Take a minute to imagine the last few weeks without successful start-ups like Netflix, Zoom or Deliveroo. Whether it be gripping documentaries, video calls to friends and family across the globe or a takeaway at the weekend, these innovative businesses have made life in lockdown slightly more manageable for many of us. Indeed, start-ups account for roughly 30,000 businesses and 300,000 workers in the United Kingdom. But government loan schemes introduced in response to the COVID-19 crisis do not present a feasible form of funding for many start-ups in the early stages of development. With one of the United Kingdom's most prominent and forward-thinking industries at stake, where does the solution lie?

Why are the current loan schemes not suitable for start-ups?

The criteria underpinning the government's various COVID-19 loan scheme initiatives effectively preclude many start-ups from applying for and securing vital funding to keep their businesses afloat. Most notably, the schemes are unlikely to be available to businesses which were operating at a loss before the pandemic.

This is particularly problematic as start-ups in the earliest stages of development are usually loss-making: the typical start-up model prioritises long-term growth over short-term profit. Issues are also posed by the existence of turnover thresholds and the need to demonstrate established credit ratings for public companies. Quite simply, the current schemes are not 'start-up friendly'.

Of course, some of the economic measures introduced by the government will benefit start-ups. Tax holidays and the furlough scheme will provide some form of financial relief. But start-ups are heavily reliant on the general wellbeing of the economy to achieve their development goals and, ultimately, become profitable.

Absent a healthy economy, the necessary consumer demand and a suitable government rescue plan, many start-ups are naturally concerned by the prospect of funding shortages and cashflow issues.

What is the solution?

While the Scottish Government confirmed on 15 April 2020 an additional £100 million fund to assist the self-employed and viable micro and SME businesses, it is yet unclear if this will include funding for businesses which are loss-making and whether such funding would take the form of a grant, debt or equity.

However, a potential solution has been mooted by the UK Government in the form of state-supported convertible loans. In short, convertible loans would provide start-ups with an injection of funds to meet fixed costs in the short-term. The scheme would likely be administered by the British Business Bank or Scottish Enterprise (if the Scottish Government adopt a similar approach).

The suggestion is that any government investment would be matched by venture capitalists. These loans would then be either repaid by businesses after the crisis has passed or, if appropriate, converted into state-owned equity stakes.

Any proposed scheme does, however, pose questions. While there have been suggestions that the government is readying a deal designed to aid start-ups, no details have been confirmed.

Notably, questions remain over the logistics of the eventual repayment of the loan and the rights of the shares to which the loan would ultimately be convertible.

There is also the important matter of how the convertible loan would be managed alongside any existing venture capital investment. For example, if the government were to convert any loan to an equity stake, they may insist on shareholder consents to protect their investment and their interests.

In any event, government backing would both facilitate the survival of some of the UK's fastest-developing companies and nurture the inherent long-term economic and societal benefits that such survival would bring. Just how that backing is implemented, however, remains to be seen.

How can Brodies help?

Our corporate team regularly advise on debt and equity investments in start-ups and high-growth companies and would be happy to assist if you have any questions about this or any other matter relating to the impact of the COVID-19 on your business. For more information please do get in touch with any member of the corporate team or your usual Brodies LLP contact.

This post has been co-written by Richard Murdoch and Alasdair Madden.


Alasdair Dunn

Senior Associate