Mercia Growth Fund 8

Mercia Growth Fund 8 is the latest EIS/SEIS offer from Mercia, focusing on early-stage technologies from university spin outs and industry. Mercia has an extensive commercial network across the Midlands, North of England and Scotland and makes initially small investments across the regions. It then has the ability, thanks to its parent company Mercia Technologies, to provide later stage support to successful investments, offering what it calls a “complete capital solution”.

Highlights

  • EIS offer with an SEIS option
  • Seeks to commercialise high-growth technology and intellectual property from industry and university spin-outs
  • Target return 3x including tax relief (returns not guaranteed)
  • Particular focus on the Midlands, North of England and Scotland
  • Experienced, well-resourced team
  • Portfolio expected to consist of around 15 companies with advance assurance
  • Additional exit route and early liquidity potentially offered by AIM-listed Mercia Technologies
  • Minimum investment £25,000

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The manager

Mercia Fund Managers is an early stage technology investor managing EIS funds and government money to develop and commercialise technology from industry and universities. It was founded in 2000 to manage money for the West Midlands Enterprise Fund and was originally named WM Enterprises Ltd.

Dr Mark Payton, CEO, led Mercia’s buyout from West Midlands Enterprise in 2010. This opened the door to external investors and Mercia’s first EIS fund.

The wider Mercia group includes Mercia Technologies Plc, which itself invests in emerging technology. Mercia Technology Plc listed on AIM in 2014 and has over £336m assets under management. Its largest shareholders at March 2017 include Invesco Perpetual (29.5%), Woodford Investment Management (24.9%), Forward Innovation Fund (11.3%) and Baillie Gifford (7.5%).

By funding early-stage businesses via multiple funding rounds which gradually increase, Mercia aims to weed out failures and provide later stage support for successful companies through to possible exit. Mercia’s EIS and third-party funds provide support at the earlier stage and can then pass the reins to Mercia Technologies Plc for more successful larger businesses. If larger amounts are required the PLC’s shareholders (such as Woodford and Invesco) may also choose to participate. This sets Mercia’s proposition apart from its peers which specialise in only EIS investment. It offers the potential for early liquidity as well as a possible additional exit route for investors.

Mercia invests nationwide but has a particularly strong presence in the Midlands, the North of England and Scotland.

The offer

Mercia Fund Managers intends to raise up to £15 million for its EIS Mercia Growth Fund 8. 

The default investment will be entirely EIS, but the fund will invest 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 stake in the business in any 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, 100% of an investor’s subscription will be invested in EIS-qualifying companies, but there is an option to invest up to 15% of an investor’s subscription in SEIS-qualifying companies. The SEIS fund will be limited to £600,000 and will be allocated on a first-come first-served basis at Mercia’s discretion.

The minimum investment is £25,000. The portfolio is expected to consist of around 15 companies, all with EIS advance assurance.

Strategy

Mercia Growth Fund 8 will invest in early-stage technology businesses with the aim of generating capital growth. It will invest in four key sectors where technology or intellectual property can be patented and exploited:

  • Life sciences and biosciences (particularly diagnostics, digital health and medical devices)
  • Digital and digital entertainment (such as virtual reality games, or mixed reality games)
  • Software and internet (cyber security, SaaS or artificial intelligence)
  • Electronics, materials, manufacturing & engineering

A proportion of these deals will come from Mercia’s extensive commercial networks, which include the investment directors’ personal networks as well as regional incubator programmes and the NHS Feeder Fund.

Others will be spin-outs from universities. Currently there are 18 university partnerships including Birmingham, Liverpool and Warwick.

Universities and their dedicated research teams are responsible for many of the current pioneering breakthroughs in science and technology across the globe. It is often the ‘Golden Triangle’ of Oxford, Cambridge and London that grabs investor attention, but Mercia believes there is opportunity waiting to be tapped in the UK regions. According to Mercia, 52% of all active spin-outs in the UK originate from the Midlands, the North of England and Scotland.

Mercia’s university team, headed by Dr Nicola Broughton, works closely with the Technology Transfer Departments of each of the 18 university partners to help support research ideas from laboratory to the market.

Mercia’s growth funds each have their own external Investment Panel and external Advisory Committee. For all investments made, the investment team reviews each proposal and circulates the findings to 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.

Target return

The target return is 3x, however this includes initial tax relief, therefore the effective target (before income tax relief) is to deliver in excess of 2.5 times invested capital. This is not guaranteed. Companies are expected to be held for five to seven years.

Exit strategy

As well as the two usual exit mechanisms for EIS investments – stock market listing or trade sale – Mercia has a third option for successful holdings, which could provide potential early liquidity for investors. This is Mercia’s Share Exchange. It means Mercia Technologies may offer to buy shares it itself holds which are also held by investors in the Mercia Growth Fund (SEIS or EIS) at a 25% discount. If offered, investors do not have to take it up if they feel the discount does not offer value for money.

Performance

Source: Mercia. Shows EIS funds and the year they opened. MGF stands for Mercia Growth Fund. MDF is Mercia Digital Fund. UGF is the University Growth Fund. EIS funds only. Returns calculated using Mercia’s own valuations. Does not include MGF funds less than one year old. Any distributed cash is included within the net asset value (for MGF1 and MGF2). Past performance is not a guide to the future.

