Guide to Venture Capital Trusts
Maven is one of the leading Venture Capital Trust (VCT) fund managers, with a VCT heritage spanning over 20 years. This guide explains the benefits and risks of investing in VCTs.
This guide is intended only to provide a brief introduction to VCTs as an investment option. For further information on VCTs, and in particular if you are unsure of the risks of investing in VCTs, you should always seek advice from a regulated financial adviser.
An investment in a VCT should only be made after reading the Prospectus in full, including the Terms and Conditions of Application, and the Key Information Documents of the VCTs for which they are applying.
What are Venture Capital Trusts?
A VCT is a London Stock Exchange listed investment company, structurally similar to an investment trust. A VCT is run by a specialist fund manager and aims to achieve shareholder returns by investing in a diversified portfolio of small, unquoted or AIM quoted companies to help them grow in value and ultimately sell them to trade or private equity acquirers.
The majority of VCTs are generalist in their investment focus (investing across a range of sectors in order to offset risk through diversification), though there are specialist VCTs focused on specific sectors or on investment only in AIM (Alternative Investment Market). Most VCTs are also evergreen in structure, meaning that they will continue indefinitely (subject to periodic shareholder approval), and so can target long-term capital appreciation and regular dividends. There are also some ‘limited life’ VCTs which will typically aim to wind up (i.e. realise their assets and distribute the proceeds to shareholders) soon after the five year minimum holding period applying to investors (for the purposes of retaining individual tax reliefs).
Why invest in a VCT?
VCTs offer investors exposure to an alternative asset class that is otherwise difficult to access, with portfolios sourced by specialist managers with expertise in SME investment. VCTs were introduced by the government in 1995 to encourage investment into smaller British companies in order to support their growth, as SMEs are widely regarded as the engine room of the UK economy, through their proven record of creating jobs and contributing to economic growth. In that time VCTs have collectively raised more than £12 billion from private investors and invested that capital in thousands of entrepreneurial UK companies.
How to invest in a VCT?
A VCT raises money (at launch and typically also through periodic ‘top up’ fundraisings or ‘share offers’) from experienced retail investors and invests the funds in a portfolio of early stage companies which are typically privately owned or AIM quoted. An investor receives shares in the VCT, rather than in the underlying portfolio companies in which the trust invests (and for investors in a top-up offer they acquire shares in the VCT and therefore gain exposure to the VCT’s existing portfolio as well as new investments made by the VCT).
The VCT has an appointed Investment Manager, usually a specialist investment firm, which will invest the VCT’s cash into new VCT qualifying investments (see below) or provide additional ‘follow on’ funding to portfolio companies as they scale up and achieve growth objectives.
Who are VCTs suitable for?
Investment in the Maven VCTs is intended for UK taxpayers aged 18 or over who: have an investment horizon of five or more years; are able to bear up to 100% capital loss; and have a medium to high risk tolerance. Investors will generally be informed investors with either experience in investing in VCTs or with an understanding of the risks involved. Maven VCTs are not suitable for investors who: have an investment horizon of less than five years; are looking for capital protection or full repayment of the amount invested; are risk averse or have a low risk tolerance; are reliant on income from the investment; or do not have basic knowledge or experience of VCTs.
VCTs can offer a number of attractions for investors who, for example, are interested in backing ambitious, young businesses before they become widely known; or are close to their lifetime pension limit or maximum annual contributions; or have a significant tax liability they wish to reduce; or are attracted to a potential tax free income stream; or are simply looking to achieve further portfolio diversification through access to a new asset class.
The tax benefits
Investing in small businesses carries a higher degree of risk than investment in the shares of established, listed companies. So, in order to encourage private investors to invest in VCTs, and thereby provide valuable funding support to the SME sector, generous tax benefits are available:
- Up to 30% tax relief* at the outset on investment of up to £200,000 per tax year (only available on newly issued VCT shares)
- Tax-free dividends – with no requirement to declare VCT dividends on a tax return
- Tax-free growth – exemption from CGT on gains from sale of VCT shares
* Subject to having sufficient tax liability in the year of investment. Taxation rules and legislation may be subject to change, and the value of tax relief depends on personal circumstances.
At any given time, the overall asset value of a VCT is the aggregate value of its assets (portfolio companies and other assets such as cash), known as the Net Asset Value (NAV), and each share in the VCT has an equal share of that NAV (NAV per Share). For example, in a VCT with an NAV of £50m and 100m shares in issue, shareholders will have an NAV per Share of £0.50.
