This article first appeared in Professional Paraplanner.
When it comes to venture capital trusts (VCTs), there are several big questions you should ask if you want to make your due diligence as smooth as possible. Getting the right answers to these questions will help you explain to clients why you’re recommending one VCT over all the others. Here are five questions to consider before deciding whether a particular VCT is right for your client.
How high are fixed costs relative to the size of the fund?
A VCT is a company in its own right, which is listed on the stock exchange. That means it must publish its own annual report and accounts, have an independent board of directors, hold general meetings for shareholders and generally meet standard corporate governance requirements just like any other public company.
These activities cost money. A bigger VCT can spread these fixed costs over a larger asset base, reducing their impact on each individual investor’s returns.
Does the VCT have an established portfolio?
Larger VCTs that have been around longer tend to have more established portfolios. By contrast, a newer VCT may still be in the process of building up its holdings.
This matters, because it affects how much you and your client can know about the investment before you go in. After all, your client will have to hold the investment for five years to keep the upfront income tax relief VCTs offer. A VCT that’s still building up its portfolio could look very different by that time.
Of course, larger VCTs will still add new positions and sell existing ones. The point is that with a VCT that holds 50 or more companies, you have a much better idea what its portfolio will look like over the time your client holds the investment. Such a VCT is also likely to have a longer track record, giving you a better idea of how the investment managers have delivered on their mandate. Of course, keep in mind that past performance is not a reliable indicator of future results.
Do the VCT’s activities fit with the spirit of government legislation?
Successive governments have supported VCTs because they recognise the contribution they make to the wider economy.
The Octopus High Growth Small Business Report, published last month, finds that these types of business make a huge contribution to the economy relative to their size. Less than 1% of UK businesses account for more than 20% of economic growth and create one-in-five new jobs – more than 3,000 jobs a week.
The Treasury recognises the need to support the next generation of British businesses, with the 2017 Budget maintaining the tax reliefs for VCT investors.
So why does this matter to you and your client? Well, although the Budget maintained support for VCTs, there were some rule changes. The new rules are aimed at investment managers rather than clients, and are designed to encourage them to invest more of the funds they raise into high growth companies, and in a more timely manner.
This is entirely in keeping with the rationale behind VCTs, which is to direct capital to the most dynamic businesses. The new rules shouldn’t be a problem for those VCTs whose activities align with the spirit as well as the letter of the legislation. Such VCTs should also be better placed for any future rules changes too.
How will your client exit after five years?
Some VCTs will be closed as soon as possible after the minimum holding period of five years has passed. These are known as ‘limited life’ VCTs, and will sell their assets and distribute the proceeds to shareholders.
Other VCTs, often called ‘evergreen’, are set up to last indefinitely, with the aim of providing long-term capital growth and dividends. To enable shareholders to sell their shares after five years, evergreen VCTs should have a process in place where the VCT buys back shares from its shareholders.
Make sure you ask about the buyback process, including what kind of discount to net asset value the VCT applies when buying back shares.
Is your client comfortable with the risks of investing a VCT?
As an incentive to take on the risks of investing in smaller companies, VCTs offer attractive tax reliefs. Any dividends and capital gains are free from tax, while investors can also claim upfront income tax relief equal to 30% of the amount invested on the first £200,000.
It’s important your clients understands that a VCT puts their capital at risk, and they may not get back the full amount they invest. They should also be aware that tax treatment depends on individual circumstances, and may change in the future. Tax reliefs also depend on the VCT maintaining its VCT-qualifying status. VCT shares can move up and down in value by more than other shares listed on the London Stock Exchange’s main market, and may also be harder to sell.
Make sure your client is aware of the risks as well as the benefits of investing in a VCT.
The new tax year means it’s a time for planning. Make sure to have any conversations with clients about VCTs sooner rather than later. This will put you in a good position when VCTs start fundraising, and should make sure your client doesn’t miss out on any early bird discounts. And, of course, the sooner they invest the sooner they can claim their income tax relief.
You might want to consider a VCT as part of your clients’ ISA planning too. Some VCT managers facilitate clients to use existing ISA funds to benefit from VCT tax reliefs, all without taking money out of the ISA wrapper.
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. We record telephone calls. Issued: April 2018