Venture Capital Trusts (VCTs)
- What are Venture Capital Trusts?
- VCTs invest in small companies
- VCTs may be high risk
- Types of VCT
- VCTs and tax
- Tax benefits when VCTs are bought at launch
- How VCTs differ from other investment companies
- Non-qualifying investments
- Valuing the underlying portfolio
Venture Capital Trusts (VCTs) invest mainly in a specific type of company – small companies with high potential for growth that need some financial support.
VCTs get special tax benefits because of their importance in supporting the economy.
- VCTs invest in small, private up-and-coming companies, not well established public companies with a long track record.
- VCTs may be higher risk than conventional investment companies given the companies they invest in.
- VCTs should be viewed as long-term investments.
- VCTs offer generous tax benefits – but you shouldn’t invest in a VCT simply for the tax benefits.
- The value of the underlying investments of a VCT can be uncertain, as they are often unquoted investments that do not have a readily available market price.
- It can be difficult to sell VCT shares on the secondary market, although some VCTs offer a ‘buy-back’ facility.
- VCTs are generally more suitable for experienced investors, as they can be higher risk than other investment companies.
- Returns are not guaranteed and you may get back less than you invest or even nothing at all.
- You should take professional advice if you’re not sure whether VCTs are right for you.
VCTs typically invest in unquoted shares including:
- new shares of privately owned companies
- new shares of companies that are traded on the Alternative Investment Market (AIM)
VCTs invest in businesses that:
- promote innovation, industrial change and modernisation of working practices
- are not generating enough cash flow to get loans or other traditional sources of finance
- need a lot of capital (usually between £100,000 and £2 million), more than most single investors could afford
Investing in a VCT is a relatively low-cost way to access the benefits of a professionally run portfolio. But remember, with any equity investment your money is at risk.
VCTs employ a professional fund manager to make the day-to-day investment decisions. All VCTs aim to buy into companies that have the potential for good growth, but you should remember that they buy shares in small, often privately owned and young companies which may or may not succeed. They can be a much riskier investment than investing in larger, more established companies.
VCTs commonly fall into three broad sectors:
- generalist (which covers private equity including development capital)
- specialist sectors, for example technology or healthcare
However, the investment strategies employed by VCT managers differ enormously.
VCTs offer investors certain income and capital gains tax reliefs.
- no income tax on the dividends from your VCT shares
- no capital gains tax on the growth of your shares
- income tax relief on the initial investment when you buy new VCT share issues (providing you hold the shares for a certain length of time)
If the VCT itself doesn’t comply with a range of conditions, both the VCT and the investors lose all the tax benefits.
The tax relief you get from a VCT can be valuable, but you should never invest in a VCT just for the tax benefits. You should make sure the investment itself suits your needs, risk strategy and goals.
If you subscribe for new VCT shares – shares bought when the VCT launches or raises new money – you can get income tax relief. This tax relief can reduce your income tax bill to zero but there are limits on how much you can invest.
If you buy shares on the secondary market (i.e. someone else owned them before you) you can’t get tax relief on your initial investment, but you can still get tax-free income and capital gains.
VCT tax benefits
The table below shows the current tax benefits available on VCT shares:
Tax free capital gains
Rate of income tax relief on subscription
Maximum investment eligible for for income tax relief
Minimum time investor must hold VCT to qualify for income tax relief
Tax free dividends
Tax reliefs only apply to people aged 18 years or over who are UK income tax payers, and are only available if the trust maintains VCT status. The relief you get depends on your individual circumstances.
These tax rules may change in future. HM Revenue & Customs law and practice can change over time and investors who are unsure about their tax status should get independent advice from a professional adviser such as a solicitor, accountant, stockbroker or independent financial adviser.
Like all investment companies, VCTs have rules they must adhere to, set out by the management company and board of directors. But they also have to comply with additional rules in order for investors to receive tax relief.
The main rules are:
- At least 70% of their investments must be in qualifying investments – small companies (maximum size £15 million) that are unquoted or traded on the AIM rather than the main stock market.
- They must invest in the companies within three years of raising new money. Keep in mind that they may invest elsewhere while making these decisions, so the risks can be different.
If a VCT doesn’t meet these rules it could lose its approved tax status. You would lose your income and capital gains tax benefits.
The remaining 30% of a VCT’s money can be invested in essentially any investment. These are often stable investments like cash, listed equities and large company debt instruments. Some VCTs use higher risk options, which increase the overall risk of your investment. You should be able to read about the strategy in the VCT's prospectus and other literature. Make sure you know the facts so you can compare different VCTs.
Managing a VCT takes specialist expertise, so they generally have higher running costs than other investment companies. Like many other collective investments, most VCTs charge performance fees.
It’s hard to know exactly what a VCT’s portfolio is worth. Because the shares of unquoted companies aren’t freely traded on any recognised stock exchange, there’s no exact market value.
A VCT’s board of directors uses valuation methods, based on established principles (for example, the British Private Equity and Venture Capital Association’s Valuation Guidelines or the International Private Equity & Venture Capital Valuation Guidelines) to estimate the value of each private company shareholding. They can only be estimates. Sales depend on a willing buyer and the price they are prepared to pay at that time.
The extra work involved in performing these valuations means that VCTs will often only value their portfolio every three or six months. It also means that figures you see published may have been calculated weeks, or even months, earlier. This may be very different to the current share price.
AIM traded, and other investments traded on stock markets, are easier to value because there’s a quoted market price.