A Venture Capital Trust (VCT) is a publicly listed company and managed by fund managers. The primary objective of running VCT is to invest in small companies and help them grow. Governments support this investment option because when experienced investors back young entrepreneurs or startups, they help create jobs as well as support the economy.
On the other hand, these private investors get attractive tax breaks such as tax-free dividends and 30% initial tax relief for any investment of up to £200,000 a year. Companies get different tax breaks for investing in young businesses aged seven years and below because such investments have a higher risk.
So then, here is why you should consider venture capital trusts an alternative investment option.
Types of VCTs
1. Generalists VCTs
These are VCTs that invest in different companies, sectors, and businesses in various stages of development. Nearly three-quarters of the entire VCTs fall under this category. This helps them build a diversified portfolio of investments in order to fulfill the VCT mandate.
Therefore each VCT has its individual set of objectives. For instance, some may choose to invest in early-stage companies yet make some profits, and others might choose to focus on more established or mature businesses.
For that reason, an investor should first enquire about the VCT’s investment strategy prior before picking the right one.
2. Aim VCTs
This VCT only invests in listed companies or those about to list on the Alternative Investment Market (AIM). This is the junior market for the London Stock Exchange (LSE). This VCT type was created to drive the growth of UK smaller businesses or companies.
Companies listed in this section have their daily market price and must meet specific requirements in order to remain in this category. On the other hand, it’s easier to buy and sell VCT-qualifying shares on the AIM section than those are privately owned, unlisted companies.
3. Specialist VCTs
These are VCTs dedicated to a specific sector such as healthcare, energy, education, biotechnology, infrastructure, and more. The VCTs have particular investment objectives, and so they concentrate their efforts on a specific sector with specific investment risk and higher returns when the chosen sector does well.
4. Limited Life VCTs
They are set at 5+ years and get winded up at the end of the period. Others are evergreen, and so they last indefinitely.
Reasons Why You Should or Shouldn’t Consider VCTs
It’s important to talk to a financial adviser before investing in a VCT. Here are some of the reasons why you should or shouldn’t consider investing in VCT
What You Will Like About Investing in Venture Capital Trusts
Highly Tax-efficient: You will get 30% income tax relief when you hold your VCTs for five years. Further, there is no capital gains tax on the profits you generate after disposing of your shares. Also, you will get tax-free dividends if you choose to keep your shares. Therefore, VCTs investments are highly tax-efficient.
Growth Potential: Smaller businesses have a higher growth potential compared to the larger listed companies. VCTs offer investors access to a diversified, smaller company portfolio with vast growth potential. Such an investment gives such firms an attractive way to get exposed to this sector.
Attractive to Sophisticated Investors: High earners with limited options can invest in VCTs. That means individuals who have hit their pension contributions limit or exhausted their dividend tax allowance may consider VCTs. It is also a complex product only reserved for sophisticated investors.
Helps to diversify your investments: Listed companies’ shares can be affected by factors such as local and international events, or the global market conditions can change. On the other hand, smaller companies might opt for a different investment cycle in various parts of the market. Therefore, VCTs can help diversify your overall investment portfolio.
Contribute to the Growth of the National Economy: By investing in VCTs, you’re helping create jobs, economic growth, and prosperity for the nation.
What You Will Not Like About Investing in Venture Capital Trusts
Lower Returns: While tax shouldn’t greatly influence your investment, you should look at its performance, and so VCTs lag behind the mainstream equity markets. The average share price return is 123% for generalist VCT compared to 149% for average all-companies investment trust in the UK. Also, VCT providers have higher charges (1.75-2% a year) compared to investments trusts and funds charges (0.85-1%). Further, these tax incentives depend on your personal circumstances and VCT that has maintained its qualifying status. These factors can change, and you lose these incentives.
Risky: Investing in VCTs is risky because it involves putting your money in earlier-stage companies. These firms have been in business for less than seven years, so chances are higher that you might not get the entire amount you invested. Further, the investable VCTs universe is limited because of restricted investment in asset-backed firms and excluded management buyouts. So while investing in younger businesses can be profitable, it has higher risks, and rules keep on changing.
It’s a Long Term Investment: You have to hold VCT shares for at least five years. Otherwise, you will be required to pay any upfront income tax relief you have previously claimed. Further, the VCT market is not as active as the listed companies’ shares market. Therefore, it will take longer to find a buyer in the event that you decide to sell your VCT shares. Alternatively, you will be forced to accept a lower price than their net asset value (NAV).
