Published: Mar 24, 2021
The VCT sector has been supporting some of the UK’s most dynamic emerging companies for more than 25 years, with specialist investment managers helping visionary management teams bring innovative products and services into everyday use. At the same time VCTs provide private investors with a unique investment opportunity to back those high potential businesses and share in their success, while benefitting from a range of attractive tax benefits. Steve Marshall, Sales and Marketing Director at Maven, provides an insight into why VCTs are now a mainstay of many tax or income focused portfolios.
VCTs offer more than just attractive tax breaks
Whilst the range of VCT tax benefits are amongst the best available to investors, including 30% initial income tax relief and tax free dividends, VCTs offer far more for the discerning investor. The increasing maturity and long track record of the sector means that VCTs are now widely recognised as a valuable, highly tax-efficient addition to a diversified portfolio.
Experienced investors, who understand the risk profile of the underlying smaller company assets, can gain exposure to portfolios of ambitious, high-growth British businesses that are otherwise hard to access and have been carefully vetted by specialist investment managers.
SMEs – a hotbed of British innovation and talent
SMEs have historically been seen as a major contributor to UK economic growth, through their ability to embrace innovation and create skilled employment, and the SME sector has a deserved reputation for resilience, having emerged strongly from previous macroeconomic challenges. Smaller businesses tend to be more flexible and nimble than larger companies in being able to rapidly adjust their business strategy and cost base. Despite the challenging business landscape of the past year, many UK emerging companies have demonstrated their ability to develop new product or service capabilities to adapt to changing markets, and are still seeking growth funding to fuel their strategic ambitions.
The Covid-19 pandemic has had an unprecedented worldwide impact on the activities of individuals and organisations, affecting almost every aspect of business and social life. However, times of great change also often create new opportunities for entrepreneurialism and innovation, and the current crisis is no different. We have already seen significant shifts in consumer behaviour and the workplace, and the adoption of new technologies, such that by some estimates the digitalisation of the UK economy has been accelerated by up to five years as tech-enabled businesses have identified opportunities to disrupt traditional product markets through the development of new technologies and solutions.
VCT investment is crucial in supporting the SME sector and has played an important role in the growth of many of the UK’s most exciting younger businesses. VCTs provide a valuable bridge between private capital and SMEs, ensuring that entrepreneurial companies can continue to access equity finance to fund their growth.
Diversification and growth potential
A VCT provides exposure to a widely diversified pool of professionally vetted entrepreneurial private or AIM quoted companies that would otherwise not be accessible to a retail investor and, depending on the sector expertise and investment resource of the VCT manager, can back companies operating across a wide variety of sectors, from early-stage tech companies to specialist manufacturers. Some VCT management teams, have now been backing ambitious UK companies for 20 or more years, and have a wealth of experience in supporting early stage businesses in maximising their potential.
A number of the longest established VCTs in the market, such as Maven’s, periodically offer investors the opportunity to subscribe for new share issues through 'top-up' fundraisings, whilst benefitting from the full range of VCT tax reliefs. These fundraisings provide access not only to future new investments made by the VCT, but also allow new shareholders to benefit from further growth in the VCT’s existing portfolio. At the same time the new funds raised can benefit all new and existing shareholders, by allowing a VCT to expand and further diversify its portfolio through new and follow-on investments in fast growing private and AIM quoted businesses which have the potential to generate strong capital gains and support tax-free VCT dividends.
SME experience and expertise
Given the earlier stage nature of VCT investment, which focuses predominantly on younger companies at an exciting point in their development, VCT investors need access to managers which have the experience and specialist knowledge to identify the businesses with the greatest growth potential, and then build a widely diversified portfolio capable of mitigating investment risk and generating consistent returns.
The best VCT managers are active within the corporate finance and SME communities across the UK, able to identify and engage with the brightest emerging businesses. That requires not just expertise across multiple industry sectors, but also an in-depth knowledge of UK regional markets and the most vibrant sectors in the economy. In Maven’s case, as one of the most active managers in the VCT industry, its UK wide team is sourcing new investment opportunities across the regions which has enabled the Maven VCTs to invest in 11 private companies since the start of lockdown measures in March last year, with a strong focus on defensive or counter-cyclical sectors such as software, cyber security, data analytics, training and healthcare, which have typically been less directly affected by the pandemic.
However, successful VCT investment, and the ability to deliver strong shareholder returns, is about much more than simply providing finance. Experienced VCT managers will also offer strategic expertise and input to each business they back, so must have the skills and knowledge to build a strong working relationship with the management team of a portfolio company post investment and work collaboratively to help the business deliver its growth strategy.
Maven executives, for example, take a position on the board of each private company investee, which allows Maven to maintain close and regular contact with the senior team, and is crucial through an extended growth phase where strategic issues will typically need to be considered, such as the need to secure further funding, move into new markets, appoint additional executives or pivot the business model.
An attractive range of tax benefits
While tax savings alone should not drive investment decisions, it’s clear that VCTs offer a unique combination of tax benefits that are amongst the best currently available to UK investors. That can make a compelling investment case, alongside the ability to access high quality portfolios of emerging UK companies sourced by specialist managers with expertise in SME investment.
Investors in new VCT shares can benefit from up to 30% initial income tax relief on their investment in new shares, enjoy tax free dividends paid by the VCTs, and then be exempt from capital gains tax when they dispose of the VCT shares.
Helping to tackle the pensions dilemma
As the ability to make significant pension contributions has been eroded by the notable restrictions introduced to lifetime and annual allowances, the potential for tax-free VCT dividends to provide an additional income source has become increasingly appealing to investors looking to save for retirement. Many investors are now only able to shelter relatively modest amounts each year through their pension plans, so are looking for attractive tax efficient alternatives to enhance their portfolios.
Crucially, VCTs allow a generous annual investment limit to up to £200,000 (subject to the individual taxation circumstances of the investor), which means that an investor can build a sizeable portfolio with the potential to generate an attractive, complementary source of retirement and investment income.
VCT shares should be seen as a long-term investment. A VCT’s underlying investments will normally be in unlisted companies whose securities are not publicly traded and are therefore likely to be illiquid and carry substantially higher risk than investments in larger, listed companies. The value of VCT shares, and the level of income derived from them, may fall as well as rise and investors may not get back the money originally invested. Existing tax levels and reliefs may change and the value of reliefs depends on personal circumstances.