Could your esports business benefit from the Government’s new Future Fund?

Esports is fast becoming an increasingly competitive industry not just in the UK but on a global scale thanks largely to the interconnected modern world.

With investment being a key component to scaling up a business, securing the appropriate funding has become a high priority for organisations in the industry seeking growth, from teams to tech providers. With no live sport on TV during the Covid-19 crisis in recent months we have seen a spike in interest in esports. It is now seen by many as a mainstream alternative to live sports, and it has been fascinating to see a rise in participation by professionals from traditional sports personalities as well as pure gamers.

The UK’s creative industry is expected to be worth in the region of £128.4billion to the UK economy by 2025 and recently published reviews and reports, including the Bazalgette Review, have encouraged the Government to fund esports tournaments, national teams and media coverage to help raise the status of esports. However, to date, no specific Government funding for traditional esports organisation has been provided, with the traditional routes to investment (ie private equity, crowd funding, friends & family) remaining the most viable options. Whilst not specifically aimed at the esports community, the Government announced its proposed launch at the end May 2020 of the Future Fund, its flagship support scheme for start-ups and scale-ups hit by the coronavirus, which may be a funding opportunity that could benefit the esports community.

The Future Fund is a £250million fund to support high growth companies who may not be eligible for funding under other Government schemes, which will be delivered in partnership with the British Business Bank and will be open for applications in May 2020. Investments from this fund will vary between £125,000 and £5,000,000. The scheme will initially be open until 30 September 2020, but will be kept under review and may be extended.
The headline terms have been published by the Government which are discussed in more detail below, however a number of key questions as to the practical application of the scheme still remain.

Will your esports organisation be eligible?

The main qualifying conditions require your esports business:

• to be an unlisted UK registered company with a substantive economic presence in the UK
• to have raised at least £250,000 in equity investment from private third party investors in the last 5 years, and
• to be able to attract match funding from third party investors and institutions – so that the Government contribution shall comprise no more than 50% of the total funding.

It is important to note, however, that if the business is part of a corporate group, only the ultimate parent company is eligible to receive the funding.

With all the “buzz” that’s currently around the esports industry it’s easy to assume that simply satisfying the conditions above will be enough to secure the investment. However, as is the case with all other industries seeking to secure investment, your esports business will still need to have in place a suitable business plan and forecasts that are both realistic and appealing to third party investors or institutions.

Main Terms

Investment from the Future Fund will take the form of unsecured convertible loan notes (“CLNs”). High growth companies, their advisors and the world of venture capital are familiar with CLNs – the current climate requires a speedy, hassle-free approach and CLNs may provide just this. The CLN structure also keeps the investment on track by avoiding delays caused by discussions around the valuation of a company, meaning your esports business can continue with its principal projects without much delay as such valuation debates can be deferred until a future significant equity funding round occurs.

Whilst the full terms of the CLNs have not yet been published by the Government, the headline terms require the following:

• Use of Proceeds – funding may be used for general working capital purposes, but not to repay borrowings, pay dividends, bonuses to staff or management, or in respect of the government loan, pay any advisory of placement fees or bonuses to external advisers
• Interest – the interest rate shall be 8% per annum (non-compounding) to be paid on maturity of the loan, unless a higher rate is agreed between the company and the matched investors, in which case the CLN interest rate will be the same as the higher rate agreed with the matched investors
• Term – the loan has a maximum term of 36 months
• Governance / other rights – the Government will have limited corporate governance rights during the term of the loan and as a shareholder following conversion of the loan. The company may not incur debt that is senior to the loan, although bona fide senior indebtedness from a person that is not an existing shareholder or matched investor is permitted
• Transfer – the Government will be entitled to transfer the loan and (following conversion) any shares without restriction to an institutional investor who is acquiring the Government’s interest in at least 10 companies in respect of which the Future Fund has an interests. The Government is also entitled to transfer without restriction within the Government and to other entities wholly owned by central government departments.

Whilst there is a £5 million cap on the Government’s investment, there is no restriction that any matched funding from third party investors or institutions to be similarly capped (thus the aggregate of the Government funding and matched investor funding is uncapped).

The esports industry is maturing and growing every day, when you couple this with the matched funding of the Future Fund and the recent spike in media coverage the esports industry has received, now may be the perfect opportunity for your esports business to seek further funding from third party investors or institutions.

Conversion

Under the Future Fund the CLNs will automatically convert into equity in the next fundraising round of the company which raises an amount at least equal to the aggregate bridge funding (being a “qualifying funding round”).

The CLNs will convert into the most senior class of equity issued by the company. The principal will convert at a 20% discount (or higher if agreed between the company and the matching investors) (“Discount Rate”) to the price set by that funding round. Any unpaid interest will convert at the actual (non-discounted) price in the funding round.

If a further funding round is completed within 6 months of the CLNs converting, the Government may elect to convert its shares into any senior class of shares created by such subsequent funding round.

On a non-qualifying funding round (being a round which raises less than the aggregate bridge funding), at the election of the majority of the matched investors, the bridge funding shall convert into equity at the Discount Rate.

On a sale or IPO, the loan shall either convert into equity at the Discount Rate to the price set in the most recent non-qualifying funding round (unless it precedes the date of the Future Fund loan in which case the conversion shall take place at no discount) or shall be repaid together with a redemption premium of 100% of the principal of the bridge funding – whichever will provide the higher amount for the lenders.

Many founders of esports business may wish to hold on to as much equity as they can, especially during their esports business’ early years. There are certainly many opportunities that do come with further investment from third party investors or institutions, as the right investor will bring specific value to your esports business to in turn optimise their return on investment.

Therefore, with the backing of the Future Fund many third party investors and institutions may seek to capitalise on the matched funding as it will reduce the amount of capital required directly from the third party investor or institution in order for them to gain a foothold and build strategic partners in the industry.

Repayment

On maturity of the loan, after 3 years, the loan shall, at the election of the majority of the matched investors (i) be repaid by the company with a redemption premium of 100% of the principal of the Government-provided amount of the bridge funding; or (ii) convert into equity at the Discount Rate to the price set by the most recent funding round. The Government’s loan shall convert unless it requests repayment in respect of its loan. Accordingly, we would expect almost all of the Government loans provided to convert into equity at the Discount Rate, given the punitive redemption premium.

Summary

For esports businesses that may not otherwise be eligible for funding under the Government’s other COVID-19 support measures and that have already received venture capital funding and are able to secure further investment, the matched funding offered by the Future Fund may be well worth exploring further when more details around the scheme are announced by the Government. At the end of June 2020, the Government clarified that for esports and other businesses with EIS investors the Future Fund, where EIS investors participate in the matched funding, this will not prejudice their previous EIS investment. This recent change is welcomed after much campaigning that the loss of EIS relief would make participating in matched funding particularly unattractive to EIS investors.

If you would like more information on Government funding schemes available for esports businesses please contact Rebecca Burford.