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As a firm that works with high growth, innovative companies, we were excited to hear about the Future Fund when it was first announced in April.
Administered by the British Business Bank, the scheme is designed to support innovative companies facing financial difficulties due to the coronavirus crisis. It sees the Government match fund convertible loans of £125,000 to £5 million, with the loans converting into shares in the company if not repaid after three years, or in the event of an exit or new funding round.
The Future Fund opened for applications on Wednesday, May 20. We can see it having some appeal for businesses and investors, though in its current form we would be surprised if it proves to be more than a niche solution to the current funding challenges for early stage businesses.
It may be that the rules change or another product is brought to the market, as has happened with the Coronavirus Business Interruption Loan Scheme, but for now there are some potential barriers to take-up of the Future Fund:
- £250,000 equity raise as a pre-requisite for eligibility
This is going to be a barrier for lots of early stage high growth companies, specifically when one considers that the company must have raised £250,000 in equity from third party investors in the last five years.
The definition of a third party investor is: “An individual or entity that invests in the share capital of a company, other than any founder, employee, worker or consultant of the company and any of their connected persons.”
However, investment from non-executive and investment directors and from third parties who appoint an ‘investor director’ can count towards the £250,000 raised, and will be eligible for match funding.
So equity invested in the past by the founders, their family or other executives will not count towards this £250,000. However, given that Enterprise Investment Scheme investments also have to come from ‘unconnected’ investors, companies who have raised EIS funds in the past may be able to count those prior investments towards the £250,000 required to qualify for the Future Fund.
- EIS and Seed Enterprise Investment Scheme
Many early stage companies may find the Future Fund is not suitable for their needs, as such companies often attract external investors with tax breaks through the EIS or SEIS schemes. Unfortunately, the Future Fund will not qualify for these reliefs, so the new private investors will need to be prepared to invest without these tax incentives. This removes a large number of funds who may have been prepared to invest alongside the Government in this scheme.
It is important to note that if you find investors who are prepared to invest without EIS or SEIS relief, these investors are then excluded from investing in your company under these schemes in future.
- Care on conversion – point 1
Future Fund investments are designed as convertible loans, so that at pre-determined times (such as a company sale) the loans will convert into equity. Care will need to be taken over exactly how this conversion occurs as, unless the conversion falls into specific tax relieving provisions, the debtor company can be taxed on the amount of the loan ‘released’.
A genuine debt for equity swap would normally fall into one of these tax relieving provisions, however HMRC commentary says that the investor receiving the equity shares should not have immediate plans to dispose of them – which of course would be the case when the trigger event is a company sale.
- An investor-led process
We have often heard the expression “like herding cats” applied to pulling together a group of business angels to invest into a company. This may be a result of these business angels being a collection of individuals with varying degrees of interest and time capacity to be anything other than passive investors.
Since it is an investor-led process, the onus for any application to the Future Fund is placed on one of these “cats”. It therefore relies on a business having an investor or investors lined up, as the scheme does not offer a matchmaking service.
- It ignores the ‘crowd’
One of the most prevalent and interesting developments in high growth companies over the past decade has been the engagement of the ‘crowd’ in providing equity (and reward) based funding. However, the Future Fund seems to have no capacity for the crowd to be involved, which some might see as a missed opportunity.
- Care on conversion – point 2
Potential applicants need to be very conscious of the implications of Future Fund investments. If the loans are converted into shares this will have a diluting impact on existing shareholders, and the shares held by investors could be sold in a manner that is against the wishes of the original shareholders.
- Innovative companies have other options available to them
As noted above, the crowd and business angels are sources of equity funding that may be more attractive and easier to secure than investment via the Future Fund. For businesses at the research and development stage, there are also R&D Tax Credits and/or grants and loans administered by Innovate UK (and others) to consider. On the latter, at the same time the Future Fund was unveiled a package of funding totalling £750 million from Innovate UK was also mentioned – more details of this were revealed last Friday.
We wish the Future Fund all the best and will be pleased to use our expertise to assist those who meet the eligibility criteria and think this is the funding type for them in making an application. It is definitely the most intellectually interesting member of the coronavirus loan family.
Want to know more?
Read our overview of the Future Fund and how it works here.
More information about the range of support schemes available can be found in our Coronavirus Updates hub.