UK Law and Practice Contributed by: Dylan Doran Kennett, Michael Jacobs, Stephen Newby and Mark Ife, Herbert Smith Freehills LLP
More mature companies with robust business plans and management teams that forecast long-term sustainable growth and profitability are being prioritised. Investors continue to take a more focused yet cautious approach to valua - tions, emphasising the importance of commer - cial and legal due diligence. This was perhaps less of a concern in the heady days of 2021, given the amount of capital being deployed into “hot” deals back then. Equity market volatility and lower PE buyout volumes also mean that conventional VC exit opportunities are currently less numerous. How - ever, equity conditions do appear more prom - ising as macro-economic conditions stabilise, with the IPO market, both globally and in the UK, moving past its inflection point in 2024 after hitting record lows in 2023, showing signs of recovery and growth in 2025 and beyond. Consequently, UK businesses are having to look for other avenues to raise more money, often resulting in a higher degree of share capital structuring. For example, “down rounds” (when a company offers additional shares for sale at a lower price than the previous financing round) continue to occur despite the broad, overall improvement in VC terms as exit opportunities remain constrained and companies continue to need to tap the fundraising market for capital, which can crystallise lower valuations. Down rounds usually trigger anti-dilution provisions to protect investors by ensuring that they can maintain their ownership percentages through a bonus issue of shares or adjustment to the conversion ratio of preference shares to ordinary shares (the latter being more common in the US). Increasingly, “pay to play” provisions are being introduced into company constitutional docu - ments to ensure future commitment to capital-
raising by existing investors. If current investors do not provide new cash for a next round of financing, their shares can be consolidated at a specific ratio while being converted into ordinary shares, leading to a potentially significant drop in their value. General restructuring or “flattening” of the cap table has been a common theme in rescue financing for companies that have been unable to raise further funds in turbulent times; this often forces a complete rethink and overhaul of the cap table to save the company and ensure that new funds are secured. Convertible instruments (such as convertible loan notes and similar forms of structure) remain popular to avoid crystallis - ing a down round and delaying valuation dis - cussions until the markets return to a healthier state for capital raising, although they can be on onerous commercial terms and include a penny warrant style upside for the loan provider. ESG remains a priority for investors, which are demanding due diligence across the ESG land - scape. Ventures that demonstrate a commitment to ESG principles are likely to attract greater interest from socially conscious investors and to gain an edge in fundraising. Notably, in Feb - ruary 2025, the British Venture Capital Associa - tion (BVCA) revised its form documents for early- stage venture capital investments, which include provisions to ensure compliance by high-growth companies with a number of ESG concerns (see 3.4 Documentation ). These updates reflect the BVCA’s ongoing efforts to ensure compliance with ESG concerns and other regulatory require - ments, making the documents more robust and adaptable to current investment practices. This is a welcome development and ensures that ven - ture funds are imposing their limited partners’ requirements onto their portfolio companies.
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