Wealth Management

VCTs: dispelling the myths

What is the first thing that pops into your mind when someone mentions venture capital trusts (VCTs)? Is it ‘high risk’, is it ‘tax scheme’, is it ‘no idea what they are’, or is it ‘definitely not for me’? An array of thoughts and impressions may swirl through your mind when thinking about these, although many of you may not have invested into such a vehicle before.

23 October 2023
4 minutes

Investing is not an exact science, with the saying by Barry Farber, “There’s no reward in life without risk”. When considering the level of risk you are willing to take, it is important to look at your investment portfolio, as opposed to just a single investment. VCTs should not be something to shy away from as they offer many advantages, despite the level of risk they seem to pose.

If you have concerns about this type of investment, or previously avoided them due to concerns around the level of risk posed, allow me to challenge your perception.

What is a VCT?

VCTs are investment companies that are listed on the London Stock Exchange. The goal of these companies is to provide investors with the ability to invest in certain small UK companies (providing they meet the qualifying conditions) while having a certain level of diversification as opposed to being invested into the companies directly.

The company must be UK-based and carry out a ‘qualifying trade’, meaning the HMRC has determined that the specific trade the company deals in needs additional support. Examples of activities that are currently not qualifying include farming, forestry, managing hotels and energy generation. 

As the aim of VCTs is to help young companies grow, seven years (or for knowledge-intensive companies, ten years) since each company’s first commercial sale must not have been exceeded. There are exemptions for this where companies are already established but are looking to branch out into a new field. Alongside this, the company’s gross assets must not exceed £15 million (or be more than £16 million immediately afterwards) and have fewer than 250 full-time employees (or for knowledge-intensive companies, fewer than 500 employees) at the time of investment.

Qualifying companies can be owned privately or listed on the Alternative Investment Market (AIM), providing scope to the managers of VCTs when choosing which companies they wish to include within the vehicle. 

How risky is risky?

Due to the volatile nature of young, small companies, VCTs are considered to be a high-risk investment. However, when utilised as part of a portfolio of investments, VCTs can be used as a diversifier that can also offer tax benefits to the investor.

By allocating a proportion of their investment capital to a VCT, investors gain access to innovative and possibly high-growth businesses that may not be available through other avenues. However, VCTs can counterintuitively be suited to planning for income, as income is paid out from the sale of business within its portfolio.  

A saying to remember is, “Mighty oaks from little acorns grow”. Household names such as Zoopla and Gusto were once a part of VCT investments, and although not all businesses will succeed, if a quarter of them fail and half stay as they are, the other quarter will need to only just more than double in size for the VCT to produce a positive return.

VCT investment managers can invest into many different industries, creating a Generalist VCT involving no focus area, or they can create a Specialist VCT that focuses on one specific area. Providers of VCTs tend to show the main holdings within each VCT, normally showing the top ten holdings on their factsheets. In addition to this, they will normally provide information on how much of the fund is split between different sectors.

What this means is each VCT will have its own risk profile, dependent on the underlying investments. Therefore, some VCTs will be more appropriate to certain individual investors than others. 

Tax benefits

While VCTs are not directly backed by the Government, they do receive certain tax benefits to incentivise investors investing into qualifying businesses. If a VCT is held for a minimum of five years, the following tax benefits are available:

  • · up to 30% upfront income tax relief on the investment
  • · tax-free dividends 
  • · no tax on capital gains 

Although the tax benefits do not remove the risk of the investment, as you may not get back the full amount invested. The ability to qualify for upfront 30% income tax relief and tax-free income does provide the potential for some downside protection. 

In conclusion

Although the underlying holdings in VCTs can be considered high risk, they can be a valuable diversifier if held within a well-managed wider portfolio. Indeed many individuals invest in VCTs with the aim of creating strong tax free dividend income annually, for the long term, supplementing other income sources.

After reading this, you may be interested in the possibility of investing into a VCT but do not have the time to choose the best company to invest through, or the time to build a diversified portfolio to suit you. You may just want someone else to take the stress when deciding on investments for you and knowing how VCTs may best fit into your investment strategy.

Whatever the reason, if you would like to know more regarding VCTs and are considering investing into one yourself, please contact your Mattioli Woods consultant, or email info@mattioliwoods.com and one of our consultants will contact you.

All content correct at time of writing.

This article has been written by Trainee Consultant Taylor Hillery.

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