The British Business Bank (BBB), responsible for delivering the UK government's Future Fund (FF), has published a revised Directors' Certificate that includes a new obligation to confirm that none of the private investors participating in the relevant FF convertible loan agreement are 'connected' with the applicant company.
These changes will reduce the number of companies eligible for the Future Fund, and will affect many applicant companies in a way that we do not believe is intended or appropriate in the context of the purpose and goals of the Future Fund. We have contacted BBB and the Treasury to request amends (see Our interpretation and action below for more information).
Please note that this is a high-level summary of the changes, which is intended to alert companies and investors to the potential risks of the new obligations. The issues described in this article are complicated and the analysis in relation to each applicant company will be different and fact specific. This overview should not be solely relied upon.
If you have concerns regarding your company's ability to give the confirmation set out in clause 2 of the Directors' Certificate, you should seek appropriate legal advice.
More detailed advice and analysis can be provided on request; please contact corporate technology partners Angus Miln or Howard Palmer using the details provided on this page.
What the update entails
The revised Directors' Certificate, published on 2 June 2020, includes a new obligation to confirm that none of the private investors participating in the relevant FF convertible loan agreement (CLA) are 'connected' with the applicant company.
The Directors' Certificate states that "connected" is to be determined by reference to s.1122 and s.1123 Corporation Tax Act 2010 (CTA), rather than s.1124 (which arguably contains a more appropriate control test). Sections 1122 and 1123 import the 'economic control tests' from sections 450 and 451 CTA 2010.
The economic control test will capture an investor that holds shares which carry a liquidation preference to the extent that such investor, together with its connected persons (related fund entities etc), would be entitled to receive over 50% of the proceeds available for distribution in the event of the winding up of the company (or in any other circumstances) on the date the test is applied (ie the date the Directors Certificate is signed).
Who it applies to
A significant portion of the companies that are intended to benefit from the Future Fund scheme (including almost all companies that have institutional venture capital investors) will have investors that benefit from some sort of liquidation preference.
The issues described in this article potentially apply to all of those companies, to the extent they have investors that are intending to participate as private investors in a FF CLA.
A company, not otherwise controlled by the private investor(s), will potentially be caught by these provisions, if:
- it has one or more investors who are intending to participate in the FF CLA that are also existing shareholders in the company
- those investors hold shares which carry a liquidation preference - including an "EIS qualifying" type of liquidation preference attaching to a separate class of ordinary shares – regardless of the nature of that preference (participating vs non-participating; with or without a multiple and/or a cap), and
- any one of those investors, together with its connected persons (eg related fund entities), would be entitled to more than 50% of the proceeds available for distribution in the event of the winding up of the company (or in any other circumstances) were any such event to occur on the date the Directors' Certificate is signed or at any time from that date until closing of the FF CLA.
A company, not otherwise controlled by the private investor(s), will also potentially be caught by these provisions if the company has one or more secured lenders who are participating in the FF CLA as a private investor.
Although less common in the market (and therefore less likely to be an issue in practice), investors with certain forms of preferred dividend income entitlements may also be caught by the economic control tests.
How investors can avoid 'control' status
A company that would otherwise be caught by these economic control tests may avoid an undesirable outcome (whereby a participating private investor is deemed to 'control' the company, and therefore be prevented from participating as a private investor) if:
- It has three or more investors that hold shares carrying a liquidation preference such that none of them individually (but together with their respective connected persons, related fund entities etc) would be entitled to more than 50% of the proceeds available on a return of capital in the event of the winding up of the company (or in any other circumstances) – regardless of the value of the company's assets or its valuation in connection with a sale. In this context, the more investors a company has, the less likely it is that any single investor or group of connected investors would be in this position.
- It has a pari passu preference 'stack', rather than a "last money in, first money out"-type preference stack (since any distribution on a return of capital is likely to be spread amongst a greater number of investors, thus reducing the likelihood of any single investor (together with its connected persons, related fund entities etc) being entitled to more than 50% of the proceeds available for distribution.
- It has a senior or venture debt facility in place and/or other liabilities on its balance sheet which suggest that there would be no proceeds available for distribution to the equity holders were the company to be wound up on the date the Directors' Certificate is signed – but noting that similar arguments in relation to an analogous situation in relation to the availability of Entrepreneurs' Relief have been rejected by HMRC, so companies may be reluctant to rely on this argument.
Directors beware
The relevant confirmation (set out in clause 2 of the Directors' Certificate) is subject to an awareness qualifier that may deter companies and/or investors from making proper enquiries in relation to this test. However, if a Directors' Certificate is submitted which contains inaccurate information, it risks triggering an event of default under the FF CLA which would give rise to a redemption right on the part the Future Fund (and/or the private investor(s)).
The Director's Certificate is given by a director, who has been authorised to do so by the company. The certificate is given by the director in his/her capacity as a director of the company and, accordingly, may involve personal liability if the statements prove to be incorrect. The statement relating to connected parties is provided subject to the director's awareness, but that would not entitle the director to give the statement recklessly without proper consideration. Further, there is a statement in the certificate that the director acknowledges that the Future Fund will be entering into the CLA and providing the loan, at least in part, in reliance on the contents of the certificate. As such, there is a nexus of reliance between the director providing the certificate and the Future Fund. In order to avoid potential personal liability, the director should ensure that the contents of the certificate are accurate.
Safe harbours
There are some potential 'outs' or safe harbours for companies that are potentially caught by these provisions (as outlined above) but these will only apply to some companies.
Whether the 'outs' or safe harbours apply will largely be dependent on the composition of the company's investor base and capitalisation table. The potential 'outs' or safe harbours do not apply on a rational or defensible basis across the market or the universe of companies that are intended to benefit from the Future Fund scheme – the stated aim of the scheme being to support innovative companies which are facing financing difficulties due to the coronavirus outbreak and are otherwise unable to access other government business support programmes because they are either pre-revenue or pre-profit.
Our interpretation and action
We believe that the recent change to the Directors' Certificate was not intended to give rise to the issues described above, and will affect many applicant companies in a way that we do not believe is appropriate in the context of the purpose and goals of the Future Fund.
We have contacted the BBB and Treasury legal teams to request that the Directors' Certificate is amended so as to either:
- refer to s.1124 CTA 2010, which is arguably a more appropriate test in these circumstances (since it relates to voting control, board control and the power to otherwise direct the affairs of the Company – and is asset and company valuation agnostic), or
- deem s.450 CTA 2010 to be modified for the purpose of applying to the connection test, in a similar way adopted in connection with VCT legislation such that the connection test in s1122 is adopted, but with a provision that s450 (as applied by s1123(1)) is deemed modified - for example, by removing s450(3)(c) and s450(3)(d), so that typical, market standard liquidation preferences do not inadvertently result in a disqualifying "connection".
