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Mercia investors warm to group’s approach to university start-ups

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October 18-20, 2023 / Tucson, AZ
The annual summit for research institution gap fund and accelerator programs, including proof of concept programs, startup accelerators, and university venture funds

The Story

If only investors had it that easy: gaining some exposure to the next hot start-up without the risk that it might fail.
Several University spinout groups such as Imperial Innovations and IP Group have had mixed fortunes as investors took fright after the 2008 financial crisis.

Now, Mercia Technologies, which listed on Aim last December, has come up with a possible solution: a hybrid that identifies promising, young businesses, but keeps funding the best performing ones for up to 20 years.

The specialist investor aims to have sufficient spread that some businesses will be paying out dividends while it invests in other, younger ones. And while it has relationships with nine universities, mainly in the Midlands where it is based, it also looks elsewhere for opportunities.

“About half our investments are university spinouts. We want to build digital businesses. They don’t tend to come from universities although many of the people that work in them do,” says Mark Payton, the chief executive. A former Oxford university academic, he has 20 years’ experience of spinouts and has made more than 30 venture investments.

Investors seem to believe the story. In just two weeks, Mercia last year managed to raise £70m before expenses through a placing and flotation. The fund run by veteran fund manager Neil Woodford, holds 20.2 per cent of the stock, while Invesco has taken a 29.5 per cent stake in it.

Mercia operates a dual strategy. It runs Mercia Fund Management, which invests in early stage companies along with private individuals using tax-friendly means such as the Seed Enterprise Investment Scheme. The £22m fund has a portfolio of 44 companies — about 15 of which are break-even or profitable. One is paying a dividend.

Mercia Fund Management will normally make an initial investment of between £50,000 and £250,000. When one of these reaches the right stage, Mercia Investments takes a direct stake in Mercia Fund Management companies, leading them to an eventual sale or flotation.

Mercia then offers existing investors and the founders the chance to sell part of their stake at a discount, allowing them to “clear the mortgage” while retaining an interest in growing the business, says Mr Payton.

Mercia Fund Management sees about 400 business plans annually. In the first quarter it invested in 12. Mercia has invested £13m in later-stage businesses since listing, which have attracted a further £57m from elsewhere.

“We have already worked with the management team and know the business,” says Mr Payton. There should be no surprise nasties under the hood.

It holds pre-emption rights to maintain its position in companies on future issues of equity. If others do not take up their rights, Mercia Investments also has first option to make further investment through its third party holdings, because it might take them over the tax relief threshold.
First established in 2011, Mercia Fund Management’s first fund has returned 15 per cent. Including tax relief that rises to 60 per cent.

“There is plenty of impatient capital. But there is a shortage of patient capital,” Mr Payton says. We have a 15-year cycle. We are trying to build a valuable asset with our own investment capital.”
Investments include nDreams, which makes software for virtual reality headsets, and Soccer Manager, a computer game business in Preston, Lancashire, that operates across most gaming platforms.

It has spent £5.7m on its 45 per cent stake in Science Warehouse. In April it paid £3.5m for a further 18 per cent, valuing the business at £19m. Science Warehouse, a Leeds University spinout, has been profitable since 2009 and increased its revenues 89 per cent in the past three years.
For Mercia, there are lucrative fees as well as a performance incentive. Future trade sales and flotations of the companies it invests in will generate even more.

Mr Payton hopes there will soon be more of such listed investment funds to replace venture capital funds — many of which have struggled to raise money and which work to a compressed time cycle: investing in the first two years and selling out after five.

But he also admits that Mercia is a “Marmite” stock as dividends may be some way off. “Some people get the capital growth model,” he says. Many fund managers would rather not invest in other fund managers, even if they have access to early-stage companies not normally on the market, says Marcus Tregoning, analyst at Cenkos, Mercia’s broker. That can reduce demand and depress the share price.

The market remains open minded. The stock is hovering just above its 50p listing price. House broker Cenkos estimates its net asset value at £75m. With a market capitalisation of about £113m, that gives it a price/net asset value of 1.5. The sector has historically traded on roughly three times net asset value.
While the risk may be hedged, it is still a volatile business. Imperial Innovations and IP Group hit as high as four times net asset value in the mid-2000s but IP Group was worth just half its net asset value after the 2008 financial crisis. It is now back to two times net asset value.

It is little coincidence, then, to see that Mercia’s largest are the sort that invest for the long haul.

Mercia investors warm to group’s approach to start-ups – FT.com.

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