Fund Structure & Administration

Purpose

Each Microfund must be a privately managed fund vehicle, established specifically for the purpose of investing equity or quasi equity (Mezzanine) capital in high-growth companies. Proposed investment strategies must remain commercially viable and attractive to investors, combining impact with strong financial fundamentals.

Fund Life

Microfunds will be fixed-life funds, extendable only with the consent of the British Business Bank and other investors; they will not be ‘evergreen’ funds that continually recycle investment returns.

Ownership

The instruments of ownership of a Microfund will not be tradable on public markets.

Structure

The fund’s principal place of business must be in the UK. The British Business Bank assumes that Prospective Managers will wish to structure their funds as English Limited Partnerships (“LPs”). This is a widely used structure for funds that are managed by professional fund managers on behalf of ‘passive’ third-party investors and is likely to be suitable for most Prospective Managers. Scottish Limited Partnerships and Northern Ireland Limited Partnerships may be considered if justified by the Prospective Manager’s location or investor base, subject to approval by the British Business Bank.  

Waterfall

Once the Microfund has met its expenses and liabilities (including fund management fees), subsequent proceeds from investments will be distributed to investors in the following priority order:

1. first, repayment of capital to both the private investors and to British Business Bank; and
2. once all payments under (1) above have been made, as distribution of profits to private investors, the British Business Bank, and (where appropriate) as carried interest to the fund managers.

Prospective managers must specify the terms for capital repayment under (1) and the profit-sharing ratio and any carried interest arrangements under (2). Repayment of capital under (1) shall be on terms that are no less favourable to the British Business Bank than to the private investors.  

Operations of the Limited Partnership

It is expected that the standard limited partnership structure will be appropriate for Investor Pathways Capital Microfunds. In this structure, the British Business Bank and other investors in the fund would be limited partners, and the general partner would appoint a fund manager responsible for managing the activities of the partnership. In order to preserve their limited liability, the limited partners do not become directly involved in the management of the fund.

Structure of Participation

The limited partnership must have a fixed lifetime, though the legal documentation may allow for extension with the consent of the British Business Bank and other limited partners. It is envisaged that most funds will adopt a ten-year lifetime with an option to extend for up to two years, in line with common practice in the venture capital industry, but the British Business Bank may consider alternatives where a suitable justification is provided.

The British Business Bank, other investors and carried interest recipients will each contribute a nominal amount of capital to the partnership, in proportion to their respective shares of the profits of the fund. As in a standard venture capital limited partnership, these capital contributions will constitute a fraction of the total commitments to the fund.

The remainder of commitments will be in the form of loans, to be drawn down into the partnership as and when required by the fund manager. Loans will be non-interest- bearing.

Fund Manager Renumeration and Other Fees

The British Business Bank recognises that investors expect to remunerate fund managers through a combination of:

• A management fee, set at a level that is just sufficient to enable the fund manager to invest and manage the fund effectively; and
• an appropriate carried interest provision, with any hurdle set at a level that is stretching but achievable. The carry rate should be no more than is sufficient to create a strong incentive for the fund manager to maximise the financial performance of the fund.

However, this structure may not be appropriate in all situations, and Prospective Managers may want to discuss alternative remuneration structures. If so, they will need to explain why the proposed structure is desirable from the perspective of the British Business Bank and other investors in the fund, and they must demonstrate that it provides a clear link between the performance of the fund and the remuneration of the fund manager.

Prospective Managers must also specify the level, structure and timing of any other fees or charges that would be applied, e.g., any application, arrangement, and monitoring fees to be charged to investee SMEs. They should also note the British Business Bank’s very strong preference for such charges, where levied, to accrue to the fund rather than to the fund manager. Prospective Managers should demonstrate that any such fees are kept to a minimum, so that as much of each investment as possible is available for the SME to use to develop its business, rather than to pay fees back to the Microfund. Where fees relate to a specific investor in the Microfund, e.g., in the case of commission fees paid to IFAs or intermediaries who introduce investors to the fund, the British Business Bank would expect these to be borne by the investor or manager concerned, and not by the fund as a whole but would again expect these to be kept to a minimum.

As part of each proposal, the British Business Bank will also wish to see projected budgets for the fund manager, to demonstrate that the level of the proposed fees will be sufficient to enable the fund to be properly managed, but not excessive.

Taxation

Limited partnerships should be treated as transparent vehicles for UK tax purposes; the tax treatment of the general partner will depend upon its legal structure.

The rights of the British Business Bank as a Limited Partner

The British Business Bank requires a right to participate in decisions that normally require the consent of the majority of limited partners, such as extending the lifetime of the partnership, replacing the general partner, changing the terms of the partnership agreement or resuming drawdowns and investments following a suspension.

