Venture Capital Trusts

VCTs

What is venture capital?
Venture capital is money invested to finance and develop ‘start-up’ companies that are in the earlier stages of growth or product development.

Typically, these companies will be looking to raise between £500,000–£10m although, under Inland Revenue rules, they can only receive venture capital funding if their total assets do not exceed £7m before investment and £8m afterwards.

People who make such investments are known as ‘venture capitalists’ and their aim is to generate significant capital returns once the companies they invest in realize their full potential (and, in many cases, are listed on a major stock exchange, e.g. the FTSE).

What are venture capital trusts (VCTs)?
Launched in 1995, venture capital trusts, or VCTs, are investment companies quoted on the stock exchange that are broadly similar to investment trusts. Usually managed by UK private equity firms, they are ‘pooled’ investment vehicles that allow people to invest in ‘high octane’ British start-up companies (usually 30–40) with big growth potential.

Their holdings tend either to be unquoted or listed on the AIM or Plus indices, the home of some of the fastest-growing and innovative companies in the UK. However, there are certain rules and restrictions:

1. A VCT must invest at least 70% of its funds in ‘qualifying holdings’. These holdings must be in unquoted companies that will carry on a ‘qualifying trade’ wholly or mainly in the UK. Some types of trade are specifically excluded
2. At least 10% of the holding in each qualifying company must be in new ordinary shares with no preferential rights
3. No more than £1m can be invested each year in an unquoted trading company and any holding in a single company must not exceed 15% of the value of the VCT’s total investments at cost
4. The VCT cannot invest in any company whose gross assets exceed £7m immediately before the investment in it, or £8 million afterwards
5. The VCT cannot retain more than 15% of the income derived from shares and securities

But one of the biggest attractions of the VCT is its lucrative tax advantages (see below.

What are the tax advantages of investing in VCTs?
As long as investors hold their shares for at least five years, the net rate of income tax relief for investors in VCTs will be 30%. Any dividends paid are free of tax, as are any capital gains on disposal. Unfortunately, capital gains tax deferral relief is no longer available on investments in VCT shares made on, or after, 6 April 2004.

What are the risks of investing in VCTs?
Because they generally invest in small companies without a proven track record, and which are often highly dependent on the success of a certain product, venture capital trusts are much higher risk than, say, a unit trust investing in established UK equities.

However, as with all investment vehicles, some will be riskier than others, so it’s important to differentiate between individual trusts. For example, a ‘specialist’ VCT concentrating specifically on one sector — biotechnology, for example — would be much higher risk than a ‘generalist’ trust investing across several different sectors (thus providing greater diversification).

Also, some VCTs may be geared, either to capital growth or to income generation, which makes them riskier still.

Of course, in return for taking higher risks, investors can potentially benefit from significantly higher returns than would be available through a mainstream fund.

Before you invest in any trust, it’s important to look at its past performance and the spread of companies it’s investing in. Also be wary of selling after three years, as many investors will seek to exit at this time, which could result in the share price collapsing.

How much can I invest in VCTs?
The most an individual can invest in VCTs, currently, is £200,000. To qualify, you also have to be a UK resident aged 18 or over.