Venture capital trusts (VCTs) have had a record year for fund raising as investor interest in unlisted companies increases – but exactly what do these specialist investment trusts do and who might they suit?
VCTs are a type of investment company focused on investing in small, micro or early-stage businesses. These might be unquoted businesses, which are not yet listed on a stock exchange, or those listed on the junior Alternative Investment Market (AIM). This, of course, means that VCTs are inherently risky vehicles – small and early stage companies have a higher rate of failure and require a long investment time horizon.
While a number of investment funds and trusts have a small amount of exposure to this type of investment, VCTs are entirely focused on them and have to operate to particular rules. They must, for example, invest in companies with assets of £15 million or less, which have fewer than 250 full-time employees.
Investors poured £731 million into VCTs in the 2018/19 tax year, according to figures from trade body the Association of Investment Companies (AIC). Part of the reason they have been able to attract so much money is that VCTs come with extra potential perks for investors because of their higher risk nature. There is no income tax to pay on dividends received from VCTs, for example, and nor will you be liable for capital gains tax on gains made when you come to sell the shares. Investors can also receive tax relief of 30% on investments into VCTs as long as they hold the shares for at least five years.
Ben Yearsley, director at Shore Financial Planning, says: “The appeal of tax-free growth and income combined with investing in dynamic smaller companies is certainly an exciting blend, but it is important to remember that VCTs are higher risk and, therefore, should be longer term than most other investments.”
The tax relief means that if you invest £10,000 into a VCT it effectively only costs you £7,000 – in much the same way that a pension contribution costs you less than the amount you are actually investing once tax relief is taken into account. However, if you sell your shares before the minimum holding period of five years you will have to repay this initial tax rebate, so investors need to be sure they won’t need to access their cash when investing in a VCT.
Alex Davies, chief executive of Wealth Club, says: “There are two main reasons why the government offers such generous tax benefits: firstly, to encourage investment into small businesses, which is a proven way to create jobs. Secondly, to help compensate for the additional risks of investing in small businesses compared to larger ones.”
As well as these benefits, VCTs have grown in popularity with investors as businesses have tended to stay private for longer in recent years. Historically, the average age of a company when it listed on a stock exchange was just five years, but today it is closer to 10. Experts point out that by the time a company comes to market many of the gains have already been made, too. That means investors may have to consider unquoted companies to get access to some of the most exciting growth stories out there.
Beware Charges and Failure Rates
There are downsides to bear in mind, however – not least that the failure rate among early-stage businesses is generally higher than among established companies, which can result in capital losses. Charges on VCTs are typically far greater than other funds – often 3% a year or more – and this can seriously eat into your returns. The Unicorn AIM VCT (UAV) ongoing charge is 2.24%, Maven Income and Growth (MIG6) 2.7%, and Octopus Titan VCT (OTV2) 3.1%.
Yearsley adds: “It’s important you aren’t just thinking about the tax breaks when choosing a VCT, you need to be comfortable with what you’re investing in – these are small, entrepreneurial businesses. Each VCT will invest in 20 to 30 of these companies to diversify but this is definitely not a no-risk investment.”
Which companies the trusts focus on varies. Maven Income and Growth, for example, looks for businesses doing “real things”. Investments include the UK’s largest manufacturer of shower trays and a business that provides services to refineries and chemical plants around the world.
Davies says: “If any VCT is going to find the next Facebook, I believe it will be Octopus Titan.” The VCT has an early investor in property portal Zoopla, which was the first VCT-backed business to be valued at more than £1 billion. Other investments in the trust include holiday specialist Secret Escapes, mattress maker Eve Sleep and snack company Graze.
The Unicorn AIM VCT focus on companies listed on the junior UK stock market. Davies says: “The trust has a history of growth and steady dividend payments and has held up comparatively well through market wobbles.” Its investments include life sciences firm Abcam, fund supermarket Interactive Investor, and City Pub Group, which owns pubs across the south of England.