Examples of VCTs
Hargreave Hale AIM VCT: This is an AIM VCT launched in 2004. The fund invests in companies quoted on the AIM market of the London Stocks Exchange. The fund reported a market cap of £204M in 2021 after a merger with its sister fund Hargreave Hale Aim VCT 2 PLC in 2018. The management of the fund makes investment decisions based on the business strategy, strong balance sheet, strength of the management team, competitive landscape, and barriers to entry, among others.
Draper Espirit VCT: It is managed by Elderstreet Investments and has diversified its portfolio by including smaller unquoted companies focusing on the technology sector. Its core investment portfolio comprises Aiven, Aircall, Apperio, Allthings, Bitwala, Hadem, Freetrade, Ledger, Peak games, Socialbakers, TransferWise, and Unbound. The minimum investment in Draper Espirit VCT is £6,000.
Maven Income and Growth VCTs: It operates Maven Income and Growth VCT PLC. This is a generalist VCT with a diversified portfolio and a track record of generating positive shareholder returns as well as regular dividends. Since the VCT is listed on the London Stock Exchange, a retail investor can buy its shares through a broker without paying entry fees to the fund. The fund’s investments targets include Bio Ascent, Coniq, Hublsoft, Mirrorweb, Nano interactive, and Symphonic. The latest offer quoted £5,000 as the minimum investment.
Unicorn AIM VCT: This is the UK’s largest AIM-focused VCT managed by Unicorn Asset Management Ltd. Its investment target comprises Abcam, Anpario, Avacta, Cohort, Hasgrove, Interactive investor, MaxCyte, Tacsis, Tristel, and Surface Transforms.
Downing VCTs: It has nearly 250,000 investors and £1b in assets across a wide range of collective investment schemes. Downing LLP is the investment adviser and administer of this generalist venture capital fund. Further, its portfolio has 60 companies spread across income and growth opportunities. Its recent investments include ADC Biotechnology Limited, Cambridge Touch Technologies Limited, Ecstase Limited, FundingXchange Limited, Hummingbird technologies Limited, JRNI Limited, and Lineten Limited. Its minimum investment is £5,000 or £1,000 per month, the fund’s dividend policy target is 4% of NAV, and its ongoing management costs is 2.75% per annum.
Baronsmead VCT Venture Trust: The VCT was launched in 1998 and is managed by Gresham House alongside Baronsmead Second Venture PLC. It focuses on sectors such as business services, technology, education, healthcare, and consumer markets. The following companies are some of its investment targets Carousel Logistics Ltd, Cerillion PLC, Custom Materials, Ltd, Ideagen PLC, and Netcall PLC. Its minimum investment is £3,000.
Other notable VCTs are Albion VCTs, Amati AIM VCT, Blackfinch Spring VCT, Calculus VCT, Hazel Renewable Energy VCTs, Northern VCTs, Foresight VCTs, Pembroke VCT, ProVen VCTs, Puma Alpha VCTs, Triple Point VCT, and Seneca Growth Capital VCT.
How Can I Buy VCT Shares?
You can join a VCT by participating in its new share offer, which entails applying for shares when it opens a new investment opportunity. To apply, you can read the VCT’s new share offer prospectus, fill the application form and make an electronic payment or send a check.
Alternatively, you can go through a financial adviser or online discount broker and buy second-hand shares since VCTs are listed companies. Usually, VCTs are high-risk investments, so it’s recommended to first speak to a financial adviser before diving into this sector.
Investing in VCTs by buying shares that were previously owned will not give you an upfront tax relief received when you invest in new VCT shares. However, these VCT shares will be factored in your £200,000 tax-free limit per tax year.
How can I Sell My VCT Shares?
As mentioned, the second method of investing in VCT doesn’t give you an upfront tax relief, and as a result, the market for second-hand shares is extremely limited. Therefore, it’s hard to sell your VCT shares at a reasonable price.
On the other hand, most VCTs’ Board of Directors has initiated a ‘buy back’ to help existing investors dispose of their shares at a small discount. VCTs are not mandated to buy back shares from their shareholders and can only do so when they have sufficient cash reserves.
Further, the discounts to NAV vary from one VCT to another, but the recommended rate is 5-10%. Therefore, it’s important to study the VCT’s share buyback track record and the discount to NAV before investing in it.
What Is the Procedure of Claiming My Income Tax Relief?
You will receive two certificates once you invest in VCT.
VCT share certificate indicates the number of shares you own. You will need it when selling your shares, and so you should keep it safely.
VCT tax certificate is the document you need when claiming your upfront income tax relief. Those investors that pay their tax through PAYE have two ways of claiming their tax relief from HMRC.
First, they can get a tax code adjusted by calling HRMC, thus immediately start paying less tax. Alternatively, they can use the SelfAssessment form to claim their income tax relief at the end of the tax year.
Which are the Companies Included in VCTs?
The HM Treasury has set rules regarding the companies that can be included in the VCT portfolio. These rules aim to ensure that all VCTs meet policy objectives established by the Government. One of these objectives is to channel funds to companies in need in order to help them grow. Here are the requirements.
Allowable Business Activities: These are UK-based companies engaging in qualifying trade as stated by the HM Revenue and Customs. While most trades are allowed, HM Treasury has set additional eligibility criteria that disqualify most small businesses in need of financial support. They include forestry, land dealing, farming, energy generation, running hotels, and financial activities.
Investment Amounts: A VCT can only put 15% of its funds in one company, while each business can only receive £5 million in the form of VCT in any 12 months. This also applies to any other tax-efficient funding. The maximum VCT is capped at £12 million over the company’s lifetime.
Company Size: The qualifying company must have a gross asset of up to £5 million at the investment time. It should also have £16 million immediately after the financing. Additionally, the company should have less than 250 full-time employees at the time of investment.
Company Age: VCTs can only invest in companies that are seven years or less from the day they made their first commercial sale. Still, follow-on investments exceptions apply as well as companies intending to enter the geographic market or new product.
Knowledge-intensive Companies: At times, funding rules might be expanded to allow companies to support government policy objectives. This favors firms with a higher percentage of highly skilled workers or those that meet certain innovative conditions. As a result, such a company might be allowed to have 500 employees, a generous lifetime investment cap of up to £20 million, and they can be up to 12 years old.
Management of VCT: There are rules pertaining to how a portfolio of VCT investments is constructed or managed. A VCT has three years to invest all the funds it has received from investors. It should also invest 80% of the funds in VCT-qualifying companies. The balance can be put on cash equivalents like market funds or FTSE listed shares that can be readily realized in seven days or held as cash.
How are the Companies in My VCT Portfolio Shares Valued?
VCTs basically invest in unlisted companies’ shares, and so they are not freely traded on any stock exchange. Therefore it is hard to tell the worth of your VCT portfolio. However, you can calculate the worth of those listed under the AIM because these VCTs are valued on a day-to-day basis.
Still, the VCT portfolio is regularly monitored by the Board of Directors using established international valuation methods. These techniques help them to calculate the net worth of each VCT portfolio shareholding. This is done every 3-6 months while the AIM VCTs valuation is done every day.
The estimates help the VCT calculate its total value, and the actual valuation of the portfolio company is only known once it is sold.
What is the Lifespan of a VCT?
There are two categories of VCTs based on their investment lifespan.
Evergreen VCTs: These are VCTs that are created or set up to last indefinitely. Their objective is to provide either a steady stream of dividends or provide long-term capital growth.
Limited Life VCT: The minimum holding period for this VCT is five years, and so it is closed when the term ends. In other words, the VCT sells all of its assets and distributes the entire proceeds to its shareholders.
What Happens When I Die?
Your shares form part of your estate when you die and are transferred to your beneficiaries. These individuals may choose to transfer this investment into their name or sell them. Also, they will not pay upfront income tax relief claimed when you die less than five years after making this investment.
Still, your VCT dividends will be tax-free, and your beneficiaries will not pay capital gains tax when they sell these shares.
What Gives VC Firms an Edge?
Venture capitalists (VCs) are experts or experienced professionals in financial and management disciples. VCs are skilled at analyzing financial statements, performing due diligence, valuing a business, assessing how effective the management is, advising businesses on financial management, and executing exit strategies.
VC firms are very transformative because they open doors to different investment opportunities which might not be available for those intending to invest individually.
These firms have an excellent social and professional network. So they operate on who you know rather than not what you know principle when sourcing for investment opportunities.
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