A VCT achieves growth in value through the profitable sale or capital appreciation of its assets – in the case of private companies the VCT manager will typically be invested in each for between two and seven years, and will look to directly contribute to their growth by playing an active role in the strategic management of the business, typically providing close board level support to help it professionalise and scale and ultimately become attractive to larger trade buyers or private equity acquirers. SME investment is a highly specialist area, so the expertise of the VCT manager in adding value to help each company grow is fundamental to the overall ability of the VCT to generate profitable realisations and pay dividends.
When a VCT sells an asset for a profit, or an asset increases in value, that increases the overall NAV (and therefore the NAV per Share for Shareholders). However, whereas the growth investors experience in other investment vehicles, such as Investment Trusts, is typically in the form of capital growth, alongside modest levels of dividends or income, VCTs are able to return a large element of their overall returns in the form of tax-free dividends*, and indeed many VCTs will target an annual yield of between 4 and 6%. For this reason, it can be the case that when the VCT is achieving positive returns the NAV per share may remain fairly level or even fall (if significant funds have been paid out as dividends), so the most relevant performance measure for a VCT is the NAV Total Return per share, which comprises the NAV per Share plus the value of any dividends paid to date.
* Dividends are variable and not guaranteed.
What are the risks with VCTs?
The VCTs’ investments are directly into private or AIM quoted companies. They carry a higher risk than investments in larger more established companies or those listed on the Main Market. Shares in private companies are not publicly traded and are therefore likely to be illiquid and can be difficult to realise.
Investors could lose all or some of the value of their investment. The value of VCT shares, and the level of income derived from them, may fall as well as rise. VCT shares should, therefore, only form part of a diversified investment portfolio.
Existing tax levels and reliefs may change, and the value of reliefs depends on personal circumstances. If a VCT loses HMRC approval, or an investor in a new issue sells their shares within five years, tax reliefs previously obtained may be lost.Taxation rules and legislation may be subject to change, and the value of tax relief depends on personal circumstances.
What does a VCT invest in?
VCTs offer investors the opportunity to gain exposure to portfolios of emerging UK private companies selected for their high growth potential.
Legislation governing VCTs has evolved significantly since 1995, to ensure that VCT funding is only provided to early stage, high-growth companies which, due to their risk profile, struggle to obtain growth finance from other source such as bank loans.
There are strict HMRC criteria governing which companies can qualify for VCT funding, including:
Age of company
VCTs are generally required to invest in companies that are less than seven years old (i.e. from the date of their first commercial sale). There are exceptions for ‘follow-on’ investments into existing VCT portfolio companies, where the age requirement can still be met if the follow-on funding is to a company for which the original investment was made inside the seven-year period.
A company must generally have no more than £15 million in gross assets immediately before investment and must have fewer than 250 employees at the time of investment (see below for ‘knowledge-intensive’ companies).
A VCT must not hold an investment in any single company which exceeds 15% by value of the VCT’s total investments. Each company is generally allowed to receive up to £5 million of VCT or other tax-efficient funding in any twelve-month period, with a cap of £12 million over its lifetime.
In line with Government policy objectives, the VCT funding rules for companies that have invested in research, development, or innovation are more flexible. These ‘knowledge-intensive companies’ can have up to 500 employees, they can receive up to £10 million of funding per annum (with a cap of £20 million over its lifetime) and the basic age limit by which the initial relevant investment must be made is within 10 years of the company’s first commercial sale.
Allowable business activities
A company must have a permanent establishment in the UK and carry out what HMRC calls a ‘qualifying trade’. Most trades are allowed, but there are some exceptions such as land dealing, forestry, farming, hotels and energy generation.
There are also certain conditions that apply to how a VCT should construct and manage its investment portfolio in order to maintain its qualifying status. These rules are specific to the VCT and when it raised its funds. For example, a VCT has three years in which to fully deploy money raised from investors, regardless of whether it was raised through an initial share issue or a ‘top-up’ fundraising. A VCT must also have at least 80% of its portfolio invested in VCT-qualifying companies. The remainder can be held as cash or invested into cash equivalents which can be readily realised within seven days – such as money market funds or shares listed on the FTSE.
VCTs: In summary
Since their introduction in 1995, VCTs have been providing a tax-efficient investment option for investors who have a significant income tax liability they wish to reduce or are attracted to the regular tax-free income stream VCTs can generate. The tax-efficiency of VCT investment can also help combat the annual allowance restrictions on pension planning or the impact of other tax changes such as on capital gains tax and dividend tax. VCTs can also provide investors with an effective way to further diversify an investment portfolio.
However, you should never invest in a VCT simply because of the tax benefits. Whilst VCT investment can offer the potential for attractive returns, and investing in the future of British business can be rewarding, it also carries a risk of loss and tax rules are subject to change.
If you are in any doubt about a VCT investment, you should seek advice from an authorised financial adviser.