Much is written about Silicon Roundabout and it’s easy to think all UK start-ups are based in London.
A lot are of course, but not all, as Mark Payton will happily attest.
Payton is chief executive of investment group and fund manager Mercia Technologies PLC (LON:MERC).
The name is the giveaway. From its Midlands base, Mercia has quietly established itself as the go-to funder of choice for early stage businesses in the Midlands, the North and now Scotland as well.
And business is clearly good.
A question of value
“In three years we have gone from one office with seven people to eight with a staff of 74,” he told Proactive.
Funds under management now total £336mln while the company’s own assets are worth £124mln, including £65mln of direct investments.
Those are meaty amounts, especially for a business that goes out of its way to shun the London hot spots.
“The golden triangle [London, Oxford, Cambridge] is brilliant but already well served.”
It’s a question of value, he adds.
While there are many great businesses setting up in and around London, they are just too expensive to back.
“We see deal flow in the triangle but entry prices are eye-watering compared to the Midlands, the North and Scotland.
“We are all ultimately selling to the same acquirers,” he adds, “And the sale price will not be influenced by the level you went into the business at, but by what it’s worth at exit and therefore the return on your investment that you make.”
High risk, reward funds
But its geographical focus is not only the only thing that marks out Mercia.
An investment strategy distinctly different from almost any other listed venture capital investor in the UK is also notable.
The fund management side is focused on businesses right at the start of their journey and, as such, the casualty rate is high.
Between 40-50% of the firms backed by its funds fail says Payton.
To cope with this heavy attrition the funds it manages are by necessity very long-term vehicles with lives of between 10-14 years.
That is a long time to be locked in, too long even for many institutions while retail investors are excluded completely except through Mercia’s EIS funds, which account for around 10% of the inflows.
Payton believes EIS tax relief is crucial to maintain a healthy flow of new UK start-ups.
“I’m quite passionate about it, he says.
“It’s the right product.” People need tax relief for getting into this high- risk end of the market.
And although retail investors cannot access the real ‘scary-end stuff’, Mercia Technologies PLC is always an option and this comes with one big plus.
The PLC company often has pre-emption rights over any funding undertaken by a business where its funds have invested.
“If we take a 20% stake through the funds and other investors come in, our balance sheet [the PLC] typically has the option to do 20% of the round.”
“In effect, it means our funds are our proprietary deal flow.”
Or in other words, Mercia Technologies PLC gets an extended due diligence period over the circa 300 businesses within the funds that can last months, even years.
That gives an invaluable insight into how management and a business are performing and importantly when or if it should be brought across onto the PLC balance sheet.
Northern Powerhouse & Midlands Engine Room
Mercia also has relationships with nineteen UK universities and underlined its position as a big fish in its space when it was apportioned a large chunk (circa £108m) of the government’s initial allocations of the Northern Powerhouse Investment Fund and £23m of the equivalent equity element via the Midlands Engine room Investment Fund
Nonetheless, Payton says people in the City are still surprised when he explains how large Mercia has become.
“The City does not know that, for example, that we raised 200mln in the last twelve months.”
Any fund manager though is judged on performance and both the funds and balance sheet portfolios have seen some big winners.
Most famous is the Liverpool-based automation group Blue Prism.
A fund investment of £900,000 has turned into £70mln with that particular fund still owning 2.5% of the £866mln market cap group.
Allinea Software was sold to ARM for £18.1mln or 21 times the original investment, while most recently Science Warehouse was bought by Advanced Business Software for £16.9mln. Mercia’s balance sheet had meaningful stakes in both these businesses.
These were cash deals and that is another must for Mercia when it comes to an exit, Payton says.
Of the current portfolio, virtual reality games specialist nDreams is clearly a favourite of Payton’s and he foresees an explosion in content for VR once the next generation of headsets hits the market.
Do it yourself
But in another intriguing aspect to its strategy, he adds that if Mercia can’t find a business that fits an opportunity it has identified, it will build it itself.
“It’s like a home bake. Get to understand a sector, hunt for the right people and tech and see if we can build it.
“Don’t look for it overseas, the UK’s regions have more than enough to offer.”
At 37.5p, Mercia is valued at £113mln or a 9% discount to assets.