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Future Fund investment
Funding Guides Apr 21, 2020 3 min read

The government’s Future Fund won’t help UK startups

Anthony
Anthony Rose

Few startups will qualify, and for those that do it’s a bad deal

This article was written before the final Future Fund documentation was made available. We updated this article on 30 May 2020 to reflect the latest information available since then.

There’s been a great deal of excitement and expectation in the UK startup community about the government’s “save the startups” Future Fund.

We’ve looked carefully at the details, our conclusion is that the fund is not suitable for its target audience and is unlikely to be of help to your company. And, even if it was, it has some terrible deal terms, including a shocker that indicates the deal terms were driven by VCs looking to be the match investor beneficiaries.

Our detailed analysis is below, but in short:

  • The £250M pot is woefully small, it will benefit perhaps 5% of startups that need funding.
    Update: The government has subsequently stated that the £250M was only on initial amount, that they intend to top up the fund, and the nobody will lose out for lack of funds.
  • Whoever came up with the package failed to understand that the vast majority of early-stage UK funding is powered by SEIS/EIS. The scheme, as it stands, is incompatible with SEIS/EIS.
  • Worse, even if you persuaded an angel investor to invest without SEIS/EIS for this investment to help your company in this time of need, the SEIS/EIS rules would preclude them from ever getting SEIS/EIS again in your company, so that investor is lost for future rounds.
    Update: The government has stated that they plan to talk to HMRC to fix that, though it’s not clear if that will happen.
  • Some of the deal terms are awful, the sort of thing a VC’s lawyers would come up with and your lawyers would tell you to never agree to. Except here there is no lawyer on your side, it’s take-it-or-leave-it, with the government, for no good reason, including deal terms that see a 2X pay-out to the investors and the government if the company doesn’t do another funding round before the convertible note hits the 3-year maturity date.

Will your company benefit from this scheme?

Let’s start by seeing which companies would be in a position to benefit from this scheme:

  Can benefit from the scheme
You’ve raised less than £250K so far No. The company needs to have raised more than £250K already.
You don’t have investors currently lined up No. The scheme provides match-funding, which means you need to find other investors first. If you don’t have other investors, the scheme can’t help.
You’re starting discussions with investors No. Since there’s only money for perhaps 1000 companies in all of the UK, if you’re only starting to look for investors now, it’s probably too late.
You have existing outstanding convertible notes, ASAs or SeedFASTs that you issued in the last year No. Those agreements probably won’t be compatible with the terms of the scheme, and unless you renegotiate the deal terms you won’t be able to count them for match funding. Entering into this scheme may also conflict with the terms of those convertible notes.
You have SEIS/EIS angel investors lined up, ready to invest, maybe as a follow-on from your last round No. The scheme isn’t SEIS/EIS compatible. So, bad news, those investors won’t be interested in investing.
Your company doesn’t have revenue yet No. Companies that are pre-revenue are generally too early for VCs or funds and rely instead on SEIS/EIS angel investment. Since the scheme isn’t SEIS/EIS compatible and you’re too early for funds, you’re out of luck.
You’ve found £100K in match funding investment No. Great work having investors lined up! Unfortunately the minimum investment for the scheme is £125K, you need to find at least £125K before you’ll qualify.
If you could raise just £150K, that’s all you need to tide you over till things pick up No. Sorry, the minimum you can use the scheme for is £250K, you’ll need to find more investors and incur more debt than you need.
Your business is revenue generating, you’ve raised more than £250K, you’re not offering SEIS/EIS, you don’t have outstanding convertible notes, you do have new investors lined up, those investors are happy to invest with a convertible note rather than a funding round, and they’re comfortable with the government’s deal terms. Yes. Congratulations, this scheme may be useful to you.

You’ll need to find those investors quickly though, because there’s only money for 1000 or so companies.

Be sure to check the deal terms… keep reading…

Okay, great, you made it this far, your company is in the target zone to use the scheme.

Is it a deal you should take?

The next question is… should you take this deal? To answer that, let’s take a quick look at the key deal terms (our full analysis of the deal terms here):

  A typical convertible note Future Fund deal terms
Conversion into shares in next round Investors get the most senior class of shares in the next round Ditto, but if you then go on to issue better shares in the 6 months after that, the investors get a free upgrade to whatever share class you offer to investors in that round.
Repayment After 3 years the loan plus interest can be repaid, or (typically if the company doesn’t have the money to repay the loan) turned into equity. After 3 years, DOUBLE the loan is to be repaid to the investors and the government if you haven’t done a funding round before then, should the investors decide that the loan is to be repaid rather than converted into equity.

If you don’t have the cash to pay back the loan then, your company will be bankrupted.

Company decision-making Convertible note investors aren’t shareholders, but are often given some consent rights Similar, but the government gets some consent rights… and who knows how long it will take to get government permission to do any number of still-to-be-defined company actions…
Transfer rights Investors can usually transfer their investments within their group, but not beyond. The government can sell their ownership in your company to anyone they want, which could include selling a stake in your business to a fund with interests in a competitor of yours, or a fund that invests in fracking, etc.

Summary

In summary, the government had a difficult job here, they needed to avoid being accused of throwing away taxpayer money indiscriminately, and they also needed to find a way of funding large numbers of companies at short notice. That rules out investment committees reviewing pitch decks, which would take months to make even a dent in the number of applications they would get and lead to endless challenges about subjective bias, etc.

The problem is that they’ve swung the dial too far the other way. Basically, it looks like a bunch of VC lawyers got together to try to come up with the best deal terms that an aggressive investor would squeeze out of a distressed company that had nowhere else to go. But that’s not the goal here, it’s for the government to come up with a scheme that really helps startups, not puts them in a position where investors get 2X their money back and take control of the business if the company can’t or doesn’t need to raise investment later.

Worse, the scheme creators failed to understand that the UK startup ecosystem is fuelled by SEIS and EIS angel investment, so by creating a scheme that’s not SEIS/EIS compatible, they’re making it useless for the very audience that can most benefit from it.

So, what’s the answer?

We’d love to see a modified set of scheme deal terms that

  • are compatible with SEIS/EIS
  • lower the match funding minimum to £50K Future Fund plus £50K investors
  • are compatible with existing outstanding convertible notes, ASAs and SeedFASTs
  • can be converted into equity on maturity rather than bankrupting the company
  • have repayment terms that won’t dissuade future investors from investing in the company
  • have deal terms that make it harder for the match funding VCs to drive the Discount Rate up and the Valuation down holding founders to ransom later.

Until then, our conclusion is that this scheme will benefit few startups, and those who qualify should think carefully before signing up. Most startups would be better off ignoring the scheme and focussing on finding SEIS/EIS angel investors, and the government would do better to focus its efforts on SEIS/EIS tax breaks than this scheme.

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