The British Business Bank recognises that private investors may be reluctant to invest if the British Business Bank were able to liquidate a Microfund or take other major decisions without consulting the other limited partners. For such decisions, the consent of the British Business Bank and a majority of the other limited partners would normally be needed. This should provide reassurance for private investors that the British Business Bank cannot unilaterally act to their disadvantage.

The only exceptions would be in cases where the fund manager has materially breached the terms of the partnership agreement (including the agreed investment strategy) or is otherwise fraudulent or negligent. In such cases, the British Business Bank will require an option to remove the general partner, with or without the consent of the other limited partners. The choice of the replacement general partner would need to be agreed between the British Business Bank and the private investors.  

Interaction with the regulatory system  

Although Microfunds themselves are unregulated, the General Partner will be required to appoint a fund manager to establish, operate, and in due course wind up the partnership. The British Business Bank will make available pre-approved fund service providers for this purpose, ensuring that all Microfunds benefit from consistent standards of governance and regulatory compliance. Where the fund manager is managing the Microfund from the UK, they will need to be authorised by the Financial Conduct Authority (FCA) to carry on regulated activities in accordance with FSMA.

No implied warranty

Any specific reference to the Government, the British Business Bank or the British Business Bank in publicity materials relating to an Investor Pathways Capital Microfund must be approved in advance by the British Business Bank, except where providing only basic factual information that is already in the public domain, e.g., the amount or terms of the proposed British Business Bank participation in the fund. Under no circumstances should our agreement to participate be described or interpreted as implying any kind of endorsement, warranty or guarantee of performance by the fund, and any promotional materials issued in relation to the Microfund must include a warning to that effect.

Drawdowns

Loan commitments will be drawn down into a Microfund on a ‘side by side’ basis from the British Business Bank and the private investors, pro rata to their total loan commitments. It is anticipated that loan commitments from the British Business Bank will be drawn down on a six-monthly schedule. It is anticipated that a fund service provider, appointed by the British Business Bank, will coordinate drawdown processes and provide monthly indicative forecasts of likely drawdown requirements.  

Prospective Managers wishing to raise private capital from individual investors will need to propose arrangements to satisfy the British Business Bank that the private capital will be available for drawdown when needed.  

In the event that a limited partner fails to meet a drawdown notice, it will be liable to pay interest and, unless the default is rectified, the defaulting partner will lose their entitlement to distributions during the lifetime of the fund. Any distributions to that investor at the end of the lifetime of the fund would be limited. However, the British Business Bank does not believe that such punitive provisions should be applied following the death of a limited partner.

Capital that is drawn down into the fund but not yet invested or otherwise expended (e.g., on management fees) must be held on deposit with a major UK bank, except where the British Business Bank approval has been sought and obtained.

Fund managers may wish to cancel outstanding loan commitments if it becomes clear that they will never be drawn down. In such cases, loans will be treated as having been drawn down and repaid immediately.

Distribution of returns

When a Microfund earns a return from an investment, either from interest or dividend payments from an investee SME or from a realisation, it will not be permitted to recycle those funds for further investment (except under the specific circumstances described in the Microfund Limited Partnership Agreement, if any). The Fund will be expected to make distributions once it has the necessary income or capital gains from realisation of its investments and has met its expenses and liabilities (including fund management fees), as summarised in the Waterfall above.

Repayment of capital

Once the General Partner has received their Share (Management Fee), loan commitments may then be repaid to Investors under the terms specified in the proposal, which will be written into the legal agreements. Repayments may be made to the various parties on a pro rata basis, or Prospective Managers may specify an alternative arrangement that repays the British Business Bank more quickly.

Where there are amounts of loan commitment still to be drawn down, repayments will continue in tier 1 of the Waterfall until Investors have received the full amount of their loan commitment.

Distribution of profits

Assuming obligations under tier (1) of the Waterfall have been met, all further distributions to investors will be divided pro rata among all limited investors, including the British Business Bank and private investors, in proportion to their respective capital contributions. Profits will typically be distributed as follows, in line with standard carried interest provisions:

(i) first, to all investors until a specified ‘hurdle rate’ has been achieved and distributed. The hurdle rate is to be specified EITHER:

• as an amount equal to interest calculated on the daily balances of loans outstanding to the British Business Bank and private investors; OR
• as being just sufficient to ensure that the private investors have received a certain annualised IRR.

In either case, the level of the hurdle and the basis for calculation should be clearly specified. Prospective Managers may choose to provide for a gradual ‘catch-up’ for the carried interest recipient from the private investors’ share; and

(ii) second, any further profits are divided between the fund manager (in line with the carried interest share) and the British Business Bank and the other private investors (pro rata to their respective investments in the fund).

Prospective Managers may specify alternative incentive structures to the standard carried interest provisions if this is more appropriate for their proposals, so long as they can still demonstrate a clear link between fund performance and fund manager remuneration.

