Venture Capital Trusts (VCTs) are investment companies, tradeable on the London Stock Exchange, that aim to provide an avenue to invest in certain small UK companies subject to qualifying conditions.
To encourage investment in these businesses, and to offset an element of risk given these investments tend to be of a high-risk nature, the Government offers extensive tax benefits to investors:
- up to 30% upfront income tax relief on the investment (where the investment is held for a minimum of five years)
- tax-free dividends
- no tax on capital gains
The tax incentives alone might encourage some investors, but it is important to delve deeper into the construction of a VCT to better understand their suitability as long-term investments. So, which companies are eligible to be included within a VCT?
They must be based in the UK and carry out a ‘qualifying trade’. This means that HMRC has determined that the specific trade the company deals in needs additional financial support. Some examples of activities that are currently NOT qualifying include farming, forestry, running hotels and energy generation.
The companies must also be young – no more than seven years (or ten years for knowledge-intensive companies) must have passed since each company’s first commercial sale. However, some exemptions apply for companies that are already established but are looking to enter a new field. A VCT cannot invest in a company if their gross assets exceed £15 million (or be more than £16 million immediately afterwards). Each company must also have fewer than 250 full-time employees (fewer than 500 for knowledge-intensive companies) at the time of investment.
The qualifying companies can be privately owned or listed on the Alternative Investment Market (AIM). This provides VCT managers with plenty of scope when deciding which companies to include within the vehicle, although often they will declare whether they are looking to invest focussing on AIM listed or unlisted companies or a combination of the two. Each VCT can look to spread their investments across many different industries (Generalist VCT) or focus on one area (Specialist VCT).
Most VCT providers will show a breakdown of the main holdings in each VCT, usually the top ten. They will usually also provide information regarding how much of the fund is split between different sectors, and indeed whether the fund is more highly weighted to larger or smaller companies.
These factors will often give a good indication of the risk profile within which the VCT operates. Typically, VCTs are deemed high risk investments, given the nature of the smaller, younger companies they invest in. However, each VCT will have its own risk profile, considering the differing underlying investments, and therefore some will be more appropriate to individual investors than others.
As such, it is sensible to look to build up a diversified portfolio of VCTs to spread your investment across a spectrum of different sectors and companies. By doing this, you will reduce the overall risk profile of your investment. Some of the companies invested in will fail, while others may go on to be household names – take Zoopla or Secret Escapes as examples.
A good way to think is on the basis that if a quarter of them fail, and half stay as they are, the other quarter only need to just over double in size for the VCT to produce a positive return.
If you are considering bringing VCT investment into your overall wealth management strategy and/or would like to have a discussion about whether a VCT investment may be suitable for you, speak to your Mattioli Woods Consultant or email email@example.com.