Funding information

Any Eligible Company can apply for a Loan that will be converted into equity of the Eligible Company on the occurrence of certain conversion triggers, with the form of the convertible loan agreement being prescribed by the UK government (Loan Agreement). There is no flexibility on how an Eligible Company can draw down funds from the FF (it must be a loan).

The level of and conditions around funding are unique to the FF, when compared to other facilities made available by the government to distressed companies. Please see our summary table on the UK government COVID-19 facilities at reedsmith.com. In summary, the key features of funding under the FF include:

• Loan amounts:
  • The FF will match 100 per cent of the amount provided by Private Investors, from £125,000 up to a maximum of £5 million.
  • If there is a group of Private Investors, the lead Private Investor must invest at least £12,500.
  • Eligible Companies can raise further sums outside of the FF portal within 90 days up to the headroom amount agreed in the Loan Agreement.

• Interest:
  • The Loans are repayable at an annual 8 per cent (non-compounding) interest rate, or any higher rate agreed between the Eligible Company and the matched.
  • Interest is not payable on a monthly basis and will instead accrue until the Loan converts, at which point the interest will either be repaid or convert into equity of the Eligible Company.

• Conversion and repayment:
  • Eligible Companies cannot choose to repay the Loan. Instead, Loans will be repayable in certain circumstances, such as the occurrence of a specific exit event, the maturity of the Loan, or an event of default. Events of default include the Eligible Company ceasing to pay its debts or carrying on all or a substantial part of its business, the commencement of any insolvency proceedings in relation to the Eligible Company and breaches of the Loan covenants. Loan covenants include a covenant by the Eligible Company and the Private Investors not to enter into any side agreements amongst themselves (or with other investors participating in any other existing convertible loan) that would adversely affect the economic interest of the FF under the Loan.
  • Conversion of the Loans into the most senior class of shares will happen in certain specified events, for instance, where amounts raised under the next fundraising round are equal to or exceed the FF’s funding (see ‘Conversion of the Loans’ below for further information).

• Maturity:
  • Loans will mature 36 months after the execution date of the convertible loan instrument.

• Security and ranking:
  • No security needs to be given.
  • Loans will rank alongside all other unsecured debts or obligations and are subordinate to any secured debt.

• Use of proceeds:
  • To prevent any misuse of the Loan for any purpose that is not directly connected to supporting the ongoing running of the business, the Loan cannot be used for the following:
    • Repaying any borrowings from a shareholder or a related party (other than any bank or venture debt facilities)
    • Paying any dividends or other distributions
    • Paying any bonuses or discretionary payments that are non-contracted or not in the ordinary course of business for 12 months
    • Paying advisory, placement or similar corporate finance type fees in relation to the convertible loan instrument

Conversion of the Loans

The FF contains a variety of conversion mechanics whereby the Loan will convert (with the Private Investors and the FF becoming shareholders in the Eligible Company) into the most senior class of shares. The key conversion mechanics include:

• 'Qualifying round’:
  • Where the Eligible Company’s next funding round raises an amount at least equal to the aggregate amount of the Loan, the Loan will automatically convert into equity.
  • Loans will automatically convert into the most senior class of equity issued by the Eligible Company, with the principal converting at a discounted rate of at least 20 per cent (but this can be higher, if agreed between the Eligible Company and the matched Private Investors) to the price set by that funding round.

• ‘Non-qualifying round’:
  • Where the Eligible Company’s next funding round raises an amount that is less than the aggregate amount of the Loan but more than 25 per cent of the Loan, the majority of Private Investors can elect for the Loan to convert into equity.
  • Where the Eligible Company’s next funding round raises an amount that is 25 per cent or less of the aggregate amount of the Loan, the majority of Private Investors, in conjunction with the FF itself, can elect for the Loan to convert into equity.
  • Loans will convert into the most senior class of equity issued by the Eligible Company, with the principal converting at a discounted rate of at least 20 per cent to the price set by that funding round, and any unpaid but accrued interest will convert without an applicable discount.

• Exit:
  • On a sale or initial public offering (resulting in a change of control or listing of the Eligible Company), the Loan will automatically convert into equity where the Private Investors and FF would be in a better position in the event of such a conversion as compared to receiving the Loan repayment.
  • The price per converted share will equal the lowest price paid by the Private Investors in the most recent funding round, subject to any discount to the conversion price having been agreed in the Loan Agreement.

In each of the above cases, the Loan will convert with the relevant discount rate; however, a discount rate will not be applied to any interest.

Process and key documents

Process

The application is investor-led, meaning that the Private Investors, or lead Private Investor of a group of Private Investors, certifies matters relating to eligibility under the FF. The Eligible Company then confirms the accuracy of the investment application before submitting the full application. Lastly, successful applicants must execute the Loan Agreement and satisfy certain conditions precedent before funds are released. The Loan Agreement is entered into between the FF and the Private Investors as lenders, and the Eligible Company as borrower.

