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Venture Capital Trusts (VCTs)

What are VCTs?

VCTs are retail investment products. They are pooled investments where a number of investors buy shares through individual subscription that then creates sufficient money to make the investment opportunity possible. VCTs were launched by the Government in 1995 to encourage individual investors to invest in small unlisted UK trading companies i.e. companies whose shares, stocks, debentures or other securities are not available to be bought or sold publicly. Investors were, and still are, incentivised to make an investment in return for some generous tax breaks.

Why small companies?

The UK has moved away from a large industrial economy based on large scale manufacturing and is seeing most growth in small to medium enterprises (SMEs). Successive governments have realised that this part of the economy has the most potential to sustain UK GDP but suffers from a lack of seed capital or longer term financing. Since the credit crunch retail banks have been more reluctant to lend to SMEs so have had to look to private finance as a route to fund further growth.

Individual companies can therefore apply for VCT investment money to satisfy their requirement for capital.

How is a VCT structured?

VCTs used to be companies that were listed on the London Stock Exchange, but from April 2011 VCTs are companies admitted to trading on a regulated market. A regulated market is one named as such by the EU, covering markets in EU and EEA countries.

VCTs are similar to investment trusts and are run by fund managers. Investors can subscribe for, or buy, shares in a VCT, which in turn then invest in trading companies, providing them with funds to help them develop, grow and expand. The VCT provider will issue a prospectus inviting investors to subscribe to its latest issue of shares. This issue must be approved by HMRC.

What are the tax benefits?

Income Tax relief               at 30% – available on a maximum investment of £200,000.
Tax-free income                 if the VCT shares pay dividends, these distributions are tax-free.
No Capital Gains Tax       on the sale of the shares.

What are the risks?

Primarily there are two main risks associated with VCT investment:

1. Investment Risk

You could lose all or some of your invested money. By their very nature VCTs invest in small or start-up companies who are looking to fund their businesses further; such businesses carry much greater risk than their more established mature counterparts.

VCT companies will try to mitigate this risk by:

  • Spreading investor’s money across a number of different companies
  • Investing in more mature or lower risk businesses or those that own real assets e.g. property
  • Select the companies carefully and follow a rigorous process of due diligence
  • Maintaining 30% of the VCT fund in cash deposits, fixed-interest securities or quoted shares

2. Liquidity Risk

There may not be a market to sell your VCT shares. An investor must retain his VCT shares for a minimum of 5 years to keep the 30% income tax relief given. The second hand market for these shares may be limited especially as the income tax relief is not given to the purchaser.

VCT companies will try to mitigate this risk by:

  • Offering to buy back their own shares at a specified date in the future if certain conditions are met.
  • Structuring the VCT as a planned exit or limited life offering.

What kinds of VCTs are there?

These are some of the basic types of VCTs:

a. Generalist VCT

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 i.e. a Management Buy-Out.

b. Specialist VCT

These VCTs invest mainly in a specialist sector or specific market. These sectors could include technology, media, leisure, healthcare or low carbon, alternative energy businesses.

c. AIM VCT

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.