Venturing forth

Good news for retail investors interested in venture capital investment. The sector, traditionally the preserve of high-net worth investors and institutions, appears to be opening up to a retail audience. Venture capital funds are increasingly raising money through public market IPOs, the Financial Times reports, providing retail investors with an opportunity to take a stake in a way that is not possible when such funds raise cash privately.

This should be welcomed. The risk profile of venture capital means it is not suitable for everyone. But retail investors should not be denied the opportunity to invest in early-stage businesses offering rapid growth trajectories. And managed funds offer a means to secure this exposure with diversification benefits and with the support of professional venture capitalists.

Still, it is worth pointing out that retail investors have had an attractive route into the sector for quite some time. It is now more than two decades since the Government launched a range of tax breaks to encourage investors to support young companies in need of capital. Today, the venture capital trust (VCT) sector which those tax breaks created is thriving.

Like traditional venture capital funds, VCTs provide diversification, investing in a portfolio of qualifying companies in order to spread risk. There are strict rules about what constitutes qualifying – largely focused on the size and age of the business – but VCTs are nonetheless stuffed with the early-stage businesses that venture capital investors are looking for.

Moreover, unlike conventional venture capital funds, VCTs qualify for special tax treatment. Most importantly, investors in new VCT shares get upfront income tax relief of 30% on stakes of up to £200,000 a year (the money must be repaid if you do not keep your VCT shares for at least five years). The effect is to mitigate the risk of even quite substantial losses – investors are 30% up before a penny of their money has been invested.

In addition, profits on VCT shares are free from capital gains tax when you come to sell. Plus any dividends generated by the funds are tax-free too. This has come to be a much-admired feature of the VCT sector, which often pays surprisingly generous dividends – handy at a time when income is so hard to come by on most savings and investments.

None of these tax breaks are, in in their own right, a reason to invest. However, for investors who have decided they want exposure to venture capital assets, the tax treatment of VCTs certainly adds to their allure. In any conversation about the merits of these funds compared to the kind of vehicles highlighted in the FT’s coverage, tax is going to loom large.

In fact, we may be about to see another spike in demand for VCTs. One driver of interest in the sector in recent years has been successive governments’ moves to curtail the tax advantages of private pension saving. With investors in pensions increasingly limited on how much they may pay in each year – and accumulate over a lifetime of investment – they have looked to other forms of tax-efficient saving.

Today, the Government is once again rumoured to be looking hard at the tax breaks on offer via private pensions. Cuts to higher-rate tax relief on pension contributions have been mooted, as has a reduction in the lifetime allowance. In which case, expect demand for VCTs to grow even stronger.