Venture Capital Trusts: Investment Outlook for 2024

2023 was a fairly turbulent year for the UK economy, with inflation at 10.1% at the start of the year and economic growth remaining sluggish. As we start 2024, the financial markets appeared to have weathered the worst of the recent economic volatility, with encouraging falls in inflation and a more positive outlook from market commentators suggesting that we are on the path to stability. 

However, the economy isn’t out of the woods yet, despite expected interest rate cuts, and in 2024 VCT investors will be weighing a number of factors in making their investment decisions, from tax considerations to the economic and market implications for the SMEs in which VCT invest.

The Tax and Regulatory Landscape

The regulatory landscape around VCTs has remained unchanged for several years since amendments were made to the scheme to ensure its focus on early stage businesses. One major development though is the government’s continued support of the scheme as the Chancellor recently confirmed the ongoing availability of VCT tax reliefs to 2035 by extension of the so called ‘sunset clause’, providing much needed certainty for investors and UK SMEs.

VCTs are often referred to as ‘evergreen’ due to their ability to provide long term, patient capital for early stage companies that require investment to scale. This continuous source of funding enables businesses to focus on innovation, playing a crucial role in fostering entrepreneurship and driving economic growth. Good news for ambitious, growth focused UK businesses.

As for investors, the abolition of the pension lifetime allowance limit will become law in April 2024, allowing UK citizens to save as much as they want into a private pension without being hit with a tax penalty. That said, an annual allowance limit of £60,000 is still in force and continues to taper down for higher earners, triggering a tax charge if you were to breach that limit. The extension of the VCT scheme ensures that the limited strategies available for tax efficient savings and investments isn’t further diminished. According to the Institute for Fiscal Studies (IFS) one in five people will soon be higher income tax rate payers, so for those ‘capped out’ of saving more into their pension in 2024, VCTs may be an attractive option.

Market and Economic Uncertainty

Economic downturns, global events or geopolitical tensions can significantly impact financial markets, as we’ve seen over the past few years with Brexit, the COVID-19 pandemic and conflicts in Europe and the Middle East, which have all contributed to increased economic uncertainty across the world.

Businesses of all sizes are impacted, but rapid price changes in commodity and raw material markets may force smaller businesses to act sooner than their larger counterparts – they may have to accept lower profit margins or charge their customers more to counteract these changes. Bigger businesses often have more resources and strategies at their disposal to counter the effects of market volatility, such as hedging, dynamic procurement and raw material management. 

That said, the size of smaller businesses can have advantages. Flexibility and nimbleness are key traits of SMEs, allowing them to change quickly to position their market or product offering in a growing segment of the economy. As new technologies emerge and market trends evolve, many show remarkable ingenuity in developing new opportunities by adapting their strategies or evolving processes, products, and target customers. The growth of early stage companies is also less driven by traditional market cycles and instead factors such as such as technological advancements, innovation, and market disruption come into play.

Despite the recent market uncertainty, entrepreneurs remain overwhelmingly positive towards the UK as a location to build cutting edge, technology-enabled businesses. In a recent survey by Venture Capital Trust Association (VCTA) of its member firms’ investee companies, close to three quarters of respondents (73%) continued to identify the UK as an attractive place to grow a company. The vast majority – more than 90% – also aim to expand outside of the UK and capture international opportunities, demonstrating a confidence and optimism amongst business leaders to continue to innovate and succeed.

  
Due Diligence in a Rapidly Developing Tech Landscape

The technology sector is evolving at a rapid pace, with the emergence of new digital technologies and business models. When evaluating investment opportunities in such a fast-changing market, private equity firms need to use their knowledge and experience to avoid overhyped tech segments and apply the fundamentals of assessing what makes a good business. 

While constant innovation often opens up new niches and opportunities, today’s leading technology can also quickly become obsolete, so it is crucial to look for an investment manager with a solid track record and expertise for investing in the sector. In the face of high competition and often inflated valuations, the ability of an investment manager to thoroughly evaluate the viability of potential investments is essential to making prudent decisions, mitigating risks, and ensuring long-term value creation for shareholders. 

Environmental, Social, and Governance (ESG) Factors

Increasingly, PE houses are considering ESG factors in their decision-making processes, reflecting a shift in attitude among investors and consumers towards more societally conscious and sustainable investments, and a recognition that sustainable economies and systems are needed to support future growth. 

The pool of ESG focused businesses is still relatively small, and it remains challenging for private equity firms to source opportunities in some sectors where the awareness and implementation of ESG practices is not yet widely implemented. As a result, competition for ESG focused assets can be higher, so VCT investors will be looking at a manager’s sector expertise, presence across all UK regions and the size of its investment team. An established profile in the key corporate finance territories will help to ensure that a VCT manager sees the largest and most diverse range of potential investments. 

Private investors themselves may face challenges in evaluating the environmental and social impact of companies within a particular portfolio. Greenwashing remains a presistent challenge so transparency and a programme of enhanced shareholder communications from the VCT manager is essential. Regulatory bodies are attuned to this issue though and I’d expect further steps to be taken this year to further combat it.

There is also increasing awareness of the value of diversity and inclusion within companies and investment portfolios. Research compiled by McKinsey shows that companies with greater diversity among management are likely to financially outperform those with less diverse leadership, providing a potential competitive edge for those business. In addition, there are greater stakeholder expectations that private equity firms should demonstrate their own progress and expertise in this area, so a clear investment focus in this area is important.

Keep Informed

In making their investment decisions, private investors will want to stay informed about tax incentives and wider economic factors which may change their immediate objectives. In addition, they should also consider a number of other factors that demonstrate the experience and skills of the investment manager in maximising investor returns. This will include areas such as the ability and team resource to identify and evaluate the best and most diverse range of potential investments in high growth sectors such as Software-as-a-Service (SaaS), fintech, cyber security, healthcare and life sciences, which can be more resilient to economic and market challenges.

Further details about Maven's VCTs and any current open offers can be found here.