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I) Investment restrictions

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This section specifies the investment restrictions that will apply to all ECFs, and that will therefore be written into the partnership agreements. Applicants may commit to more restrictive conditions as part of their proposals, and CfEL will regard this as a very positive feature if the applicant can demonstrate that it will be constrained to invest in an area where the equity gap is particularly severe. If these more restrictive conditions are to be considered as part of the assessment process, the prospective manager must indicate how they will be incorporated into the partnership agreement.Schedule 1 of each draftpartnership agreement provides some possible suggestions.


(a) Investment sizes – first investment


There is no lower investment limit for the ECF programme as a whole, though in assessing the proposals CfEL will consider the likely interaction between a proposed ECF and existing publicly supported venture funds. Where a proposed ECF is directly targeting a part of the market that is well served by existing suppliers of risk capital (including other publicly-supported funds), CfEL is unlikely to be satisfied that the ECF would be tackling a genuine gap in the market.


Specific criteria for the maximum size of investment are needed to ensure that investments are in the equity gap, and not made as part of syndicates that take the investments beyond the equity gap. At the same time, the Government recognises the need for some flexibility for ECFs to follow on successful investments, in order to protect their equity stakes from dilution in subsequent funding rounds.


Applicants are welcome to specify tighter criteria to be included in the ECF partnership agreement, but the following restrictions will apply to the first investment made by an ECF in a particular company:

an ECF may not invest, or agree to invest, more than £2 million in that company; and

an ECF may co invest with other investors, including other ECFs, so long as the total amount invested or agreed to be invested is no greater than £2 million. In complying with the £2 million limit, the ECF must take account of all investors, including the ECF itself (but excluding investors who are only providing debt finance with no equity or quasi-equity elements).


Suitable provisions will be built in to the legal documentation for each ECF to ensure that these restrictions cannot be breached, and further details are given in the draft partnership agreement at http://www.berr.gov.uk/files/file41229.pdf. [ www.capitalforenterprise.gov.uk ]


(b) Investment sizes – second and subsequent investments


Within a period of six months from the ECF‟s initial investment in a particular SME, follow-on investments in that company will be permitted only where the total amount invested in that company (including the initial investment) is no more than £2 million. The ECF will need to


Guidance for Prospective ECF Managers - 16


take account not only of its own investments on or after the date of initial investment, but also those made by any other investor (except an investor providing only debt finance).


Once that period of six months has elapsed, more flexible provisions for follow-on investment will apply. Follow-on investments will be permitted if:

EITHERthe cost of all the ECF‟s investments in the SME will not exceed £2 million;

ORthe investment is necessary to prevent or reduce dilution of the ECF‟s equity stakein the company, and the total cost of all the ECF‟s investments in the company will not exceed 10 per cent of the total ECF fund size.


(c) Size, sector and location of investee company


An ECF may invest in any company:

that meets the EU definition of a SME (as amended from time to time);9

where the purpose of the relevant investment is, or the application of the proceeds of such investment by the relevant company or undertaking shall be, predominantly related to or for the benefit of the economy of the UK;

whose equity or other securities are not, at the time of investment, listed on a


„recognised‟ stock exchange (such as the London Stock Exchange) or otherwise quoted on a non-recognised exchange (i.e. AIM, Ofex or any other market on which prices are quoted publicly);

that does not operate in any of the restricted sectors referred to in Article 32 of the EC Treaty or in sensitive sectors for which the guidelines on State Aid and Risk Capital do not apply10; and

where the trade of such company is a “qualifying trade" as defined in Paragraph 4,


Schedule 28B of the Income and Corporation Taxes Act 1988, 11 or where the company is undertaking research and development with a view to carrying on a qualifying trade.


(d) Investment structures


ECFs will be allowed to structure investments in the most appropriate manner for each deal, so long as:

there is an equity component to the investment, or the investment includes warrants or other instruments conferring a right to acquire equity;

there is a realistic and significant prospect that the investment will earn a material capital gain (and not just an interest yield) for the ECF12; and


9 See Annex B.

10 See Annex C.

11 See Annex D.


Guidance for Prospective ECF Managers - 17

the ECF is not using drawdowns to finance the secondary purchase of existing equity (except where providing finance to support a management buy-out).


(e) Cumulation of state aid


European state aid approval for ECFs was conditional on the Government taking steps to avoid the cumulation of state aid to a single enterprise. Before investing in any portfolio company, an ECF will therefore need to make the company aware that it is an ECF and that the SMEs eligibility for certain other Government support schemes may be reduced in the future.


ECFs will be permitted to invest in companies that have previously received funding from other publicly-supported venture capital schemes, including Regional Venture Capital Funds, University Challenge Seed Funds and RDA-sponsored funds. ECFs will also be able to co-invest with such funds, so long as this is compatible with (i) the investment mandate of those funds; (ii) the investment restrictions that apply to the ECF; and (iii) the satisfactory resolution of any conflict of interest that may arise. However, ECFs will not be able to make secondary purchases of existing equity from these or any other funds.



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