Annual Financial Report for the Year Ended 31 March 2023

15 June 2023

NORTHERN 2 VCT PLC

ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 MARCH 2023

Northern 2 VCT PLC is a Venture Capital Trust (VCT) managed by Mercia Fund Management Limited. It invests mainly in unquoted venture capital holdings in growing UK companies and aims to provide long-term tax-free returns to shareholders through a combination of dividend yield and capital growth.

Financial highlights (comparative figures as at 31 March 2022):

*Excluding proposed final dividend payable on 18 August 2023

Enquiries:

James Sly / Sarah Williams, Mercia Asset Management PLC – 0330 223 1430
Website: www.mercia.co.uk/vcts/n2vct/

CHAIR’S STATEMENT

Uncertainty in the economic landscape persisted over the past year. Inflationary pressures resulted in interest rate increases and volatility in the financial markets which presented challenges. While consumer facing companies have been particularly impacted by the high-inflation environment, many quoted equity indices experienced large declines and company valuations across most sectors fell from previous highs.

Against this challenging backdrop, it is pleasing to report that the valuation of our unquoted portfolio increased in the year, supported by a number of excellent exits both in the year and immediately post year end. Realisation of our unquoted investments in the year generated proceeds of £12.1 million, delivering a £6.2 million return on initial cost of £5.9 million. Investment activity has remained high, with £16.0 million invested in 27 promising early stage businesses.

Despite declining business confidence generally, our public share offer of £6 million was fully subscribed and I would like to thank existing shareholders for their continued support and warmly welcome new investors. Proceeds from the share offer together with sales proceeds from investments mean that the Company is well positioned both to pursue new opportunities to support small and medium businesses and to work with existing portfolio companies to realise their growth plans.

Results and dividend

In the year ended 31 March 2023 the Company delivered a return of minus 1.9 pence per share (2022: 0.6 pence), equivalent to minus 3.0% of the opening net asset value (NAV) per share. Gains in the unquoted portfolio were offset by declines in our listed investments, particularly musicMagpie, a legacy AIM investment that was impacted both by challenging trading conditions and the repricing of AIM shares generally. The NAV per share as at 31 March 2023, after deducting dividends paid during the year totalling 3.6 pence, was 59.0 pence compared with 64.4 pence as at 31 March 2022.

Several investment realisations were completed during the year, with a number of notable transactions either completed or in progress as at the balance sheet date. One particular highlight after the balance sheet date was the sale of Evotix, sold in May 2023, for proceeds of £11.5 million compared to an original cost of £2.5 million, a 4.6x return, which is particularly welcome as it was an early-stage investment made since the VCT rule changes in 2015; the realised value has been represented in the Directors’ unquoted valuations as at the balance sheet date. Other highlights were the sales of Lineup Systems and Knowledgemotion that registered returns of 7.8 times and 1.7 times cost respectively over their lifetimes (inclusive of loan interest received). These gains contributed to an overall increase of £0.6 million in the Directors’ valuation of the unquoted portfolio.

The unquoted valuations were also impacted by a number of write-downs including the failure of Channel Mum, which was unfortunately put into liquidation after facing challenging trading conditions. In addition, the Company’s investment in Axial was sold at a loss following its loss of several large contracts.

In 2018 we set an objective of paying an annual dividend representing a yield of at least 5% of the opening NAV per share in each year whilst endeavouring to protect the NAV from erosion over the medium term. Over the three years since 31 March 2020 the NAV per share has increased by 10% from 53.5 pence to 59.0 pence, after taking account of dividend payments totalling 14.6 pence over the same period. We have therefore broadly continued to meet our objective.

Having already declared an interim dividend of 2.0 pence per share which was paid in January 2023, your Directors now propose a final dividend of 1.3 pence per share. The total of 3.3 pence per share is equivalent to 5.1% of the opening NAV of 64.4 pence per share. The proposed final dividend will be paid on 18 August 2023, subject to approval by shareholders at the Annual General Meeting.

