Why government funding could prove costly for startups and fast-growing businesses

The UK government announced on Monday a new £250m fund to support fast growing SME businesses. The Future Fund will make loans of between £125,000 and £5m to businesses, with loans needing to be match-funded by external investors. The Fund is only available to unlisted businesses that have a substantial economic presence in the UK and have previously raised external funding of up to £250,000 in the last five years. Loans will be delivered in partnership with the British Business Bank.

The loans, however, come with a catch: an interest rate of 8% and a trigger, such as an IPO or sale, that could see the loan converted into equity with a 20% discount to value, or repaid with a 100% premium.

“Businesses may firstly find it difficult to secure match funding from external investors,” Jack Clipsham, Partner and Head of Corporate Finance at Kreston Reeves comments. Kreston Reeves advises dynamic organisations, private individuals and families on their business, tax and wealth needs. They help them make confident decisions about the future.

The majority of investors, whether Family Offices, VC investors or Private Equity firms are currently very much focused on supporting businesses in their existing portfolios and not actively looking to make new investments. Businesses looking to take advantage of this pot of money are likely to have to turn to their existing investors who may well take a dim view of the Government’s terms

“Secondly, whilst the 8% interest rate is quite high it is pale in comparison to the rates associated with the trigger mechanism – a conversion into equity with a 20% discount or repayment with a 100% premium. Whilst this may be a good deal for the Government, businesses and investors may disagree.

“We would recommend that businesses looking for cash to see them through these unprecedented times look first at the various other schemes the Government has introduced before exploring the Future Fund. If other options are not open to businesses, then the Future Fund might prove expensive but a viable option, particularly if loans are repaid in full before any trigger points.

“We do, however, expect the Government to make further changes to the terms of this fund, particularly opening it up to businesses with EIS and VCT funding. We recommend that businesses watch this space.”