The return of VCTs

They’re back, by popular demand. Venture capital trusts raised just shy of £1.1bn in the 2022-23 tax year, close to an all-time record. Now this sector of the investment companies market is starting to open up for 2023-24, with around 15 funds announcing new offers over the past month or so. There will be more to come, but the funds launched so far are looking to raise close to £400m.

VCTs invest in small, early-stage companies. Generally, for a company to be eligible for VCT investment, it must be less than seven years old, with assets worth less than £15m and fewer than 250 employees. Naturally, these fledgeling businesses carry a higher risk of failure than their larger and more established counterparts, so the government offers a range of generous tax reliefs to VCT investors to encourage them to put money into this important part of the economy.

At the top of the list of these reliefs is 30% upfront income tax relief – invest the maximum allowed in a VCT in any one tax year, £200,000, and you can claim back £60,000 via your tax return. Critically, however, this perk is only available on investments in new VCT shares, which is why there has to be a fundraising round each year. VCT managers either offer completely new funds or issue new shares in their existing funds. Either way, they’re raising new money for investment in growing businesses, which is what the tax regime is designed to encourage.

Other tax breaks on VCTs include tax-free income and capital gains. At first sight, the latter sounds more valuable, since the early-stage businesses in VCT portfolios aren’t typically in a position to make dividend payments. In practice, however, VCT managers typically structure the funds to pay out most of their returns in the form of income rather than profit, so the fact this is tax-free can prove very valuable.

All that said, it is never a good idea to make an investment purely to secure a tax break. You need to be comfortable with the elevated risk that comes with a VCT, and to pick a fund and manager that you expect to give you the best opportunity to secure a good level of returns.

On the risk front, VCTs do at least offer a portfolio approach to investment in early-stage companies – with constituents chosen by professional managers – which provides diversification benefits. A couple of failures should not sink the ship. It also helps that managers are allowed to hold up to 20% of assets raised in cash, rather than investing the money. This can provide a helpful risk-free buffer, particularly in the early years of the fund.

As for returns, what you’re looking for is a fund that picks the next big small business winners. Household names including Zoopla, Gousto, Virgin Wines and Graze all got off the ground partly thanks to VCT funding and went on to deliver handsome returns for investors. Look for a VCT manager with a strong track record and the experience and network to pick their future equivalents.

Clearly, VCTs aren’t for everyone. Most investors in these funds are likely to have already used their individual savings account (ISA) allowances in full (or have plans to do so), and to have a broad spread of more conventional assets in their portfolios. But for those happy to accept the higher risk that comes with a VCT, the funds can be a good way to add potential for additional performance to your investments, particularly with the extra boost of tax efficiency.

One question to consider is whether you want to invest in a VCT for 2023-24 in the coming weeks or wait until closer to the end of the tax year. The advantage of the latter approach is that other funds will become available. But bear in mind that the most popular VCTs close once they have raised their target amounts – the managers don’t want to be left scrambling to find businesses in which to invest more money than expected. That means delaying could mean missing out.

That said, you don’t have to put all your eggs in one basket – the rules permit you to invest in multiple VCTs. One option could be to allocate some money now, while earmarking some for further investment if another VCT catches your eye later in the tax year.