Published: Jan 23, 2024
Focus: Growth Capital
VCTs have been a part of the investment landscape for well over two decades, offering a unique blend of tax incentives and potential for high returns. In that time VCTs have transitioned from being a niche ‘alternative’ investment option with little track record and known largely for their tax reliefs, into a mainstream tax-efficient investment option used by many investors and advisers as part of their tax and portfolio planning.
A VCT is similar in structure to an investment trust and is listed on the London Stock Exchange. Each VCT uses the funds provided by individual investors to provide growth capital to small (private or AIM quoted) UK companies selected by a specialist fund manager with expertise in SME investment. In return, the VCTs offers investors the potential for tax free income and capital growth based on the development and ultimate sale of those companies.
But are they the right choice for you?
As with any investment, that will depend on an investor’s individual circumstances and financial objectives, and it’s important to understand the features and risk of investment in VCTs. Not every investor is suited to the high-risk, high-reward nature of investment in VCTs, therefore understanding the benefits and potential pitfalls is crucial before making an investment decision.
Benefits to VCT investment
There are a number of key motivators behind the decision to invest in a VCT:
VCTs offer crucial diversification for investors on two levels. They can provide an attractive, complementary option in building a portfolio alongside mainstream asset classes such as listed equities and property, through exposure to a portfolio of expertly researched smaller companies that would otherwise be hard to access for many investors. Additionally, established VCTs will typically build large, highly diversified portfolios of businesses, which can mitigate the risk associated with investment in smaller companies by avoiding over concentration in a small number of assets or sectors.
VCTs offer generous tax reliefs to investors, to encourage investment into earlier stage, growing businesses. This includes up to 30% upfront income tax relief when shares are held for 5 years from date of issue, tax-free dividends, and exemption from capital gains tax.
VCTs invest in smaller, emerging companies that are not listed on the main market of the London Stock Exchange and have the potential to grow much faster than their larger listed counterparts. Smaller companies also tend to be more nimble and adaptable in responding to economic challenges or market change.
VCTs invest in young and often privately-owned UK companies, which allows investors to participate in their growth. The VCT rules mean that these smaller, growth focused businesses will typically be bringing innovative, disruptive new technology, products or services to their markets, and will often be operating in some of the highest growth sectors of the economy.
Supporting the UK Economy
By investing in some of the UK’s most exciting new companies, VCTs have helped to drive innovation, create skilled employment across the UK, and bolster the UK’s economic growth.
Risks to VCT Investment
While VCTs offer the potential for high returns, alongside generous tax breaks and an additional investment option, they are not suitable for everyone, and investors should also consider these factors before investing:
VCTs are considered higher risk than investments in ‘traditional’ assets such as listed equities and bonds. This is because VCTs invest in small, often privately-owned companies, whose growth and performance tends to be more volatile than their larger, more established counterparts, so it can take a longer time for the underlying value or quality of the businesses to be reflected in their market values. As a result, investors should typically be looking to invest for the medium to long term.
Despite their rise in popularity in recent years VCTs are sophisticated, long term investments that are only suitable for experienced investors with a knowledge and understanding of the underlying assets and the risks involved with managing a portfolio of smaller companies.
To retain the initial tax relief, investors must hold their VCT shares for at least five years after issue. This long-term commitment aligns with the risk profile of VCT investment but might not suit all investors.
The market for selling VCT shares is generally illiquid. As a result, if there is not an available buyer a VCT’s shares can be difficult to realise at a share price that fully reflects the value of the underlying assets, so the shares may be priced at a discount to their Net Asset Value (NAV) per share. Investors will therefore typically be looking to invest in VCTs that operate share buy-back policies, through which the VCT itself can periodically buy back shares in the market when other buyers are not available, in order to maintain a share price discount that offers investors the opportunity to sell their shares at close to market value. To maintain an orderly market most established VCT’s will typically undertake share buy-backs at a discount of around 5% below NAV per share.
Regulatory and Taxation Changes
The rules and regulations governing VCTs can change, potentially impacting the tax efficiency and potential returns of the investment. That said, successive governments have provided their support for VCTs since their introduction in 1995, in recognition of the role VCTs play in supporting high growth SME, and the current government has announced the further extension of VCT tax reliefs until at least 2035.