Co-investment agreements

Microfunds wishing to enter into co-investment agreements with other parties should provide details of the proposed terms of such agreements as part of their initial proposal, including the reasons why the proposed arrangements would be in the interests of the Microfund’s investors. This might, for example, be appropriate for a Microfund wishing to raise and leverage funds from institutional investors, to be co-invested alongside a group of experienced business angel investors.

Co-investment agreements may also be appropriate where a Microfund fund manager is associated with another venture fund and where the investment mandates of the two funds overlap. In these circumstances, it would be appropriate to agree in advance how deals will be allocated and shared.

Conflicts of Interest

There is scope for various conflicts of interest to arise during the lifetime of a Microfund. Potential managers will be required to highlight any potential areas where this may be the case and should propose mechanisms to resolve or manage these conflicts. This will not be regarded as a negative feature of an application, so long as the British Business Bank is satisfied that any conflicts would be handled in a manner consistent with the interests of the British Business Bank and other investors in the Microfund. Wherever possible, Prospective Managers should follow commercial best practice in managing potential conflicts. Prospective Managers should note that failure to disclose any material conflict of interest that is subsequently identified in the assessment process will be regarded as a significant negative feature of an application.

Key personnel  

‘Key personnel’ includes any individual whose experience and expertise a Prospective Manager wishes the British Business Bank to take into account when assessing their application. For these individuals, the fund partnership agreement will include provisions to ensure that the key personnel named in the application actually dedicate the specified amount of time and effort to the Microfund.

The partnership agreement will specify the circumstances under which key personnel may be replaced. Such changes will require the consent of the limited partners, including the British Business Bank. Before giving such consent, the British Business Bank will wish to be satisfied that the replacement is at least as well qualified and experienced as the individual being replaced and will integrate successfully with the rest of the management team.

The legal agreements will include a right for the investors (including the British Business Bank) to agree to remove the general partner or suspend new investments by the partnership in the event that satisfactory replacements are not put in place within a reasonable time period.

Transfer or sale of instruments of ownership in a Microfund

It is intended that investors should be committed to retaining their interest in a Microfund for the lifetime of the fund, but the British Business Bank recognises that changing circumstances may mean that a private investor wishes to sell or transfer their interest in a fund. On transfer, the recipient will take over the obligation to meet any loan commitments not already drawn down from the vendor (as well as the right to receive repayments of capital and profit share).

The British Business Bank approval will not be required for transfers of ownership where the Microfund is operated by an FCA-authorised fund manager who has undertaken an appropriate level of due diligence in relation to the new investor. However, consultation with the investor committee will be required.

The British Business Bank will also wish to retain the right to transfer its interests in a Microfund.

Reporting and ESG requirements

The British Business Bank intends to secure pre-approved fund service providers to support each successful Investor Pathways Capital Microfund. Once appointed, the service providers will take responsibility for organising the legal and operational setup of the fund and will lead on ongoing requirements including regulatory compliance, administration, and investor reporting. This approach is intended to ease the operational burden on first-time managers.  

Investor Pathways Capital Microfunds will be expected to provide reports, produced by the pre-approved fund service providers, using the British Business Bank’s reporting templates. These reports will include both summary fund data and more detailed portfolio reporting for all investments, covering at a minimum:

• the length of time since the acquisition of each investment within the portfolio;
• details of the investments purchased and sold within the period;
• a statement of the investments and assets of the partnership with commentary on the progress of investments and any significant developments or events affecting the portfolio;
• the fund managers unaudited valuation of each investment; and,
• all prospective investment opportunities considered by the fund manager in the period.

Fund managers should be prudent and consistent in their valuations and will be expected to follow the International Private Equity and Venture Capital Valuation Guidelines produced by the International Private Equity and Venture Capital Valuation (IPEV) Board when valuing investments.

Through the fund service provider, the British Business Bank will expect to receive annual accounts for the Microfunds, in accordance with IFRS accounting standards.

Relevant ESG reporting, determined by the British Business Bank’s requirements, will be requested from the fund manager on a half-yearly basis. We intend to work with fund managers who can demonstrate they have credible plans, to report on their own portfolio emissions and to enable portfolio companies to transition towards net zero. Regulation around emissions reporting is fast changing, and the Bank will work with fund managers throughout this journey.

All such information received by the British Business Bank will be treated as confidential, although the British Business Bank may wish to release aggregated data on the performance of the Investor Pathways Capital initiative as a whole. Information relating to specific funds or businesses will be passed to external parties only where required by law or where necessary to support independent evaluation of the Investor Pathways Capital initiative, and any external researchers would be bound by appropriate confidentiality provisions.

National Audit Office Requests

The role of the National Audit Office (NAO) is to report to Parliament on the spending of central Government money. It conducts financial audits of all Government departments and agencies and many other public bodies, and reports to Parliament on the value for money with which public bodies have spent public money.

Microfunds will be required to cooperate fully with any requests for information from the NAO.