Venture capital trusts (VCTs)
Here’s how to back bright, young UK opportunities.
Understanding the basics
Generous tax benefits are on offer when you invest in VCTs, because of their value to the growing economy.
Going for growth
Venture capital trusts provide finance to some of the most dynamic small businesses in the UK to help them grow.
This guide explains the benefits and risks of investing in VCTs, and takes a closer look at some of the exciting businesses that VCTs have helped to flourish.
What are venture capital trusts?
Venture capital trusts (VCTs) invest in small companies with high potential for growth that need some financial support.
VCTs attract special tax benefits because they support the UK economy.
- VCTs invest in small UK companies which are not usually quoted on the stock market.
- VCTs are higher risk than most other investment companies because of the companies they invest in.
- VCTs should be viewed as long-term investments. New VCT shares bought directly from the manager are only eligible for the full set of tax reliefs if they are held for five years.
- 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 to other investors on the stock market as you would with other shares, 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 shares of small UK companies 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 and industrial change.
- 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.
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. This can be a much riskier investment than investing in larger, more established companies.
VCTs fall into three broad sectors:
- generalist – by far the VCT biggest sector, home to VCTs that invest in all kinds of small, unquoted UK companies.
- AIM – for VCTs that invest in AIM-quoted companies.
- specialist sectors, for example technology or healthcare.
However, the investment strategies employed by VCT managers differ from one VCT to another.
VCTs offer investors certain income and capital gains tax reliefs. These include:
- Tax-free 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 tolerance 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. In theory, this tax relief can reduce your income tax bill to zero but there are limits on how much you can invest in VCTs each year.
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 new VCT shares
|Maximum investment eligible 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. The relief you get depends on your individual circumstances.
These tax rules may change in the future. Investors who are unsure about their tax status should get independent advice from a professional adviser such as a solicitor, accountant or independent financial adviser.
Like all investment companies, VCTs will have an investment policy, agreed between the management group and the board of directors. But they also have to comply with HMRC rules in order for investors to receive tax relief.
The main rules are:
- At least 80% of their investments must be in qualifying investments – small companies (maximum £15 million) that are unquoted or traded on AIM.
- They must invest in these companies within three years of raising new money. Keep in mind that until VCTs have fully invested the money they raise, the risks can be different.
The remainder of a VCT’s money (up to 20%) is usually kept in cash but can be invested in other investments. 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 a lot of work and expert knowledge, so they generally have higher running costs than other investment companies. Most VCTs charge performance fees as well, which are paid if their performance exceeds an agreed hurdle or benchmark.
It’s hard to know exactly what a VCT’s portfolio is worth. Because the shares of unquoted companies aren’t traded on a 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. It’s much easier to value the holdings of AIM VCTs because AIM companies have a quoted market price.