The target dividend yield will remain subject to regular review and the level of future dividend distributions will continue to reflect the level of returns generated by the Company in the medium term, the timing of investment realisations, the availability of distributable reserves and continuing compliance with the VCT scheme rules.

Investment portfolio

The Company continues to be a generalist investor, with large allocations in the software, healthcare/bio-technology and consumer sectors. The older investments made under the ‘pre 2015’ rules continue to be realised, and comprised 19% by value of the Company’s investments as of the balance sheet date. This mature portfolio will continue to reduce as a percentage of overall capital invested as we realise our holdings in these investments, and we expect that it will continue to provide a series of profitable exits in the years to come, supporting the overall return of the Company.

Over the year the Company saw reductions in the valuations of its listed investments, notably the continued fall in value of AIM listed musicMagpie and the listed portfolio of investments, in line with the decline in investment markets generally. Overall, the value of the Company’s listed investments declined by £1.9 million of which £1.0 million was MusicMagpie. Despite the marked-to-market losses of the listed portfolio that is held to generate a yield on cash pending investment, the portfolio has generated annualised total returns of 3.1% since investment in 2018 and has therefore provided a positive contribution to NAV in what has been a very low interest rate environment. Your Directors always consider the state of the investment markets and how these might impact the valuations of the unquoted venture portfolio and have updated valuations to reflect current market conditions where appropriate.

Investment levels have remained high and exceeded the previous year’s record breaking deployment level, with £10.0 million of capital provided to 9 new venture capital investments and £6.0 million of follow on capital invested into 19 existing portfolio investments, including a second tranche of investment into one company that was new in the year (previous year: £14.7 million combined).

Share offer and liquidity

As a result of the public share offer launched in January 2023, 10,290,184 new ordinary shares were issued in April 2023 for gross proceeds of £6.0 million.

Following the smaller non-prospectus top-up offer in 2022/23, and taking into account the increased rate of investment that has now been sustained for a second successive year, the Board is pleased to announce that the Company will launch a prospectus offer in the 2023/24 tax year for £14.0 million, with an over-allotment facility of £6.0 million. This offer will launch in September 2023, and full details will be published shortly.

Our dividend investment scheme continues to operate. This enables shareholders to invest their dividends in new ordinary shares free of dealing costs and with the benefit of the tax reliefs available on new VCT share subscriptions. During the year around 15% of total dividends were reinvested by shareholders.

We have maintained our policy of being willing to buy back the Company’s shares in the market when necessary in order to maintain liquidity, at a 5% discount to NAV. During the year, a total of 4,673,456 shares were repurchased for cancellation, equivalent to approximately 2.5% of the opening share capital.

Changes to the performance-related management fee (‘performance fees’)

Following a review of current arrangements by the Board, included in the Circular for the upcoming General Meeting is a resolution proposing changes to the Management Agreement in relation to the performance-related management fee with the Manager. If approved by shareholders, these changes will be implemented by a deed of variation to the Company’s existing Management Agreement.

The changes in VCT legislation in 2015 required the Company to focus new investment on earlier stage companies which, by their nature, are higher risk and therefore likely to deliver more volatile investment returns. A number of changes are proposed in order to better align future performance fees with shareholder returns as well as to bring the performance fee methodology more in line with other market participants and to harmonise its application across the Northern VCTs. The changes are designed to ensure strong returns above a hurdle are delivered consistently, not just in a single year, with a requirement that any decline in shareholder NAV must be made wholly good before a performance fee is payable to the Manager. Full details of the changes are set out in the accompanying Circular for the General Meeting, which will be held immediately after the Annual General Meeting on 29 July 2023.

Responsible Investment

The Company is mindful of its Environmental, Social and Governance (ESG) responsibilities and we have outlined our evolving approach in the annual report.

VCT legislation and qualifying status

The Company has continued to meet the stringent and complex qualifying conditions laid down by HM Revenue & Customs for maintaining its approval as a VCT. The Manager monitors the position closely and reports regularly to the Board. Philip Hare & Associates LLP has continued to act as independent adviser to the Company on VCT taxation matters.