Applications are expected to take a minimum of 21 days from the initial application to funds being awarded and are allocated on a first come, first served basis.

The FF requires the company to appoint a solicitor to facilitate completion. The solicitor must be permitted under the Solicitors Regulation Authority rules to receive and hold client money to order – i.e., the completion monies from the investors.

Key documents

Three prescribed documents must be completed, comprising:

• the Loan Agreement;
• a solicitor’s confirmation letter from the company’s nominated solicitor confirming that it acts for the company; and
• a director’s certificate confirming the fulfilment of certain conditions.

Whilst the Loan Agreement is generally non-negotiable, the UK government has enabled the following commercial provisions to be negotiated between the Eligible Company and Private Investors:

• Interest rate (although a minimum of 8 per cent applies)
• Conversion discount rate (although a minimum of 20 per cent applies)
• Headroom, which can be included for investments on the same terms (but such amounts will not be matched by the FF)
• Valuation cap, whereby there is a ceiling valuation at which the conversion into equity will occur (no cap will apply if it is not agreed)

Commentary

Loan Agreement

In keeping with the principle that the Loan Agreement cannot be negotiated or tailored for any specific business model, the Loan Agreement has been drafted with a view to being commercially practical. For this reason, the Eligible Company’s obligations and representations under the Loan Agreement are not, on the face of it, overly onerous or unworkable in the context of a start-up’s business. Correspondingly, the events of default under the Loan Agreement (mentioned in ‘Conversion and repayment’ above), which trigger a mandatory repayment requirement in respect of the outstanding Loan amount, are succinct and primarily address what would usually be considered the key concerns for any lender, being insolvency, cessation of business and non-payment of debts.

Notwithstanding this, Eligible Companies should be particularly aware of their ongoing obligations under the Loan Agreement to ensure that the obligations are feasible for them to adhere to. These encase, amongst other things, disclosure and information delivery obligations in the form prescribed under the Loan Agreement in respect of the Eligible Company’s accounts, forecasts, reports and capitalisations tables; restrictions on incurring other additional senior indebtedness which is not expressly permitted under the Loan Agreement; and an obligation to comply with all laws, including anti-money laundering, sanctions and anti-corruption laws. Whilst the Loan Agreement provides a 20-business-day grace period to cure any breach of these obligations, Eligible Companies should strictly monitor any breaches or potential breaches to ensure that a repayment obligation is not inadvertently triggered.

Role of the government

The FF is intended to provide emergency funding for start-ups in the form of a Loan, and this type of funding permits the FF and Private Investors to gain upside advantages where the Eligible Company is doing well by converting the Loan into equity of the Eligible Company. The FF initiative is a welcome development and will no doubt be used widely by early stages businesses that remain attractive to investors and viable. The FF is substantially different to each of the existing UK government COVID-19 finance facilities. Those major schemes were devised for immediate deployment to an ailing real economy, meaning that the process to receive funding was comparatively streamlined. The FF is noticeably not streamlined and has a longer time horizon given that the UK government is capable of receiving a controlling interest.

This form of funding is unlikely to form part of an initial investment strategy for a sophisticated investor. From the perspective of the Private Investor, many investors making an initial investment into an early stage business will want to blend equity and debt financing, build mechanisms of corporate control into the start-up’s organisational documents (including reserved shareholder and board matters), and take board seats in order to effectively supervise their investment. Co-investing with the FF does not permit this and gives little flexibility.

Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)

The UK government has made it clear that the FF loans do not meet the criteria to benefit from the tax reliefs under the EIS and SEIS. The industry has criticised this aspect of the FF given that it will likely be most beneficial to venture capital-backed companies.

European approaches

The FF is analogous with the approaches taken in France and Germany, where €4 billion and €2 billion, respectively, has been made available in support packages to start-ups. However, whereas the FF is generally available to any start-up companies (regardless of industry) that meet the eligibility criteria, Germany’s scheme is targeted at start-ups that have a market value of more than €50 million. Please refer to our previous alert setting out a summary of those French and German schemes.

Reed Smith is well positioned to advise potential borrowers and Private Investors on investment transactions, business acquisitions and disposals, financing arrangements, rescue and restructuring arrangements, as well as any M&A, capital markets or private equity transactions, or any type of commercial matter. Our transactional, regulatory, litigation, restructuring and structured products teams work seamlessly to find solutions for your business in UK and cross-border transactions.

Our Reed Smith Coronavirus team includes multidisciplinary lawyers from Asia, EME and the United States who stand ready to advise you on the issues above or others you may face related to COVID-19.

For more information on the legal and business implications of COVID-19, visit the Reed Smith Coronavirus (COVID-19) Resource Center or contact us at COVID-19@reedsmith.com

Client Alert 2020-387