Prospects for the VCT Generalist sector

Tim Levett, Chairman, NVM Private Equity, managers of the Northern VCTs.

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For the past few years the leading generalist VCTs have consistently provided a tax-free dividend yield of between 5% and 8%, with some funds outperforming, whilst seeking to maintain or grow the underlying net asset value per share. Investors have become used to generalist VCTs being tax-free income funds. In an environment in which interest rates are very low, VCTs have naturally become very attractive to investors. The consistent returns have been generated by a combination of exits at high money multiples, unrealised gains in the portfolio and the yield from investee companies. Recently all the leading generalist VCTs have enjoyed a number of quite high profile exits, with the investee companies often being sold to mid-market private equity firms, as well as corporate buyers.

In the current tax year expectations are that around £300 million will be raised from VCTs, in the expectation that the total return performance will be sustained for at least the next three years. There are two things that will drive total return: Dealflow and profitable exits.

Dealflow

With the UK economy growing strongly, helped by low oil prices, there is optimism that the companies eligible for VCT investment, that primarily focus on the UK market, will flourish and there will be a strong demand for equity funding. In the past, small companies have depended on bank support to help fund their growth, but post the financial crisis this is no longer the case. VCTs have been around for nearly 20 years, and have backed hundreds of businesses. They therefore have a track record of supporting growing UK companies, and many advisors see VCTs as a primary source of equity. Even though the weakness of the Euro and a sluggish global economy is likely to impact on the growth prospects of small UK based companies, many VCT-backed SMEs continue to increase their export revenues on the back of innovative products, and it is these companies that VCTs will seek to back.

Profitable exits

Successful VCT-backed businesses have usually benefited from having sound operating and financial systems, and are used to the discipline of board meetings and strategic planning.  This is attractive both to private equity and corporate buyers, who feel confident that when they acquire these companies there will already be a high level of corporate governance and professionalism. This is borne out by the multiples that have been paid in the last few years, and it is anticipated that this will continue. Since the generalist VCTs each hold around 30 companies in their portfolios, and are typically making at least six new investments a year, there is every prospect that there will be a consistent flow of exits – potentially at high money multiples.