Venture capital trusts (VCTs) celebrated their 25th birthday last month and a lot has changed in the industry over that time. From a fledgling marketplace in 1995, the VCT sector now has a market cap in the billions and has seen investments of over £700 million per year with no sign of this slowing down. Once dubbed ‘a tax-efficient way to lose money’, VCTs are now a firm favourite with investors, thanks to the preferential tax treatment and lower correlation to mainstream equity markets.
VCTs are aimed at encouraging private investors to invest in small UK trading companies, while benefiting from substantial tax benefits. By their very nature, these smaller companies have a higher level of risk than traditional listed businesses, but that also gives them the potential to grow strongly along with the flexibility to be dynamic in challenging economic conditions. The rules around qualifying companies were loosened substantially in 2012 and as VCTs have matured they now hold some sizeable and well-known brands such as Rightmove, Five Guys and Fever-Tree.
Investing in vibrant companies with strong ambition and growth potential is the main attraction for most investors, but increasingly we see VCTs being used effectively in structuring a tax-free income in retirement.
The tax treatment of VCT investments is very generous and investors can benefit from:
- 30% income tax credit on investment, subject to a 5 year qualifying period
- tax-free dividends
- no Capital Gains Tax on disposal
Upper limits on how much an individual can invest per tax year are also generous with investors allowed to place £200,000 into VCTs in the current tax year, meaning at the top end up to £60,000 income tax can be reclaimed from a tax return.
By their very nature, VCTs are high-risk investments and there have been several failures that sit alongside the success stories. Proactive monitoring of the VCT market is essential. Over the last decade, our specialist team has selected a small portfolio of fund managers from the 40 or so VCTs in the marketplace, to provide the diversification needed to help control risk and volatility, as well as having the potential to deliver attractive returns.
Our research team focuses on the nature and purpose of the underlying investments of each of the VCT managers. When putting together a recommended shortlist of VCT funds, we seek to offer a selection that combines strong, established dividend track records, those with a greater focus on capital preservation, or those that are more growth-orientated. We look to avoid those VCTs that rely on artificial mechanisms or in our view do not meet the entrepreneurial spirit of the legislation, as we believe this may expose investors to unnecessary risk.
Although 2020 has seen extreme volatility in investment markets since the COVID-19 pandemic took hold, smaller cap markets including VCTs have performed relatively well and the natural focus on tech start-ups and healthcare within the venture capital world makes it an exciting sector for the future. The 2018/19 tax year saw £731 million invested in VCTs and the outlook for the current year also looks promising with many providers now launching new funding opportunities allowing investors to buy into successful VCTs with strong track records. We expect demand for the better funds to continue to outweigh supply with many existing investors looking to add to their portfolios.
Often seen as the baby brother of the VCTs, for over 20 years Enterprise Investment Schemes (EISs) have been helping smaller companies raise finance by offering generous tax relief to investors. While the tax treatment is similar to VCTs, there are key differences. The investment is made directly into a business rather than into a number of companies via a fund. Investing in a number of EISs is nonetheless recommended to increase diversification.
Similar to the VCT regulations, companies cannot exceed £15 million in assets or have more than 250 employees prior to the new shares being issued. The tax advantages are:
- 30% income tax credit on investments, subject to a 3 year qualifying period
- no Capital Gains Tax on disposal
- Capital Gains Tax deferral
- Business Relief against inheritance tax after two years
This article has been produced for information purposes only. It is not intended to be an invitation to buy or act upon the comments made. All investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances and one must satisfy certain investor criteria before being considered eligible to invest. Any forward-looking statements and forecasted returns represent the current views of Mattioli Woods plc and may be subject to change. Your capital may be at risk and past performance is not a guide to future returns. Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority.