This article first appeared in Money Observer.
Recent restrictions on pension tax reliefs and buy-to-let have led some investors to look for other ways to make tax-efficient long-term investments. One popular destination has been Venture Capital Trusts (VCTs).
Since 1995, VCTs have been a valuable source of long-term capital for smaller companies. They’ve helped to grow some of the UK’s entrepreneurial success stories, like property portal Zoopla Property Group and Eve Sleep, the online mattress company.
They’ve also helped create jobs – the average VCT-backed company hires 51 new employees.
VCTs offer attractive tax reliefs for investors prepared to put money into higher risk smaller companies for at least five years, such as tax-free dividends and 30% upfront income tax relief. However, dividend payments are not guaranteed and an investor’s tax treatment will depend on their individual circumstances. The tax reliefs also depend on the VCT maintaining its VCT-qualifying status.
Currently, the average yield on a VCT is around 8.4%. Bear in mind that past performance is not a reliable indicator of future results.
The 2016/17 tax year saw £570 million flow into VCTs, a 28% jump from the previous year. This surge in popularity means it’s a good time to review what investors should look for in a VCT.
- Does the VCT deliver more than just tax relief?
A VCT should be a good investment in its own right. Does the VCT manager have experience of working with entrepreneurs and management teams in order to properly understand the companies they are backing and the growth potential? You’re investing through a listed company into a portfolio of smaller, higher risk companies, so you also need to be comfortable with the associated risks.
- Does the VCT offer diversification?
There are, broadly speaking, three types of VCT. Generalist VCTs invest in unquoted early stage companies. AIM VCTs invest in companies listed on the Alternative Investment Market (AIM). Specialist VCTs operate within a specific sector or market, such as infrastructure, or technology.
Generalist and AIM VCTs tend to offer broad diversification across a range of sectors. They can also usually spread their costs over a bigger asset base, making them cheaper for investors. Remember though that all three types invest in small, less established, higher risk companies.
With a VCT, like other types of investment, capital is at risk. It is very important that an investor fully understand the risks involved before deciding whether a VCT is the right investment for them.
- Does the VCT have a history of successful exits?
When the time is right, a VCT manager might look to sell some or all of its interest in a portfolio company (known as an ‘exit’). The proceeds of the disposal belong to the VCT, and can be reinvested in new opportunities or distributed to investors, usually in the form of tax-free dividends (which explains the relatively high target yields, since it includes an element of capital gain). Tax reliefs do depend on the VCT maintaining its VCT-qualifying status, and the tax benefits available will depend on an investor’s own personal circumstances and can change.
- How well does the VCT support growth?
VCTs offer tax reliefs because they help support the growth of innovative UK businesses which may not otherwise get the capital they need. And it’s this growth that can drive returns for VCT investors.
Look for a VCT manager that aims to add real value to a business beyond the finance provided. Not only can this nurture companies directly, being actively involved with entrepreneurs helps the management team spot other promising companies that are also doing the right things.
- Has the VCT provider proved it can adapt to changes in legislation?
Over the years, successive governments have made regular changes to VCT legislation to ensure they continue to meet their policy objectives. Most recently, there has been speculation about potential changes to VCTs arising from the Patient Capital Review.
While no one can predict what announcements might be made on 22 November, it remains clear that VCTs are a well-established and proven provider of patient capital supporting the next generation of UK businesses. The most experienced managers have seen many adjustments to legislation over the years, and so are well placed to adapt to potential changes.
A huge investment opportunity
For those comfortable with the risks associated with smaller company investing, VCTs remain a great way for people to invest
in some of the UK’s most promising growth businesses. They are an attractive, tax efficient investment while providing critical funding for those companies, helping to generate thousands of jobs and making a significant contribution to the UK economy.
 Nurturing success, delivering growth: VCT investment 1995 to 2014 (The Association of Investment Companies, October 2015), p3 https://www.theaic.co.uk/system/files/search-hidden-file/AICVCTDeliveringGrowthOct15.pdf
2 AIC Stats (The Association of Investment Companies, September 2017), p3 https://www.theaic.co.uk/sites/default/files/statistics/attachment/AICStats30Sep17.pdf
3 Venture Capital Trust Statistics (HMRC, October 2017) p5 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/652730/171017_Venture_Capital_Trusts_Statistics_Table_8_6_Commentary.pdf
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. 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: November 2017.