Myles Hamilton is a Director in our M&A team. On the 20th April, the Government announced the launch of the Future Fund. It will issue convertible loans between £125,000 to £5 million to innovative companies which are facing financing difficulties due to the coronavirus outbreak. Myles offers his first impressions of the new scheme which launches in May 2020.
Having helped many early stage and innovative companies secure investment, the team here at Shaw & Co was very pleased to hear the Chancellor’s headline announcement that the Government is to provide a £1.25 billion support package aimed at the fastest growing of businesses.
Many high growth companies have found that they can’t access the Coronavirus Business Interruption Loan Scheme (‘CBILS’) because they are not generating the profit needed to service a bank loan. However, many of these businesses will be a key part of our future economic growth and must be supported through this crisis. Until now, they have felt ‘left out’ of the Government’s thinking.
Rather than debt from banks, early stage companies rely on equity investors for finance to support their growth with the sources of such finance ranging from High Net Worth Individuals (‘HNWI’) and Business Angels at the earlier stages to Venture Capital and Private Equity. As such some form of equity investment scheme was always going to be more appropriate.
So, the Future Fund has been announced to stimulate and encourage a public/private partnership to inject funds into the most promising of businesses. This partnership is designed to ensure selection of those businesses knowledgeable investors consider worthy of support.
Investment will be by way of a convertible loan note with the Government providing up to 50% of the funding to a maximum of £5m. A convertible loan note is a hybrid instrument that has the principal benefits of protecting the investor on the downside and kicking the debate around valuation down the road in the upside.
On the face of it this looks like a sensible plan and a good opportunity for earlier stage companies to secure additional funding. If the company can deliver strong growth within the next 3 years (the maximum expected term of the convertible loan) and more specifically before their next funding round, then the resulting dilution on conversion of the loan into equity should be acceptable to current shareholders. After all a compromise is needed to weather the storm. The funding won’t be without cost reducing returns for investors and founders; however, this is a common feature across the major Government support packages and comes as no surprise.
However, there is a major flaw. The scheme is not compatible with EIS investment.
To support investment in early stage business, the Government has historically offered tax reliefs to investors such as those that form part of the Enterprise Investment Scheme (EIS). The EIS (and Seed EIS) schemes are particularly generous as they are intended to support investment into the earliest stage, highest risk companies.
In most cases individual investors including HNWIs and Business Angels will specifically look for EIS eligible opportunities because of the substantial tax benefits, either directly or through an investment fund (of which there many) set-up to pool investor capital and invest in a portfolio of eligible companies. This has been extremely successful and EIS investment has been the largest source of early stage funding outside of London, which operates in a different ecosystem.
In structuring the Future Fund as a convertible loan note, without further specific concession from the Government in tax legislation, investors participating in the Future Fund scheme through matched funding will not be eligible for EIS relief on this investment and may also disqualify future investments. As such, one of, if not the most important source of early stage funding is being excluded.
It is therefore top of our agenda that the Government addresses this issue. We are hopeful that this can be rectified before the scheme goes live. Such an amendment will give early stage companies that are desperate for finance a much better chance of securing the private investment necessary to match that from the Government and so make this welcome initiative a success.
Other than this specific point, the headline terms being proposed appear investor friendly but that is to be expected if new private investment is to be secured in a market full of so much uncertainty and nervous investors. That said, a balance must be struck so that entrepreneurs do not conclude that they are better to put things on ice rather than take advantage of the funding being made available.
Entrepreneurs back themselves and their companies to succeed but they must also protect their investment and so consider what might happen if success takes longer than hoped or a pivot in the company’s direction is required.
One term we are looking at closely is the right of redemption at the end of the loan term, not because of the 100% premium which seems like a reasonable return on money for the risk profile of the investment, but because a company that has not been able to secure a qualifying equity round within the next 3 years may be left without money to repay and nowhere else to turn.
We are withholding judgement on much of scheme detail at the moment, awaiting further announcements from the Treasury and the British Business Bank. The devil, as the saying goes, will be in the detail.
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