Annual performance of Mercia’s Growth Funds (%)

  April 2014 April 2015 April 2016 April 2017
Mercia Growth Funds 2013 0% 26% 35% 1%
Mercia Growth Funds 2014 37% 39% 16%
Mercia Growth Funds 2015 17% 8%
Mercia Growth Funds 2016 10%

Source: Mercia Fund Managers. Shows annual % growth in Mercia Growth Funds since April 2013. Returns calculated using Mercia’s own valuations. Past performance is not a guide to the future.

Portfolio companies

Mercia has invested in 65 companies to date and has had six failures. Mercia operates what it calls a “fail fast” procedure which means it will not provide follow on funding to failing companies.

An example of a successful investment: Medherant

Medherant is a spin out from the University of Warwick. It is developing a novel patch technology for the delivery of a variety of drugs.

The TEPI-patch® is a thin, strong, easy-to-apply and easy-to-remove patch capable of delivering high doses of drugs directly to the areas where they are needed.

It has allowed the firm to produce and patent the world’s first ever ibuprofen patch. This can consistently deliver a prolonged high dose of the painkiller ibuprofen directly through the skin via a polymer matrix that sticks the patch to the patient’s skin. The drug is then delivered at a steady rate over up to 12 hours. This opens the way for the development of a range of novel long-acting over-the-counter pain relief products which can be used to treat common painful conditions like chronic back pain, neuralgia and arthritis without the need to take potentially damaging doses of the drug orally. Although there are a number of popular ibuprofen gels available these make it difficult to control dosage and are inconvenient to apply.

This novel patch incorporates polymer technology developed by the global adhesive company Bostik and exclusively licensed for transdermal use to Medherant. 

The technology is also capable of working with drugs that have failed clinical trials because of their unsuitability for oral consumption. 

Mercia invested £398,551 from the EIS funds in Medherant and follow on investment has been provided by Mercia Technologies. These EIS shares are now valued at £939,160 (as at March 2017) – remember past performance is not a guide to the future. 

Note that this is an example of an existing holding only; the Mercia Growth Fund 8 portfolio will hold different companies. 

Medherant

Medherant: a spin out from the University of Warwick, is an example of a previous holding in the Mercia Growth Fund Portfolios. The firm has created the world's first ibuprofen patch.

An example of a failed investment: DM Portal

There have been a number of failures in the Mercia Growth Funds, as is to be expected. 

All but one received only SEIS investment. One example is DM Portal which received £150,000 investment from Mercia Growth Fund 1 (SEIS) and Mercia Growth Fund 2 (SEIS) in 2014. The company provided a SaaS (Software as a Service) platform for vehicle dealerships and transporters by offering an online logistics and auction solution.

The online portal was set up to rival traditional auction houses, where dealers could sell used and ex-lease vehicles without the need for physical transportation. DMPortal also hosted a car movement module, providing an opportunity for transporters to gain business and reach full capacity for inbound and outbound journeys, whilst offering an efficient alternative for dealerships delivering and collecting vehicles.

The company showed promise but the founder was not able to deliver early revenue or reach commercial targets. The company underwent an orderly liquidation on 9 June 2015 and the investment was written off. 

Risks

This SEIS and EIS portfolio invests in very early-stage businesses which are statistically more prone to failure. Mercia openly states it expects some companies to fail, otherwise the managers believe they are not taking enough risk and will fail to deliver the expected returns. 

Investors should not invest money they cannot afford to lose. There investments are unquoted and early stage, which means they are illiquid and capital is at risk. 

The value of tax relief will depend on the circumstances of the individual investor and tax rules could change in future. 

Mercia’s investment remit is not confined to EIS investments. This can have advantages but also means there could be scenarios where Mercia’s non-EIS investments take priority over the EIS funds, for example regional deals supported by Government-backed development funds.

Fees

There is an initial charge of 1.5%. The annual management fee is 1.5%, payable for six years, of which three years are normally retained upfront. For investments over £100,000, investors have the option to pay fees by annual invoice, meaning that up to 98.5% of a subscription will receive EIS relief. 

There is an annual custodian fee of £140, payable on the same terms. Mercia (as do most EIS managers) benefits 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.

The share exchange facility is offered at a discount of 25%. This could be considered steep and could also be seen as cherry picking. However, where offered investors are not obliged to take it up: it is one exit option that could be available to them.

Summary

Investing in start-up and spin-out technologies is an exciting area for wealthy investors. It is high growth but also high risk. This portfolio is one way of tapping into this market with generous EIS and SEIS tax benefits. Mercia has invested in spin-outs and technology commercialisation since 2000, so has undoubted experience in this sector. Its strong regional presence provides good deal flow as well as access to quality deals which managers based in London or the South East may miss. 

Early-stage businesses often need more than one round of funding to achieve profitability and exit. Unlike some other EIS managers, Mercia has the ability to make multiple rounds of funding using SEIS and EIS for the early rounds followed by Mercia Technologies’ own balance sheet for the later ones. This “complete capital solution” is particular to Mercia and offers potential early liquidity at a discount, which could prove attractive to some.

In order to invest, you will need to elect to be treated as a professional client of Mercia, by completing their Professional Client Letter as part of your application.

Read important documents and apply

Wealth Club aims to highlight investments we believe have merit, but you should form your own view. You should decide based on the provider's documents and ensure you have read and fully understand them before investing. This review is a marketing communication. It is not advice or a personal or research recommendation to buy the investment mentioned. It does not satisfy legal requirements promoting investment research independence and is thus not subject to prohibitions on dealing ahead of its dissemination. 11.8.17

The details

Min. Investment
£25,000
Strategy
Growth
Amount Raising
£15 million
Type
technology
Deadline
discretionary

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