This article first appeared in Professional Paraplanner.
Investor demand for venture capital trusts (VCTs) has surged in recent years. Restrictions to pension contributions and changes to buy-to-let rules have led many clients to turn to VCTs as a way to complement their retirement planning. As the market has matured, we’ve also seen a much broader range of VCTs on offer.
Given the appetite for VCT investing, it’s good to have a grounding in how a VCT works and what that means for a client.
Raising the funds
The cycle starts when the board of a VCT decides on its fundraising target for the tax year. Fundraising then opens, with most VCTs opening a few months into the tax year.
When a VCT is open for new investment, a client can apply for shares by:
- Reading the new share offer prospectus.
- Completing an application form.
- Sending a cheque or electronic payment to the company managing the VCT.
Once the VCT manager receives the funds, it allots the client’s VCT shares at the next available date. This process can take a few months, depending on when the next allotment date is. You should be able to get that information from the VCT provider.
The client receives share and income tax certificates shortly after their shares have been allotted. They can then use the income tax certificate to claim income tax relief from HMRC. Note that tax treatment depends on individual circumstances, and tax rules may change in future. Also note that tax reliefs depend on the VCT maintaining its VCT-qualifying status.
It’s a good idea to do VCT planning ahead of time. That way your client will be in a good position to take advantage of any early bird discounts on offer, meaning they shouldn’t end up paying more for the same VCT. Your client is also more likely to get into the VCT of their choice.
A VCT fundraise will be open for one calendar year, or until the fundraising target is reached, whichever is sooner. VCTs tend to set targets they can be confident of reaching, so in practice most VCTs tend to close before the end of the tax year. Some will have the option to open up additional capacity if they reach their initial target. This is something Octopus Titan VCT did in 2017-18 when it raised £200 million, the largest ever VCT fundraise.
Deploying the funds
After the fundraise closes, the next stage is to invest the money raised. This can include follow on investments into companies already in the VCT’s portfolio, as well as investments into new companies.
To qualify for VCT investment, a company must have gross assets of £15 million or less at the time of investment, or £16 million immediately afterwards. The company must also have fewer than 250 full-time staff when the investment is made.
A VCT can invest up to 15% of its money in a single company. Each company can receive up to £5 million of VCT or other tax-efficient funding in a twelve-month period, with a cap of £12 million over the company’s lifetime. VCTs are also expected to invest in companies that are less than seven years old from the date of their first commercial sale. There are exceptions to this if a VCT is already invested in a company and is making a follow on investment, or where an established company is raising capital to enter a new market.
There are different limits for knowledge-intensive companies, which are those with a large proportion of highly skilled workers or which meet certain conditions about how much innovative activity they undertake. That’s because companies doing a lot of research and development may need extra resources in the form of employees and funding.
Knowledge-intensive companies can have up to 500 employees, up to twelve years to receive initial VCT funding and can receive up to £20 million from VCTs and other tax-efficient sources during their lifetime.
In addition, the 2017 Autumn Budget announced an increase in the maximum amount a knowledge-intensive company can receive from a VCT in a twelve-month period, from £5 million to £10 million.
It is the responsibility of the VCT manager to make sure a VCT sticks to these rules and maintains its VCT-qualifying status.
A good VCT will go beyond providing financial investment and will support companies in other ways. This might include taking seats on the board, supporting their recruitment strategy, or advising them on how and when they should expand in to new international markets, like the US and Asia.
Delivering returns for investors
VCT investors receive returns via dividends and capital gains, both of which are tax-free.
Capital gains are driven by the valuations of companies in the VCT’s portfolio, which are reflected in the VCT’s share price. Most VCTs aim to pay regular dividends, with some also paying special dividends after selling a stake in a business that has done well.
Of course, there’s no guarantee there’ll be a net increase in the portfolio’s valuation. VCTs put capital at risk, and investors may not get back the full amount they put in.
Clients need to hold on to a VCT for at least five years or else repay any income tax relief claimed. When it comes time to sell their VCT shares, most VCTs offer a buyback process, which aims to buy shares back from shareholders at a small discount to their net asset value. This is because the market for second-hand VCT shares is very limited. Second-hand shares do not offer upfront tax relief, making it difficult to sell them at a fair price.
Note that VCTs are under no obligation to offer buybacks, and will only do so if they have sufficient reserves to meet their obligations. Also note that, due to regulations governing public companies (which a VCT is), there can be specific times of the year when a buyback is restricted, for example when the VCT is preparing its accounts.
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. 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: May 2018