Review - Mercia Growth Fund 7 EIS
Mercia Growth Fund 7 invests in early-stage technology and life sciences. Up to half of the portfolio is expected to be invested in spin-outs from leading UK universities. Commercialising such technology or intellectual property can be very profitable but also time consuming. Well-known listed companies such as Imperial Innovations and IP Group specialise in this exciting, high-growth field.
- Combined SEIS and EIS offer
- 50% invested in UK university spin-outs
- Looking to commercialise high-growth technology and intellectual property (IP)
- Strong, well resourced team
- Expects to invest in up to 20 companies
Mercia manages university and government funds to develop and commercialise products deriving from university technology. Often a university will invest directly in promising technology and there may even be government or EU grants to help fund the start-up business. Mercia then invests alongside.
Mercia was formed in 2000 to manage money for the West Midlands Enterprise fund. Dr Mark Payton, the CEO, led Mercia’s buyout from West Midlands Enterprise in 2010. This opened the door to external investors and its first EIS fund. Recently Mercia bought northern venture capital manager Enterprise Ventures resulting in a total investment team of 32 and over £300 million funds under management.
Mercia Growth Fund 7 will invest in four key sectors:
- Digital & entertainment
- Life sciences
- Advanced materials & specialised manufacturing
- Electronics, software & hardware
In all these sectors technology or intellectual property can be patented and exploited. About half of the deals in the portfolio will be spin-outs from universities, with the balance from Mercia’s network of contacts. Currently there are 18 university partnerships including Birmingham, Liverpool and Warwick.
The investment team reviews each proposal and circulates the findings to the rest of the team for challenge. If the deal passes this stage, a more formal offer is made and detailed due diligence is carried out on the intellectual property. A longer and more detailed review is completed and sent to Mercia’s independent investment committee. Its members have the power to veto any deal, and have done so in the past. Both the company management and Mercia’s fund manager in charge of the deal must present to this committee. Mercia’s chief investment officer, Matt Mead, ensures there is a spread of different sectors and stages of company in the fund.
Mercia has invested in 60 companies to date and has had six failures. This is to be expected in early stage, higher-risk investing. Mercia has added several exciting new technology businesses to its early-stage portfolio including Braintrain, a start-up that is developing sleep-aid technologies; Cyan Forensics, a company that rapidly scans seized computers for contraband; and Pertinax Pharma, a University of Bristol spin-out.
The intention is to invest at least 80% of monies raised in the 2017/18 tax year, although this is not guaranteed.
Blend of EIS and SEIS
The portfolio invests in both EIS and SEIS qualifying companies. Indeed, the same company may receive SEIS funding in one round, and EIS funding later. However, there will be distinct differences. Mercia will usually take a greater percentage stake in the business in the SEIS round, as it will likely be diluted later. In addition, the technology or intellectual property will probably be further away from commercialisation.
Unless otherwise specified, 15% of an investor’s subscription is invested in SEIS-qualifying companies and 85% in EIS-qualifying ones.
Targeted performance is for three times return of money, however this includes initial tax relief, therefore the effective target (before income tax relief) is to at least double the money invested. This is not guaranteed. Companies targeted must be able to grow at a compound rate of at least 10% per annum. Companies are expected to be held for five to seven years.
Many early-stage enterprises need more than one round of funding to achieve profitability and a successful exit. Early rounds of funding come from SEIS and EIS funds whereas later-stage financing comes from sister company and AIM-listed fund, Mercia Technologies. Mercia calls this its “Complete Capital Solution Model” and believes this takes care of a company’s funding needs so management can concentrate on growing the business. As an example Mercia has continued to invest in various companies within its existing portfolio including Warwick Audio Technologies, Impression Technologies and nDreams (a publisher of games for virtual reality).
Mercia Technologies will also buy out EIS investors at a discount to fair value. Finally, Mercia now offers a new share exchange system allowing investors to sell shares in companies in which they have a stake when there is an offer on the table from other or external investors.
This SEIS and EIS portfolio invests in very early-stage businesses which may be more prone to failure. Whilst not investing in the very first round of funding, Mercia often invests to try and commercialise the technology or intellectual property. Many companies in this space will need more than one round of funding. Mercia seeks to address using AIM-listed Mercia Technologies. A secondary risk in the short term is that the recent acquisition of Enterprise Ventures, in early 2016, could distract management. However in our view, over the long term the Enterprise acquisition should be beneficial.
The usual risks with unquoted companies exist with this EIS offer. For instance, EIS investments are illiquid and capital is at risk. Investors should only invest money they are prepared to lose. The value of tax relief will depend on the circumstances of the individual investor and tax rules could change in future.
The annual management fee is 1.5%. Three years (investors can choose to pre-pay six years) of this annual fee is charged in advance, meaning the full amount of a subscription doesn’t receive EIS relief. There is an annual custodian fee of £140; again, six years of this fee is charged in advance. Mercia (as do most EIS managers) benefit from monitoring fees from underlying investments, the level of which isn’t specified. There is a performance fee of 20% of returns more than £1.05 (based on £1 subscription price) and 30% of returns above £1.30 charged at portfolio level.
Investing in spin-out technology from universities has been one of the en-vogue investment areas of the last few years. There are some listed alternatives, but this is portfolio is one way of accessing this exciting high-growth area with generous EIS and SEIS tax benefits. Mercia is expert in this field having invested in spin-outs and technology commercialisation since 2000. Unlike some other managers, Mercia can fund multiple rounds of funding for each company using SEIS, EIS and AIM-listed Mercia Technologies. Overall we like Mercia's approach, the one downside being the lack of many disposals thus far, however unrealised valuations for existing investors look promising.
This review is not intended to be advice or a personal recommendation to buy the investment mentioned, nor is it a research recommendation. Wealth Club aim to highlight investments we believe have merit, but investors should form their own view on any proposed investment.
In order to invest, you will need to elect to be treated as a professional client of Mercia, by completing the Professional Client Letter as part of your application.