of the challenge and why support is needed, is that angels have been working really hard having backed their businesses, and EIS funds, and they are looking to have their own investments now, supplemented with some co-investment whilst being willing to continue to stay in the deal. However, if angels are not eligible to match with EIS, this is more of an issue at the moment.
The Future Fund could be channelled through the British Business Bank. Most angel networks don’t meet their criteria to be to be partners. Will this mean that angel networks won’t be able to access the co-funding?
The Future Fund is likely be distributed in a similar way to CBILs. The business will apply and prove that it’s eligible by demonstrating that it’s had the equity and that it has got private match lined up. It will have to fit the main requirements, all of which have not been entirely set out. There will likely be a front-end platform and that is being separately administered, not by the British Business Bank. There are discussions as to which organisation that might be but it won’t be the same as CBILS. Because it’s an exercise of application with certain parameters, there is a decision point as to the viability of the business and all the other requirements that would be needed and the availability of that investment. I don’t think it’s a question of angel groups having to qualify, but they will need to show that it is a viable investment source. It will be very much about whether there is the available non EIS match investment to be to be demonstrated.
What’s the situation with an increase in the EIS tax relief?
We have been pressing very heavily for the need for an increased EIS tax relief. We are not making an exaggerated request but proposing for an increase to around 45%, potentially even 50%, which is a modest rise and reflects the rise that was done in 2011/12 when we moved from 20% to 30%. Whatever is the outcome of my dealings with Treasury, we have proposed that this should be a short-term measure; one that potentially ran the whole tax year or maybe just six months. I’m sure all of you who agree who are working with angel groups, if this were announced you would need time to get out there and raise awareness, educate and mobilise new investors to make that work. We do feel, as a trade body having listened to many other parts of the argument, that this is still a valid request and we are continuing to press on that. We are not alone. Many other trade bodies and entrepreneur focused groups are also pressing for this, not only the EISA and the VCT Association. Nevertheless, at this stage, it is far from clear whether this could be acceptable since this again would require legislative change. However, it is important to note that this would be a separate measure to the Future Fund Scheme. The tax relief increase needs to be complimentary to other measures. It’s not a panacea as everyone would agree.
Is the Future Fund set in stone or will there be changes to it?
I will be absolutely clear in that we are we are not just going in there to criticise the Future Fund. We had to work incredibly hard to get the Chancellor to do anything for equity backed businesses. I think it’s very clear that there is a policy intent to address this part of the market and to actually address the needs of growth-focused innovating small businesses that are unable to meet the CBILs criteria. They recognize the need to support innovation and early stage growth. I think it’s more that the actual implementation, which seems to be only really usable by growth focused VCs does not fit the rest of the equity market for earlier stage players. There is still an openness to be making changes, which is why these conversations are very important. They are continuing to have dialogue with us and with others about it, and there is a seriously high-level pressure. What we don’t want to do is heavily criticize this existing scheme at the moment because it’s still in flux so there’s a danger that this might get heavily delayed.
Could the Regional Angels Programme provide more investment for businesses that are struggling?
The Regional Angels Programme is a £100 million co-investment fund that was put on the table by British Business Investments more than 12 months ago. So far there have been only three main co-investment pots distributed to DSW, Par Equity and Start-Up Funding Club. There are some others in the close pipeline behind these, but the funds have been very slow to get out of the door and have very specific requirements, meaning that not all of our groups have been able to be eligible, ese;pcially in the regions which is the focus of the funding. We are pressing very hard on the BBB to get more of those pots out of the door because they’re very, very important. I have also been pressing very hard to see if there’s more funding in the pipeline , that they could be brought forward that has been voted for future years. Potentially, in my view, this could be effectively used to create perhaps some smaller pots that could roll out more easily and more quickly and enable many more angel groups to benefit.
What about other potential co-investment schemes?
One of the big issues we need to resolve is something that can quickly get out to market. These existing schemes are incredibly valuable. We have been presenting those, particularly in our conversations with BEIS, who are also currently looking at alternative mechanisms for the lower end of the market and recognising that the Future Fund may not be right for all parts of the market.
Will there be a limit on how many deals or how much capital will be allotted per investor?
The whole point about this is, because it’s going to be business-led, that it’s the businesses that will be making the applications. We are aware that VCs are lining up multiple businesses in their portfolios to quickly put in applications. Ultimately, it’s going to be about the viability of the businesses and we don’t think it’s going to be restricted to one deal per investor group. However with amounts of funding available between £125k and £5 million, when you start averaging that out, we’re not talking about a huge number of businesses that are going to get this money.
Is there any indication whether the private co-funders need to be approved as for other co-investment funds?
We haven’t seen those parameters yet. We have no idea whether there will be any additional tests to be passed by an angel syndicate bringing the match or even if it came from one individual angel. It’s all about the fact that there must be viable sources of match funding which is likely to exclude most angel and early stage investors under the current parameters. In the end, it’s going to be a deal that has to be approved. We would imagine there will be some scrutiny of who the investors are. We are concerned about the decision- making process and which investments will be accepted and whether there will be a fair distribution across stages, sectors, regions and gender.
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