Yesterday’s Autumn Budget was always one which the Mercia Team was going to watch with interest. With patient capital – something which sits at the heart of our business – the hot topic of the summer, our Teams had been counting the days until the Chancellor finally sets out his position on the Enterprise Investment Scheme (EIS) as he did yesterday.
In this article Dr Paul Mattick, Head of Sales and Investor Relations at Mercia Fund Managers explores what the changes in the budget mean and why he is pleased that the government is seeking to direct EIS capital into what it would term ‘knowledge-intensive companies’.
What makes Mercia well placed to comment on such a matter?
Well the answer to that is track record. As an Investment Group which is focused on sourcing and scaling innovative opportunities into businesses with global potential, the themes from the Patient Capital Review weave into nearly every area of our business. From raising and investing our own EIS Funds, to raising and investing institutional and public funds and investing the Group’s own balance sheet capital, our Investment Teams have track records that sit proudly within our peer groups. The Group has more than £330.0million under management as well as its own cash resources to provide scale up capital.
Take for example Mercia’s Funds
Mercia’s EIS Funds aims to triple invested capital within five to seven years, including tax reliefs, by investing in a well-diversified, multi-sector technology fund. The past performance is highly encouraging, with one fund having reached this target in three and a half years.
Our clients substantially benefit from the scale of Mercia as an institutional technology investor, who manages an EIS fund. Mercia offers hands on support and industry wisdom to entrepreneurial technology companies, and the potential of scale up investment from the PLC balance sheet. This support is part of the reason that, despite being less than four years old, the EIS funds already have three companies in the portfolio which are held at more than five times original cost. There are another five companies that may join this group shortly, and a few others that we expect to be valued at more than ten times original costs – this is real venture capital, with additional EIS tax benefits.
Allinea Software illustrates this point well. Based in the Midlands and a University of Warwick spinout (a partner university to Mercia), Allinea was an idea from two academics to provide a tool kit to optimise the performance of High Performance Computing. It was originally supported via proof of concept and grant funding. It received its first equity seed investment in early 2009 (including EIS) from one of Mercia’s managed funds and latterly scale-up capital from Mercia Technologies PLC. It was sold for a full cash return in December 2016 to ARM providing the equivalent of a 26x return on original investment cost to the managed fund (Mercia Fund 1 a University Challenge Seed Fund) and circa 21x return on original investment cost for the scale-up capital. Mercia Fund 1 is specifically targeted to university spinouts from the Midlands region and after fifteen years it has now started to evergreen itself.
You can also see our exemplars from within our regionally managed funds too
Mercia is a national investment Group, with more than 70 investment professionals and support staff based across our eight regional offices. But you will rarely find our teams in London, instead we prefer to source our deals in the UK regions; from places which don’t often make the financial news headlines, from Doncaster to Newton Le Willows and from Rossendale to Farnborough.
The RisingStars Growth Funds is one such fund. Its remit was to invest in the North West of England with backing from the North West Development Agency. The Funds invested in 53 companies in total, of which six have gone onto listings in the Public Markets. Perhaps the most successful of these has been Blue Prism which today has a market cap of over £900m and from which the RisingStars funds has made more than 55 x return and the fund still retains a 4.9% holding which is valued at more than £30.0million. Had the RisingStars Growth Funds been unwound once it had reached 10 years, which is typical with vehicles of this type, then the Fund’s investors would not have recouped their original investment cost.
For Mercia it is not just about picking the best opportunities and sitting back. In every case our Investment Team is side by side with the company’s own management teams; helping to shape strategy, introduce networks beyond the company’s own reach and perhaps most importantly helping to make the difficult decisions needed to ensure that the company’s performance stays on track and provides returns for shareholders.
Risk versus reward
It’s not just about the upside but of balancing the equation of risk and reward, in which failure rates vary between 30-50%. With this in mind our Investment Teams are continually seeking opportunities which have high cash multiples, in excess of five times cost, to offset the failure rates which we expect within our EIS Funds. We model the net effect of the early-stage failures, and high multiple cash exits, to be a tripling of invested capital (including tax reliefs) in five to seven years. For more information, please visit this page.
What does “patient” capital really mean?
The term patient capital is more widely recognised today than ever before and the government has played an important role in helping to raise awareness of this through its Patient Capital Review. As most venture funds are ten year limited partnerships, the traditional venture timescales do not work and this is one of the single largest challenges confronted by UK tech companies which often take longer to prove their technology and really gain commercial traction. However Mercia (and its investors) accept that from start up or seed investment through to liquid investment return you have to be patient, it can take between seven and fifteen years to realise value to shareholders. This approach is something which differentiates Mercia as both an investment partner and manager of capital and is illustrated by both Allinea (ten years) and Blue Prism (thirteen years) which fit neatly within our seven to fifteen year range.
What is the potential impact of the EIS changes proposed today?
The changes today will change the EIS market, and for businesses with high growth aspirations, for the better.
As of 1st December 2017 “capital preservation” EIS schemes, which take low risk and target low returns, cannot obtain Advanced Assurance that they qualify for EIS, and they will be totally excluded from EIS qualification on 6th April 2018. The intention of the tax reliefs introduced by the government was not to enable affluent investors to avoid tax, but to facilitate tax-efficient investment in innovative companies typically less than seven years old. Mercia has always invested EIS capital “in the spirit of the legislation,” and is recognised as one of the leading managers in this space, having been recently awarded Best EIS Manager at the Growth Investor Awards.
In 2015/2016, the EIS market raised over £1.6billion, and over half of this went into capital preservation EIS schemes (MICAP funds data, provided by EISA). In this circumstance, we would expect substantially more EIS capital to be directed towards leading technology focused EIS managers, such as Mercia. It should be noted that there is limited investment capacity in this market, and the demand to invest with leading fund managers will substantially increase.
From a Mercia Group perspective, the changes to EIS and the support for regional funds is pleasing, and it is clear that the government plans to continue to support the expansion of innovation and encourages the growth of SMEs in the UK.