Covid-19 coronavirus: UK launches Future Fund to support fast-growth businesses
21 April 2020
In what will undoubtedly be a relief for UK's technology and life science sectors, the government yesterday unveiled the ways in which it plans to support the community of fast-growth businesses that drive so much innovation within its domestic market and around the world.
Privately held UK businesses that have raised at least £250,000 in the last five years will be entitled to apply for loans of between £125,000 and £5,000,000 so long as the funds are at least matched by existing investors. Although some details will still have to be confirmed, the government investment will be by way of convertible notes, providing for a conversion into equity at a 20% discount if not repaid within three years.
Initial reaction to the announcement in the market has been cautiously positive. Although it will be important to assess the detail of the new scheme, the government's approach of using a well-understood funding instrument (the convertible note) would appear to be sensible. Both issuers and investors will be familiar with this type of investment and we would therefore hope that much-needed funds would flow reasonably quickly.
It is, of course, important for founders, investors and the companies themselves to carefully consider the pros and cons of taking on state finance. It is also important to weigh up the decision in light of the very many pressures facing these businesses in the current environment. A lifeline from government may well be essential but thought should also be given as to whether there are other competing priorities or other routes through the crisis to long-term stability.
It will also be important to understand the specifics of the government’s scheme before committing to the Future Fund. The indicative headline terms mention a number of provisions that may give issuers pause, including a most favoured nations clause, unspecified (but “limited”) corporate governance rights and an ongoing right to the same information as other investors. These may all be acceptable to start-ups and their stakeholders but, as ever, the devil will be in the detail.
Set out below are eight key considerations for high-growth and emerging businesses at all stages of development and their investors, both in relation to accessing government finance, and also the wider challenges currently facing the market:
(1) Do your existing arrangements permit you to seek the funding?
A careful analysis of the company's existing arrangements will be essential before taking on additional funding (whether from the government or otherwise). As a minimum, most companies are likely to need some form of shareholder and board consent and the relevant thresholds should be checked so as to avoid disputes further down the line (with particular care with regard to class rights). Do contracts with third parties (e.g. lenders) contain any relevant prohibitions? Do any of your investors have prohibitions on investing in entities alongside government bodies? A thorough assessment of such issues will help to ensure a smooth funding round.
(2) How will the investment interact with your existing funding documentation?
A funding round will typically take the previous round's documentation as a starting point. There is nothing to suggest that this will not be the case where the Future Fund is an investor but there may be nuances to consider in integrating the government instruments into your capital stack. Consider, for example, whether your liquidation waterfall will become unnecessarily complicated (e.g. with multiple liquidation preferences) and the interaction between existing pre-emption rights. Ensuring that the government's right to convert is properly documented and accepted by all will also be critically important. Early discussions with key stakeholders will likely be essential here.
(3) Not just short-term liquidity
Any assessment of runway and burn rate must now be viewed with the aim of providing enough capital to safely navigate the current crisis and grow into the recovery. This means a focus on medium-term needs as well as immediate funding requirements. A thorough assessment of available funding options (and the benefits and drawbacks of each) should be made: additional shareholder equity, venture debt, shareholder loans (including convertibles) and, now, government funding should all be considered.
Separately, does the interim funding round provide an opportunity to update the company's constitutional documents to allow for emergency or crisis funding in the future? Such provisions are not ordinary course in the UK growth market but may now be a sensible precaution.
(4) Are you ready to raise cash?
Whatever the circumstances, a funding round is a significant event for a business and requires a great deal of management time and attention. Being properly prepared is essential to gaining an edge and ensuring that the raise is carried off smoothly. Access to government funding is contingent upon investors matching the funds and it is therefore critically important to make that investment decision as easy as possible for the company's stakeholders. A well-organised data room, thorough understanding of the business risks, and a clear allocation of roles within the management team are all important. Reviews of earlier warranty schedules, disclosure letters and management questionnaires are often a good starting point. For a list of points to consider, our summary here may provide additional help.
(5) Business resilience and governance
A robust approach to business resilience and governance has rarely been more important. As part of any consideration of funding options, boards should review the company's positions on operational risk; accounting matters (including the continued solvency of the business); relationships with customers, suppliers and outside developers; and employees (see further below). Given that an economic downturn often brings with it an increase in disputes, a clear understanding of the potential for conflicts between the business and third parties will also be useful.
Investors and lenders will want to know that the company is focused on these matters and able to address risks as they arise. A&O Consulting has prepared a helpful set of prompts for board members to consider here.
Many of the companies that will be considering an investment by the Future Fund have been long-term advocates of remote working and will be well equipped to deal with at least some of the disruption we are all experiencing. They are not immune, however, from the wider pressures facing all businesses, with issues such as furloughing staff, reductions in headcount and employee morale all being relevant. Investors and lenders may also be considering these issues in relation to further funding. It is therefore prudent for management to think critically about these points and to do so regularly. Click here to read our guidance.
The role of the state in the economy is changing around the world, prompting new or amended regulatory arrangements for everything from capital requirements to data privacy and cybersecurity. The level of regulatory exposure will depend on the nature and stage of the relevant business but a comprehensive understanding of a company's current requirements together with close monitoring of possible changes will be vital both for the day-to-day running of the business and also for informing current and potential investors of the company's liabilities. An added layer of complexity is created where regulations are temporarily relaxed as businesses. If a business chooses to take advantage of the relaxation, it must ensure it is ready to move back to the more stringent regulations when they are re-imposed. Click here to read our guidance.
(8) Maintain focus
Notwithstanding the pressures currently faced by businesses of all shapes and sizes, it will be particularly important to maintain focus on the day-to-day necessities of running an expanding, innovative and IP-rich business. Protecting IP, fostering creativity, and defending culture will, among many other things, continue to be essential for the long-term success and stability of these businesses. Ensuring that appropriate systems are in place to preserve and protect the dynamism and drive of the business will be key to successfully navigating the challenges posed by the current market.