The upcoming 2025 ‘sunset clause’ was a European state aid requirement when the VCT scheme received state aid approval, which means that without a change in legislation investors will not receive upfront tax relief when investing in VCTs from 6 April 2025. While the government has signalled that it will extend the scheme, to date no formal legislation has been introduced to enact this commitment. The Company and the Manager will continue to monitor progress in this area. The Board considers that the Company, and VCTs more generally, are successfully delivering against the Government’s mandate, which is to channel money into higher-risk, early-stage businesses.

Another issue facing VCTs and similar schemes such as the Enterprise Investment Scheme is the ‘Financial Health Test’ that has been enforced more narrowly over the past twelve months. This test states that where a company is investing outside of its initial investing period, if more than half of an investee company’s subscribed share capital has disappeared as a result of accumulated losses, then no further capital may be invested. In reality a number of early stage businesses need to be funded for longer than that initial period, making losses originally to fund growth. The Manager has performed a detailed review of the portfolio, and while the Company’s portfolio is relatively unaffected at the current time, your Board will continue to monitor the situation carefully.

Whilst no further amendments to the VCT legislation were announced by the Chancellor in his 2023 Budget statement, it is possible that further changes will be made in the future. We will continue to work closely with the Manager to maintain compliance with the scheme rules at all times.

Board of directors

Your board recognises the need to consider succession planning and with due regard to developing its diversity. We are determined to only ever appoint when we have found high quality, value adding and experienced people who will contribute to the Board in the interests of shareholders. As previously announced, Ranjan Ramparia joined as a director in the year.

As part of the process of refreshing itself, which your board has been undertaking over the last few years, senior non-executive director, Frank Neale is not seeking re-election and retires at the AGM. As he stands down I want to thank him for his extraordinary contribution to the success of the Company over many years. It would be difficult to overstate the knowledge and expertise Frank Neale had brought to the board’s deliberations, for which we are very appreciative. His wisdom and guidance will be much missed.

As reported in previous years, the Board goes through a rigorous appraisal process both collectively and individually during which it considers the independence of each director in the light of their performance at, and between, board meetings and when engaging with the Manager. Shareholders can be assured that with the benefit of their wide experience and expertise your directors act of behalf of shareholders in challenging the Manager in respect of the strategic direction of the Company, the investment portfolio, the valuation of unquoted assets, performance-related management fees, fund raising and any other matter likely to impact the development of the Company.

All of the Directors who served throughout the year, with the exception of Frank Neale who is retiring from the Board, will be seeking re-election at the 2023 AGM in accordance with the AIC Code of Corporate Governance.

Annual General Meeting

The Company’s Annual General Meeting (AGM) will take place on 28 July 2023. The AGM usually provides an excellent opportunity for shareholders, directors and the Manager to meet in person, exchange views and comment. We intend to hold the 2023 AGM in person at Reed Smith LLP, Broadgate Tower, 20 Primrose Street, London, EC2A 2RS. Following positive feedback received from the last three years, we also intend to offer remote access for shareholders through an online webinar facility for those who would prefer not to travel. Please note that shareholders attending remotely must register their votes ahead of time, as it will not be possible to count votes from online participants at the AGM. Full details and formal notice of the AGM are set out in a separate document. The General Meeting regarding the proposed changes to the performance-related management fee will be held immediately after the AGM.

Outlook

Despite a challenging macroeconomic outlook with high Inflation and rising interest rates, we will continue to provide patient capital to support innovative early stage businesses in the UK. Your board is encouraged by the continued strong deployment rates, and will continue to invest throughout the economic cycle.

Your board has confidence in the overall diversity of the portfolio and believes that it will continue to generate long term shareholder value.

We thank our investors for their continuing support.

David Gravells

Chair                                                                15 June 2023

Extracts from the audited financial statements for the year ended 31 March 2023 are set out below.

