On April 20th the UK Government announced how it plans to help out high-growth companies make their way through the other side of the Coronavirus pandemic. Enter, the Future Fund, a £250,000,000 venture investing scheme deployed through the British Business Bank. The program aims to assist innovative companies that might struggle to survive the current climate and may have been precluded from funding assistance under the current Government schemes. The investment will vary between a minimum of £125,000 and a maximum of £5,000,000, (and, no detail yet whether Rishi Sunak will require his signature to be printed on each such cheque). What is quite interesting about this scheme is that it follows proposals that prominent venture capitalists in the UK have been espousing recently, showing that Government is actually: a) listening; and b) facilitating the needs of business.
Investments will be made by convertible loan note (“CLN”), a well-worn instrument in the venture capitalists’ toolbox. Under the terms of the loan, on a future funding round of the company, the amounts advanced to the company via the CLN will convert into equity at a 20% discount to the price per share paid by investors in that financing. The Government proposes to invest alongside other private investors and the CLN contribution shall comprise no more than 50% of the bridge funding being provided to the company by such investors.
To qualify for funding, a company must:
(i) be an unlisted UK registered company;
(ii) have raised £250,000 in aggregate from private third party investors in a previous funding round in the last five years; and
(iii) have a substantive economic presence in the UK.
Albeit this type of Government assistance is, to an extent novel to the UK, public-private funds of this nature are not that uncommon in the world of venture investing; Israel’s fabled digital economy was bolstered by government co-investment scheme led by the Office of the Chief Scientist, most notably through the Yozma program in the 1990s. There is an argument that not only will this program keep companies afloat in the very tough times ahead, it might also carry unintended consequences, acting as the necessary rocket fuel for innovative companies while their international competitors fall by the wayside.
There are a number of features that bode well about this program. Firstly, the Headline Terms published, run very close to the types of terms venture investors, companies and lawyers alike are familiar with, in short, it speaks their language. This ensures efficiencies to getting a deal done, as the wheel is not being reinvented. They are valued for their brevity, as the underlying legal document is short and to the point (and limited in legalese). The CLN as a venture capital tool is also well suited to this uncertain environment. It delays discussions around ascribing a valuation to a company, deferring those debates until a significant equity funding round comes along. Precious time can be lost arguing over valuation at the onset of an investment; the CLN cuts through this noise and gets funds into the company as soon as practicable on fairly standard and consistent terms. The CLN is the fast food of venture capital, it’s quick, it’s standardized and it will sustain you in the short term, which is exactly what is needed right now.
Some other notable features:
(i) interest on the CLN accrues at a rate of 8% per annum (non-compounding), which is ‘rolled-up’ into the principal amount to be converted into the Government’s equity (albeit the interest does not benefit from the 20% discount); and
(ii) the CLN converts into the most ‘senior’ class of shares at the follow-on fundraising. This means, if a new share class is created, ranking higher than the ordinary share class (the class of shares that most company founders hold), Government would be issued that preferential class (or ‘senior class’), thus attempting to limit their losses on any future insolvency of the company, as, on a liquidation event, they would presumably be paid first, before the ordinary shareholders, but after any creditors of the company.
It also seems as though Government is alive to criticisms that were leveled at it when the program was initially mooted, in that funding should not be made available to companies who are domiciled elsewhere. As above, to be eligible, the company must have substantive economic presence in the UK. Where a company is a group, only the ultimate parent company is eligible for funding and must be a UK registered company.
Ultimately, this should be welcomed news to a sector that has delivered significant growth to the UK economy, with estimates that the digital economy in the UK provides jobs for 2.9m people. That said, hopefully Government has learned from the lessons of the financial crises of the past and the ‘zombie’ companies it helped prop up. Venture capital by its very nature is risky, and while the Chancellor and the Government are taking their chances by donning their brand new Patagonia fleece gilets, the other option, complacency, is not a good look either.