Proposed future fund loans to mitigate the effects of COVID-19 on innovative companies

The key terms are as follows:

• The Government will grant companies bridge funding loans which will be convertible into equity in certain circumstances.
  
  
• Private third parties ("Matched Investors") will need to contribute equivalent funds to the company as are being contributed by the Government, as the Government's portion of the bridge funding must constitute no more than 50% of the total amount of the loan. The bridge funding loan from the Government will be unsecured and will be made available alongside the Matched Investors.
  
  
• The interest rate shall be agreed between the borrower and the majority Matched Investors from the outset (subject to a minimum rate of 8% annual, non-compounding, interest).
  
  
• A maximum maturity period of 3 years.
  
  
• The minimum loan provided by the Government will be £125,000 and the maximum will be £5,000,000. There is no cap on the amount that Matched Investors may loan to the borrower and therefore no cap on the aggregate bridge funding being provided.
  
  
• Maturity or prior Exit. Upon maturity or a prior sale or IPO of the borrower, the loan will be either (i) be converted into equity at the price for the most recent non-qualifying funding round (and if there has been a non-qualifying funding round since the loan was made, at the Discount Rate, as defined below, to the price), or (ii) repaid with a 100% redemption premium (plus, it is expected, interest). In terms of whether redemption or conversion applies, upon:
  
  
  • maturity, the majority Matched Investors shall be entitled to elect which one applies, provided that the Government's portion of the loan shall convert unless it expressly requests redemption; and
    
    
  • a prior exit, the current guidance suggests there will be no optionality and the result which provides the "higher amount to the lenders" will automatically apply.
    
    
• Qualifying Funding Round. The principal amount of the loan shall automatically convert into equity on the borrower's next "qualifying funding round" at a conversion discount (as agreed between the borrower and the majority Matched investors from the outset, subject to a minimum discount of 20% (the "Discount Rate")) to the price set by that funding round. For example, if on the qualifying funding round the price to be paid per share by the new investors is £1, where the Discount Rate is 20% the Government and the Matched Lenders will convert their loan into equity at the price of £0.80 per share. The borrower can elect either to (i) repay the outstanding interest or (ii) have the outstanding interest converted into equity on the same terms as the underlying principal amount, except that no Discount Rate shall be applied to the outstanding interest.
  
  
  • A "qualifying funding round" takes place when the borrower raises an amount in equity capital equal to at least the aggregate amount of the loan. It is expected that equity capital raised over multiple rounds will be aggregated for the purposes of this test.
    
    
• Non-Qualifying Funding Round. If a borrower raises an amount in equity capital that is less than the amount required for a "qualifying funding round", the majority of the Matched Investors shall have the option to require the loan to convert to equity at the Discount Rate to the price set by that non-qualifying funding round.
  
  
• In the event of any accrued but unpaid interest on the loan being converted into equity (under any of the above scenarios), it shall convert without any discount being applied.
  
  
• The loan shall convert into the most senior class of shares in the borrower (including a further right to convert to the most senior class following any further funding round that takes place within 6 months of the original conversion).
  
  
• The bridge funding (including that provided by Matched Investors) shall be used for working capital purposes only, save that the funding provided by the Matched Investors may be used to pay advisory or placement fees to external advisors.
  
  
• The Government shall have rights of transfer in respect of the loan (or any shares if the loan has been converted) to any institutional investor which acquires a portfolio of the Government's interest in at least ten borrowers under the Future Fund Scheme.
  
  
• While participating in the Future Fund Scheme, the borrower will be subject to certain covenants (including on its treatment of holders of conversion equity and provision of information), a negative pledge over taking senior ranking loans (other than bona fide third party senior indebtedness) and a most favoured nation provision (under which it will not be able to subsequently grant conversion equity on more favourable terms).

In order to be eligible for the Future Fund Scheme, a business must:

• be an unlisted UK registered company with a substantive economic presence in the UK; and
  
  
• have raised at least £250,000 in aggregate from private third-party investors in previous funding rounds in the last five years.

Where a borrower is part of a corporate group, only the ultimate parent company is eligible to receive the loan, provided that the ultimate parent company is a UK registered company. If the ultimate parent company is not a UK registered company then it is not clear whether this means that (i) no member of the group will be entitled to participate in the scheme or (ii) the borrower can be a UK registered member of the group (that is not the ultimate parent). Any eligible borrower will be subject to KYC, fraud and money laundering checks prior to any loan being made.

Commercial Questions

• Although the scheme will be available until at least the end of September 2020, fundraisings of this nature can be time consuming (especially with third party investors who will need to undergo their own diligence and potentially credit approval processes). It may not therefore be the necessary solution for a business that is facing immediate cash flow problems as a result of the current crisis.
  
  
• It is not clear how the "third party" test will operate, and so it may be difficult in some circumstances to assess whether a borrower has already raised £250,000 from private third party investors, or whether a Matched Investor can be treated as such.
  
  
• Borrowers should consider what records need to be kept to evidence that the loan has only been used for working capital purposes.
  
  
• Considering the Government is entitled to transfer the loan and any shares that it holds to an institutional investor (provided it buys a portfolio) or within Government, it will be important to ensure after that transfer that any transferee is subject to the same restrictions on transfer as other third party investors in the borrower.
  
  
• Having received recent investment from third parties, it will be important to assess at an early stage what, if any, consents the borrower will require under its shareholders' agreement (if there is one) and articles of association as well under general corporate law.
  
  
• If the borrower or its subsidiaries are already party to third party financing arrangements, careful analysis of that financing documentation will be necessary to determine if any consents or waivers are required to access and comply with the Future Fund Scheme (e.g. for incurring additional debt, impact on any maintenance financial covenants and the ultimate ability to convert or repay the loan).

Tax Questions

• Interest (together with any premium paid) will not be deductible for corporation tax purposes on either the Government loan or the Matched Investor(s) loan because the bridging loan is convertible.
  
  
• If the loan is made to the parent entity of a corporate group and the loan is converted to equity, the entity making the loan on behalf of the Government will become an equity holder in the parent company, which could give rise to potential degrouping issues.
  
  
• Once it is clear who the lending entity will be, withholding tax may need to be considered. In any event, it is not clear if the Matched Investors' proportion of the bridge loan can be listed to prevent withholding tax applying to interest payments.
  
  
• If management, directors or employees are included in part of the funding by Matched Investors (to maintain equivalent holdings of equity and debt in a group as any institutional investors), in order not to have their shareholdings diluted by any subsequent conversion, groups will need to undertake an analysis of the conversion of the bridging loan to establish whether there are employment tax consequences for the borrower and the individuals concerned.
  
  
• As the bridging loan can only be made to the ultimate parent of a corporate group, corporate groups will need to consider how to move the funding to the relevant operating company that needs the working capital (and how to unwind those arrangements so that the companies that received funding can repay the bridging loan in due course).
  
  
• Foreign incorporated companies that are UK tax resident do not currently appear to qualify for the Future Fund Scheme, as currently the headline terms of the scheme state that the loan will be made to the ultimate parent company of a corporate group which needs to be UK registered to receive the loan.

Please do pick up with your usual Travers Smith contacts of any of our team to discuss any issues that may be pertinent to your business.

We will continue to monitor the announcements made in respect of the Future Fund Scheme and will provide further updates as more information becomes available.