Income statement

Balance sheet

Investment portfolio

*Listed on AIM
**This percentage change in ‘like for like’ valuations is a comparison of the 31 March 2023 valuations with the 31 March 2022 valuations (or where a new investment has been made in the year, the investment amount), having adjusted for any partial disposals, loan stock repayments or new and follow-on investments in the year. 

Risk management

The Board carries out a regular and robust assessment of the risk environment in which the Company operates and seeks to identify new risks as they emerge. The principal and emerging risks and uncertainties identified by the Board which might affect the Company’s business model and future performance, and the steps taken with a view to their mitigation, are as follows:

Investment and liquidity risk: investment in smaller and unquoted companies, such as those in which the Company invests, involves a higher degree of risk than investment in larger listed companies because they generally have limited product lines, markets and financial resources and may be more dependent on key individuals. The securities of smaller companies in which the Company invests are typically unlisted, making them illiquid, and this may cause difficulties in valuing and disposing of the securities. The Company may invest in businesses whose shares are quoted on AIM – the fact that a share is quoted on AIM does not mean that it can be readily traded and the spread between the buying and selling prices of such shares may be wide.

Mitigation: the Directors aim to limit the risk attaching to the portfolio as a whole by careful selection, close monitoring, active management of portfolio issues, and timely realisation of investments, by carrying out rigorous due diligence procedures and maintaining a wide spread of holdings in terms of financing stage and industry sector, within the rules of the VCT scheme. The Board reviews the investment portfolio with the Manager on a regular basis.

Financial risk: most of the Company’s investments involve a medium to long-term commitment and many are illiquid.

Mitigation: the Directors consider that it is inappropriate to finance the Company’s activities through borrowing except on an occasional short-term basis. Accordingly they seek to maintain a proportion of the Company’s assets in cash or cash equivalents in order to be in a position to pursue new unquoted investment opportunities and to make follow-on investments in existing portfolio companies. The Company has very little direct exposure to foreign currency risk and does not enter into derivative transactions.

Economic risk: events such as economic recession or general fluctuation in stock markets, exchange rates and interest rates may affect the valuation of investee companies and their ability to access adequate financial resources, as well as affecting the Company’s own share price and discount to net asset value. The level of economic risk has been elevated recently by inflationary pressures, interest rate increases, and supply shortages.

Mitigation: the Company invests in a diversified portfolio of investments spanning various industry sectors, and maintains sufficient cash reserves to be able to provide additional funding to investee companies where it is appropriate and in the interests of the Company to do so. The Manager typically provides an investment executive to actively support the Board of each unquoted investee company. At all times, and particularly during periods of heightened economic uncertainty, the investment executives share best practice from across the portfolio with investee management teams in order to mitigate economic risk.

Stock market risk: some of the Company’s investments are quoted on the London Stock Exchange or AIM and will be subject to market fluctuations upwards and downwards. External factors such as the terrorist activity, political activity or global health crises can negatively impact stock markets worldwide. In times of adverse sentiment there may be very little, if any, market demand for shares in smaller companies quoted on AIM.

Mitigation: the Company’s quoted investments are actively managed by specialist managers, including Mercia in the case of the AIM-quoted investments, and the Board keeps the portfolio and the actions taken under ongoing review.

Credit risk: the Company holds a number of financial instruments and cash deposits and is dependent on the counterparties discharging their commitment.

Mitigation: the Directors review the creditworthiness of the counterparties to these instruments and cash deposits and seek to ensure there is no undue concentration of credit risk with any one party.

Legislative and regulatory risk: in order to maintain its approval as a VCT, the Company is required to comply with current VCT legislation in the UK. Changes to UK legislation in the future could have an adverse effect on the Company’s ability to achieve satisfactory investment returns whilst retaining its VCT approval.

Mitigation: the Board and the Manager monitor political developments and where appropriate seek to make representations either directly or through relevant trade bodies.

