COVID-19 EXPERT LEGAL INSIGHTS

Has the S.O.S from startups been answered?

22 April 2020

Since the start of the coronavirus outbreak, the UK government has launched a number of schemes offering financial support for businesses. This support includes the Coronavirus Job Retention Scheme, the Small Business Grant Fund, the Self-Employment Income Support Scheme and the Coronavirus Business Interruption Loan Scheme (“CBILS”).
 

However, there have been growing calls from the UK startup community for more targeted support for the UK’s startup and high growth businesses. Over the past few weeks a new campaign, “Save Our Startups”, was launched with backing from prominent entrepreneurs and from industry bodies, and a petition to the government had attracted 6,000 signatures. 

The three points outlined in the S.O.S campaign were:

  1. The Government needs to provide an equity based liquidity package suitable to save startups at risk.
  2. The Government must fast track payments to startups from public funding schemes - in particular R&D tax credits and Innovate UK funding grants.
  3. The Government must change EIS, SEIS and VCTs to stimulate private equity investment into startup and high growth businesses.

Well, in the words of the singer Meat Loaf, “two out of three ain’t bad” and the UK government has now announced £1.25 billion in support for startups. This includes:

  1. Launching a new £500 million loan scheme for high growth companies called the Future Fund. This will comprise £250 million of government funding, on the basis that the amount advanced is matched by private investors. The scheme will provide UK-based early stage companies with convertible loans of between £125,000 and £5 million.
  2. £750 million of grants and loans targeted at small and medium sized businesses focusing on research and development. This will mostly be by way of accelerated payments and additional loans to existing Innovate UK customers, with some support offered to new applicants.

Why is extra support needed for startups?

As Rishi Sunak said in his announcement “It is critical that we don’t just maintain jobs and companies that already exist but we also encourage the businesses, jobs and technologies of the future”. Startups and high growth companies have become a critical part of the UK economy. They account for 30,000 businesses which employ 3.3 million people and some of the UKs most successful businesses have followed this high growth model, including the likes of Deliveroo and Citymapper.

While government support from the Coronavirus Job Retention Scheme is helpful to reduce costs, CBILS, which is meant to provide support to smaller businesses in the UK, is available to very few startups and scaleups. As explored in our blog coronavirus business interruption loan scheme a lifeline or a distraction because startups and high growth businesses focus on growth rather than short-term profitability, they are often not eligible for CBILS. CBILS is designed to benefit established businesses that can show that, were it not for the current coronavirus outbreak, they would be “viable”. In contrast, startups are often yet to make a profit and so would have difficulty satisfying the scheme’s criteria. In addition, the general criticism around banks being slow to process loan applications and banks focusing primarily on their existing clients, could disproportionately affect startups that may not already have a relationship with a bank.  

The new support for startups announced by the government also reflects similar support given to the sector by other European governments. The French government announced a €4 billion liquidity support plan for startups which includes a short-term bridging loans aimed at companies in need of refinancing between fund raises, the early payment of some research tax credits and cash loans from banks backed by government guarantees. The German government announced €2 billion in financial assistance, which includes public venture capital investors being provided with additional public funds to co-invest in startups alongside private investors, and access to existing loan financing being simplified.

Future Fund – what do startups need to know? 

The Future Fund will launch in May 2020. Further details of the scheme are still to be published but so far the government have released some headline terms. Some of the key points coming out of this are:   

  • Eligibility – the business must be an unlisted UK registered company that has raised at least £250,000 in aggregate from private investors in the last five years and has a “substantive economic presence in the UK”. Detail as to what is meant by substantive economic presence and how that will be measured by the government is yet to be confirmed.
  • Matched Funding – the government loan has to be matched by private third party investors. At a time like this raising investment from new investors could be difficult. Institutional investors and angel investors will want to focus on supporting their existing portfolio companies, at least to start with. So businesses are likely to look to their existing investors for the matched funding. Therefore the likelihood of a startup being able to access this scheme may depend on whether its existing investors have deep pockets. If a startup has only raised investment from friends and family or angel investors, the likelihood that they are able to provide matched funding of a minimum £125,000 may be slim.
  • Matched Funding – although we know that the government funding will be by way of convertible loan note there is no detail as to how the matched funding will need to be structured. If the matched funding is also required to be by way of convertible loan note this would be a disincentive to angel investors, as convertible loans are not SEIS or EIS eligible.
  • Conversion – the loan will automatically convert into the most senior class of equity on the company’s next qualifying funding round at a minimum conversion discount of 20% to the price set by the funding round (the “Discount Rate”). A qualifying funding round is where the company raises equity funding equal to the amount of the bridging financing. On a non-qualifying funding round the loan may convert at the Discount Rate at the election of the holders of the majority of the matched investors.
  • Redemption – On maturity of the loan (which is after a maximum 36 months), at the election of the holders of the majority of the matched investors, the loan shall either convert into equity at the Discount Rate or be repaid by the company. If repaid, the redemption premium is equal to 100% of the principal of the bridge funding. Such a high redemption premium is to ensure that the taxpayers receive a good return on the investment.
  • Interest – a minimum interest of 8% per annum will be charged on the loan and will be payable on maturity of the loan.
  • Transfer rights - the government will have the right to transfer the loan without restriction to an institutional investor. Having no visibility as to the identity of the institutional investor, which might well become a substantial shareholder in the company, may make startups uncomfortable.  

Should I apply?

As with any investment the devil will be in the detail and, as we saw with CBILS, there is likely to be some refining of the scheme over the next few weeks.

The S.O.S campaign had attracted some scepticism from others in the startup community, who felt that too generous a scheme might only prop up ventures which otherwise would fail. And even in the most favourable economic conditions, many startups will always fail. The Future Fund feels like a reasonable compromise. At a time when the Bank of England base rate is so low, the interest rate and Discount Rate are reasonably substantial, so there is a definite upside for the UK taxpayer. Furthermore, the requirement for a company to have already raised in the last 5 years and the further requirement for the matching funding, mean that the more flaky startups will not qualify.

For startups, as with all investments, you will need to balance the need your startup has for the money now, against the terms on offer and the potential dilution to existing shareholdings should the loan convert into equity. How will your existing investors react to an investment which may convert at what is a reasonably substantial discount, and also gives rights to the matched investors (which may well not include your existing investors) to determine whether the loan is repaid or converted?

If you do need money, explore other options that are available to you first, which could potentially be on more favourable terms. Remember, even under the Future Fund you will still need to raise the match funding, so if you are able to raise the whole amount needed from third party investors that may be preferable.

Contact us for more information and advice

If you would like further information or advice on whether this support is right for your startup, or any other corporate or commercial issue, please contact a member of the startups and investments team.

ABOUT THE AUTHOR

Emer Hughes is a Senior Associate in the corporate and commercial department. She advises small to medium-sized organisations across a range of sectors and industries, including startups and charities on a broad range of corporate and commercial transactions.

 

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