The UK and global technology sectors have experienced a strong shake-up since the bubble in 2000 and now have defensible business models and sharply refined cost bases. According to a report by Deloitte in 2011, over the 2009/10 and 2010/11 periods, the UK technology index (measurement of listed businesses in the technology sector) has risen above the 2007 levels. Furthermore, over this period, from a selection of 70 businesses, 51 per cent had seen revenue growth and 21 per cent had revenue growth in excess of 20 per cent.

Three high profile US companies (the “gorillas” in the pack) showed strong growth during the economic down swing. At Apple last quarter’s results (for 2011) smashed market expectations by posting circa $46 billion with $13 billion in profit. Google over the same period posted $10.58 billion in revenue against profits of $2.7 billion. Set this against Facebook, which surprised many to show 2011 revenue of $3.7 billion with $1 billion in profits.

With an upturn in the fortunes of the sector and Facebook’s pending flotation, two questions immediately spring to mind: is Facebook worth the rumoured $75 billion to $100 billion float price, and is the technology sector an attractive market sector to invest in?

On the first question, at the recent CEO Agenda 2012 conference, a number of high profile investors, company founders and entrepreneurs from the likes of Google, PayPal and LOVEFiLM were asked about Facebook’s valuation. In all cases the participants believed that the valuation was sound, especially considering Facebook’s revenue growth and the fact that nearly a seventh of the world’s population use the social networking platform.

Attractive?

As to whether the technology sector is an attractive market to invest in, we would say yes, but with caution. The caution is based on the following: do not expect Google and Facebook-type businesses in the UK, we are not Silicon Valley and will likely never be. These multi-billion dollar behemoths require significant capital sums, a domestic market to accelerate growth and focused capital markets such as NASDAQ to provide alternative liquidity for investors opposed to trade sales.

It is worth noting, however, that the US historically leads the way as overseas buyers of UK technology and technology businesses, setting a value on strategic assets and new markets above and beyond that generated via fundamentals.

This stresses the importance of proving the UK technology in European and domestic markets, whilst demonstrating applicability to key markets such as the US. Two “gorillas” of note in the UK are ARM Holdings and Autonomy.

ARM forecasts revenues of $860 million for 2012 from $785 million in 2011 with profit before tax of $230 million. Both ARM and Autonomy obtained their positions in the market through acquisition and organic growth. In 2011, Autonomy was acquired by HP for approximately £7 billion ($11 billion) in cash, which reinforced the trend for acquisitions of UK technology businesses by US players.

In our opinion, critical to developing successful technology funds are:

- good deal flow (ideally the manager has sight of the majority of the investment prospects to be made prior to the fund launch);

- track record in making and growing technology businesses;

- deep sector knowledge (particular in key sectors with potential for growth and acquisition);

- investing in post-revenue businesses with commercial acceptance of their product and / or service.

Enterprise Investment Scheme

Our Mercia Growth EIS, a technology fund with a focus across four distinct sectors, provides a spread of risk in a balanced portfolio of post-revenue businesses.

While the EIS structure provides a highly tax-efficient way of investing, the fund manager needs to match the fund structure/fund size to the total investment needs of the target business. For instance, Mercia invests in capital efficient businesses seeking modest capital sums (generally less than £2 million) with a modest exit target typically in the ranges of £10 million to £100 million.

In terms of working with invested companies, we believe that most technology companies need active investors since founders tend to be technologists first and businesspeople second. We always take the option where available and within the EIS rules to preserve our rights and maintain a board seat.

Today’s thriving technology sectors include clean technology; medical technology; telecoms, electronics and software technologies; data centre management, cloud computing and related software.

Fund managers that build up teams around these core specialisms can accelerate the growth and trajectory of each portfolio company – something that a generalist investor cannot offer.

Universities represent an unrivaled source of deal flow, and we have an enviable relationship with eight universities enabling us to access technology expertise and develop grant opportunities and synergistic technology where practical and applicable.

In terms of exit strategies for invested businesses, the Mercia Growth EIS Fund backs established companies with growing revenues, to improve potential return for investors, with an aim to grow to profitability or an exit in four to seven years from initial investment. At investment stage, we have already identified potential acquirers – all of which are trade acquirers.

Within the booming technology sector, there are plenty of opportunities for good quality technology EIS investments. It is here that a track record in building and growing businesses, an investment team with expertise in specific sectors and transparency to investors are key.