What are Venture Capital Trusts (VCTs)?
The Venture Capital Trust Scheme started on 6th April 1995 and was designed to encourage individuals to invest indirectly in a range of small, higher-risk trading companies whose shares and securities are not listed on a mainstream stock exchange, by investing through Venture Capital Trusts (VCTs).
VCTs are companies which are themselves listed on the London Stock Exchange and provide capital finance for small, expanding companies with the aim of making capital gains for investors. They are a tax efficient way to invest larger sums of money and are aimed at medium to high net worth private investors.
Investors with larger portfolios can invest up to £200,000 and receive tax relief on the investment.
VCT shares issued after 5 April 2000 need to be held for five years in order to retain the initial tax reliefs, but to obtain the full benefits of the investment vehicle, the shares should be held for as long as possible.
To retain Government approval as a VCT, trusts’ income in their most recent accounting period must have been wholly or mainly from shares or securities. Throughout that period, at least 70% (by value) of its investments must have been ‘qualifying holdings’, that is shares or securities in companies which meet the conditions of the scheme.
It is important to note that new VCTs can receive provisional approval when they have not yet met the conditions but satisfy H.M. Revenue that they intend to meet them within the time allowed. In such cases conditions must be met for an accounting period beginning not more than three years after the date of provisional approval and must continue to be met for subsequent accounting periods. It is not unusual for fledgling VCTs to unwind after failing to find investment opportunities that meet these essential criteria.
How do VCTs work?
A VCT is a company listed on the London Stock Exchange, which invests in other companies which themselves are not listed on a major exchange. Therefore investors are effectively investing into a company, which invests in small companies.
The managers of a VCT have three years in which to choose companies to invest in and during this time often place the money into cash, gilts or bonds. As they become more sophisticated VCTs are now also investing in funds such as smaller company funds or funds of hedge funds, to maximise returns.
Within 3 years of the share issue at least 70% of the VCTs assets must be invested in ‘qualifying’ holdings. These are defined as holdings of shares or securities, including loans of at least five years duration, in unquoted companies and those whose shares are traded on the Alternative Investment Market (AIM). These companies must carry out a qualifying trade wholly or mainly in the UK. The balance of 30% can be invested into areas such as Government bonds – gilts – or blue chip shares.
VCTs may invest up to £1m in a qualifying company but each individual investment cannot make up more than 15% of VCT assets. The gross assets of the company into which the VCT invests must not exceed £7m, or £8m following the investment, and it must not have more than 50 full-time employees. If an investment is held in a company that subsequently becomes quoted on the London Stock Exchange then it can continue to be treated as a qualifying VCT investment for up to five years.
What are the tax relief’s available for investors?
Tax reliefs are only available to individuals aged 18 years or over and not to trustees, companies or others who invest in VCTs.
You have to hold a VCT investment for a minimum of five years to benefit from the tax reliefs.
For second-hand shares acquired, for example, through the Stock Exchange you can get two reliefs: dividend relief and disposal relief, an exemption from CGT on any gain made upon selling your shares. But income tax relief (and, where the shares were issued before 6 April 2004, deferral relief, see below) cannot be claimed on these shares.
Investments into new VCT shares offer the following relief’s:
Income tax relief at the rate of 30% on the amount subscribed for the shares. This relief is available on investments up to £200,000 in a tax year, but is subject to forfeit if the shares are not held for at least 5 years.
Exemption from income tax on dividends paid by the VCT, as well as from CGT on disposal of the shares.
If you invested in shares issued before 6th April 2004, you may be able to treat gains arising on disposals around the time your VCT shares are issued as postponed to a later year (called deferral relief).
What are the different types of VCTs?
VCTs can usually be separated into three different types: Specialist, General, and AIM. Some trusts invest in a combination of all three areas; however, more recently VCTs have started to become more focused and some invest only in one sector e.g. media or healthcare.
General VCTs spread investments between AIM listed companies and unlisted companies. They often have a policy of investing in companies that are already or very nearly profitable.
The objective is to support companies that have strong management and business models, that are in or entering an expansionary phase, and so can promise growth for their investors.
This approach encompasses those situations in which a committed management team seeks to buy up and turn around a neglected business entity – in other words, a Management Buy-Out.
These VCTs invest mainly in unquoted technology companies. A portion of the money raised may be placed in some AIM-quoted companies to reduce some of the risk. Specialist VCTs are perceived to be at the riskier end of the spectrum, but an investment decision based on a rigorous risk/reward assessment can offer higher returns.
AIM VCTs invest in companies that are quoted on the Alternative Investment Market (AIM) index. AIM is an exchange on which smaller companies’ shares are traded.
While it is easier to track the performance and liquidity of the underlying investment via its quote on AIM, only the smallest AIM-listed companies are likely to fall within the maximum size of enterprise that VCTs are permitted to subscribe to.
The tax relief offered on VCTs is often cited as their main advantage but, alone, this is not enough to recommend the trusts to investors. It is important to note that even if there were no tax concessions most VCTs are potentially rewarding investments in themselves, as these other benefits show:
Several VCTs have already achieved a total return of investors’ original investment after tax relief. This could mean that investors will have a substantial part of their initial investment returned to them within five years.
Due to the considerable amount of work that has to be put into each investment decision, VCT managers have made higher annual management charges than conventional investment trusts. All trusts so far have kept their charges at reasonable levels, but some may also charge annual performance fees if they exceed their targets. This means that managers have a strong incentive to optimise the risk/reward relationship.
Smaller Companies Outlook
Over the longer term smaller companies have tended to outperform larger companies. This is because they are more flexible and can respond to growth opportunities more nimbly. They can readily exploit niche developments under the radar and, once pinged, put themselves in the way of being bought up at premium prices by larger, institutional corporations. It is important to remember that stakes in smaller companies can be undervalued – or nor valued at all – for long periods.