Internal control risk: the Company’s assets could be at risk in the absence of an appropriate internal control regime which is able to operate effectively even during times of disruption.

Mitigation: the Board regularly reviews the system of internal controls, both financial and non-financial, operated by the Company and the Manager. These include controls designed to ensure that the Company’s assets are safeguarded and that proper accounting records are maintained.

VCT qualifying status risk: while it is the intention of the Directors that the Company will be managed so as to continue to qualify as a VCT, there can be no guarantee that this status will be maintained. A failure to continue meeting the qualifying requirements could result in the loss of VCT tax relief, the Company losing its exemption from corporation tax on capital gains, to shareholders being liable to pay income tax on dividends received from the Company and, in certain circumstances, to shareholders being required to repay the initial income tax relief on their investment.

Mitigation: the Manager keeps the Company’s VCT qualifying status under continual review and its reports are reviewed by the Board on a quarterly basis. The Board has also retained Philip Hare & Associates LLP to undertake an independent VCT status monitoring role.

Directors’ Responsibilities

The Directors are responsible for preparing the annual report and financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law they are required to prepare the financial statements in accordance with UK accounting standards, including FRS 102 ‘The Financial Reporting Standard applicable in the UK and Republic of Ireland’.

Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of its profit or loss for the year.

In preparing these financial statements, the Directors are required to:

• select suitable accounting policies and then apply them consistently;
• make judgements and estimates that are reasonable and prudent;
• state whether applicable UK accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements;
• assess the Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and
• use the going concern basis of accounting unless they either intend to liquidate the Company or to cease operations, or have no realistic alternative but to do so.
  
  

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that its financial statements comply with the Companies Act 2006. They are responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error, and have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and to prevent and detect fraud and other irregularities.

Under applicable law and regulations, the Directors are also responsible for preparing a Strategic Report, Directors' Report, Directors’ Remuneration Report and Corporate Governance Statement that complies with that law and those regulations.

The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

The Directors have confirmed that to the best of their knowledge:

•  the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company; and

•  the Strategic Report and Directors' Report includes a fair review of the development and performance of the business and the position of the issuer, together with a description of the principal risks and uncertainties that they face.

The Directors consider the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy.

The directors of the company at the date of this announcement were Mr D P A Gravells (Chair), Mr S P Devonshire, Miss C A McAnulty, Mr F L G Neale and Miss R K Ramparia.

OTHER MATTERS

The above summary of results for the year ended 31 March 2023 does not constitute statutory financial statements within the meaning of Section 435 of the Companies Act 2006 and has not been delivered to the Registrar of Companies. Statutory financial statements will be filed with the Registrar of Companies in due course; the independent auditor’s report on those financial statements under Section 495 of the Companies Act 2006 is unqualified, does not include any reference to matters to which the auditor drew attention by way of emphasis without qualifying the report and does not contain a statement under Section 498 (2) or (3) of the Companies Act 2006.

The calculation of the return per share is based on the loss after tax for the year of £3,464,000 (2022: profit of £923,000) and on 187,331,778 (2022: 162,327,282) shares, being the weighted average number of shares in issue during the year.

The calculation of net asset value per share as at 31 March 2023 is based on net assets of £109,576,000 (2022: £104,854,000) divided by the 185,640,724 (2022: 162,907,914) ordinary shares in issue at that date.

If approved by shareholders, the proposed final dividend of 1.3 pence per share for the year ended 31 March 2023 will be paid on 18 August 2023 to shareholders on the register at the close of business on 21 July 2023.

The full annual report including financial statements for the year ended 31 March 2023 is expected to be made available to shareholders on or around 26 June 2023 and will be available to the public at the registered office of the company at Forward House, 17 High Street, Henley-in-Arden B95 5AA and on the Company’s website.

The contents of the Mercia Asset Management PLC website and the contents of any website accessible from hyperlinks on the Mercia Asset Management PLC website (or any other website) are not incorporated into, nor form part of, this announcement.