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What makes a good VCT

Paul Latham

This article first appeared in Professional Paraplanner.

How do you distinguish the best venture capital trusts (VCTs) from the also rans?

In this article we’ll discuss three things you should look for if you want to find the best VCTs:

  • An ability to adapt to change.
  • A history of successful exits.
  • Access to the best deals.

Before that, let’s look at what clients can expect from a VCT no matter which one they invest in.

All VCTs offer the same tax benefits – tax free dividends and capital gains, and upfront income tax relief equivalent to 30% of the amount you invest (up to a maximum investment of £200,000 and provided you hold the VCT for five years).

All VCTs are high risk investments, as they invest in smaller, less established companies. Not only is there a risk of loss, the share prices of smaller companies can move around more than those you’ll find listed on the London Stock Exchange’s main market. They can also be harder to sell.

Investors should also remember that tax treatment depends on individual circumstances, and tax rules could change in the future. Tax reliefs also depend on the VCT maintaining its VCT-qualifying status. In short, then, all VCTs offer tax reliefs as an incentive to take on higher risk. Let’s now look at what makes a good VCT.

A good VCT manager can adapt to rule changes

There’s been a trend in recent years for more VCTs to focus on growth, as opposed to capital preservation. This is no accident. The whole reason VCTs offer tax reliefs is to give investors an incentive to take on the risks of backing early stage companies.

To that end, successive governments have changed the rules governing VCTs, the aim being to make sure capital is directed to young companies with high growth potential.

Most recently, the 2017 Autumn Budget increased the amount that knowledge-intensive companies can raise from VCTs. These are companies that meet certain conditions about how many skilled employees they have and how much research activity they do. They tend to have high research and development costs, which is why they qualify for additional funding support.

The most recent Budget also changed the rules that dictate the proportion of funds VCTs must hold in qualifying investments and how quickly they need to deploy new funds that flow in. These changes are aimed at prodding investment managers to direct capital to desired areas.

With this in mind, one thing that marks out a good VCT manager is a track record of adapting to such changes. It’s highly likely that the rules will change again at some point.

Look for providers who have been around a while and have successfully handled earlier VCT rule changes.

A good VCT should have a history of successful exits

Not every company a VCT backs will go on to be successful. Some will lose some or even all of the money invested. To deliver good returns overall, the winners need to more than offset the losers.

Part of that, of course, is picking the best opportunities in the first place. What gets less attention than it should is the importance of a successful exit, when the VCT sells its stake in a business for a price that delivers good value for the VCT’s shareholders. For quoted companies this requires good judgement about when the market share price offers a good opportunity to exit. Often this involves patience. A growth business can take a few years to mature and come to the wider market’s attention. Novices can be tempted to sell too early, before a company has reached its potential.

Similar judgement and patience is required of teams managing unquoted investments. In addition, they need to have the right contacts to find potential buyers – a lot of successful exits happen when a growing company is acquired by a much bigger player. VCT managers who invest in unquoted companies also need the negotiation skills to drive a good price.

Look for VCTs that have made several successful exits in the past, ideally by getting into a company early before most people know it exists. VCT providers have an obvious incentive to talk about their successes. If they’re not, you should wonder why.

A good VCT helps investors access the best opportunities

Of course, to be in a position to make successful exits, a VCT needs to back winners in the first place.  That means you want a VCT whose management team knows its market inside out.

It’s important for managers to have access to the best deals. Entrepreneurs tend to prefer raising funds from managers who can offer additional support beyond the initial investment. That can include follow-on funding, helping them develop valuable contacts and mentoring, for example helping a business that wants to break into overseas markets.

Look for a VCT that builds long-term relationships with the companies it backs.

 

Successful growth investing is the key

To sum up, clients who invest in a VCT can claim tax reliefs because they’re putting their money at risk. Recent changes to the rules make it clear that VCTs are expected to direct capital to smaller companies, in keeping with the spirit of VCTs. So it makes sense to pick a VCT that has an established record of doing exactly that, and has proven its ability to find the best deals and make successful exits.

For journalists in their professional capacity only. The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the VCT maintaining its VCT-qualifying status. VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange. They may also be harder to sell. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. This advertisement is not a prospectus. Investors should only subscribe for shares based on information in the prospectus, which can be obtained from octopusinvestments.com. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: February 2018