The devil is in the detail
The Future Fund, which is to launch in May, will provide loans of between £125,000 and £5 million, subject to matched funding from private investors.
While further details of the scheme, to be operated in partnership with the British Business Bank, are awaited, the published term sheet for the funding suggests that the current shareholders will need to be pretty confident about their ability to rise with the anticipated post-coronavirus recovery of the economy. If they are not able to sell or list their company within 3 years, then what the Government is offering is a loan at over 40% interest, with onerous terms.
The scheme will apply to companies which don’t have historic profits to enable them to access the Coronavirus business loans. If the company is urgently seeking funding, it’s a reasonable assumption that if it is profitable its 2020 profits are not going to be high. It would need to have sufficient growth in its 2021 and 2022 EBITDA to allow it to sell or float by mid-2023. Every other company that has taken the HM Treasury funding will be under pressure to sell by the same deadline, so there may be plenty of competition for buyers’ attention.
The published term sheet shows that HM Treasury will be charging 8% interest, but the key point is that the loan is a fixed-term loan for 3 years, and if the lender chooses not to convert the loan to shares, and if there is no sale or IPO by the end of the term, then the lender has the right to demand repayment with a 100% premium. That is, HM Treasury gets its money back and then the same amount again, so to repay a £1,000,000 loan will require £2,224,000.
If the Treasury does decide to convert its loan to shares, the loan will convert to shares with a minimum discount of 20% at the next funding round: the number of shares it receives is computed by charging it only 80% of the price paid per share by other investors.
There has been comment that the Treasury has taken advice so that the funding represents market terms. It would be interesting to know whether the timing of the recovery has been brought into that consideration. It seems that a company seeking funding might want to move its accounting date to show its post-recovery growth in accounts to, say, 31st May 2023.
Better the angel you know?
Those investors who are being asked to match HM Treasury funding to allow a company to access this scheme might also consider whether they are prepared to invest more so that the company doesn’t need to access the government scheme, as otherwise they risk their investment effectively being used to fund the 100% premium to the Treasury.
This is particularly the case if the investor wants Enterprise Investment Scheme (“EIS”) or Seed SEIS (“SEIS”) relief, because if the matched funding has to be structured as a convertible loan identical to the Treasury funding, then it won’t qualify for EIS/SEIS relief. It should also be noted that once an investor has made an investment in a company which doesn’t qualify for EIS/SEIS, no subsequent investment can ever qualify for the relief.
Suppose instead that a prospective investor provides funding now via an advanced subscription agreement which qualifies for EIS, with the intention to issue the shares in 2021, and suppose that he has income in 2020/21 sufficient to use the relief and gains in 2019/20 that he can claim deferral against. He can claim EIS income tax relief worth 30% of the amount invested against his income for 2020/21 and thus his payment on account due on 31st July 2020, and CGT deferral relief worth 20% against his gain, effective on 31st January 2021.
In those circumstances, the investor has managed to get HM Treasury to “donate” funding of 50% of his investment to him by giving the tax reliefs available; HM Treasury has matched half of his investment, with considerably less downside and considerably less hassle.
From the perspective of the shareholders in the high-growth company, including the founders, there is flexibility to sell or float at a time of their choosing, the risk of the 40% interest rate is avoided, and the potential practical problems of having a government shareholder is avoided. They may well be prepared to offer a significant discount to the angel they know to get his funding instead.
Obtaining EIS relief is not a simple matter and is a subject on which we advise frequently. If you would like to discuss this, please contact us.