VCTs: What is a Venture Capital Trust?
- VCTs were introduced by the Government in 1995 to encourage individuals to invest in smaller companies in the UK. The Government achieved this by offering VCT investors a series of very attractive tax benefits. According to the Association of Investment Companies (AIC), the amount invested in VCTs in the 2013/14 tax year was almost £436 million, compared with just over £400 million the previous year.
- VCTs are themselves listed on the London Stock Exchange and provide finance for small, expanding companies with the aim of making capital returns for investors. They are a tax efficient way to invest into smaller companies. A VCT will typically raise between £10 million and £50 million from thousands of individual investors. Money raised from individual investors is pooled by the VCT to acquire a number of different investments with the aim of spreading risk across the VCTs portfolio.
Why invest in VCTs through WealthMe?
- WealthMe is one of the leading VCT brokers and providers of independent research.
- Market leading discountsOur market position means that we are able to offer our clients some of the best discounts available on charges, making it cheaper to invest with us than going direct or via a Financial Adviser.
- Our objective is to offer you the most competitive rate.
- We aim to be cheaper than our competitors, Hargreaves Lansdown, Bestinvest, Club Finance, WealthClub etc. So if you find a better deal elsewhere, then please let us know and we will try to offer you an even a better deal.
Tax reliefs* are only available to individuals aged 18 years or over and not to trustees or companies that invest in VCTs.
You have to hold a new VCT investment for a minimum of five years to benefit from the tax reliefs::
- Income tax relief at the rate of 30% on the amount subscribed for the shares, available on investments up to £200,000 in a tax year
- Exemption from income tax on dividends paid by the VCT
- Exemption from CGT on disposal of the shares
Second-hand VCT shares, acquired through the Stock Exchange for example, still provide tax free growth and tax free income, but income tax relief cannot be claimed on these shares. The purchase of second-hand VCT shares has to be within the same purchase limit of £200,000 per tax year.
* Tax reliefs are based on individual circumstances and may be subject to change in the future.
Obtaining the income tax relief is straightforward. The VCT provider will allot VCT shares to investors every fortnight after the £1m investment point for the fund has been reached. After this point, the VCT provider will be able to send you a share certificate and a tax certificate a few weeks after you make the investment.
There are two ways to then claim the relief:
- You can write to your HM Revenue & Customs Office, asking them to change your tax coding under the PAYE system and receive your income tax relief on a monthly basis through your pay cheques
- You can wait until you fill in your tax return at the end of the tax year
- A VCT is listed on the London Stock Exchange. It invests in small businesses which themselves are not listed on a major exchange.
- VCTs have to invest 70% of the funds they raise in UK ‘qualifying’ companies within three years.
- These are defined as 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) and PLUS Markets.
- These companies must carry out a qualifying trade wholly or mainly in the UK. The balance of 30% can remain invested in other ‘non qualifying’ holdings.
- Each VCT may invest into multiple qualifying companies, but each individual investment cannot make up more than 15% of that VCT’s assets. Qualifying investee companies can receive up to a maximum of £5m of funding from VCT investors in any twelve month period.
- The gross assets of each of the companies into which the VCT invests must not exceed £15m at the time of investment, or £16m following the investment, and they must have fewer than 250 full-time employees at the time of the investment.
- 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.
- VCT shares can be sold or bought at any time, but initial income tax relief is only available on the new issue of shares and must be kept for five years to retain the relief. Secondary purchases of shares, created from existing shareholders exiting, lose their right to initial income tax relief however these investors can still enjoy tax-free income and growth.
- VCT shares must be companies quoted on the London Stock Exchange so that when investors wish to sell they can do so. It should be noted, though, that the secondary market in VCT shares is limited, and investors can expect to dispose of their holdings on the open market only at a, sometimes substantial, discount to the underlying net asset value.
- For this reason, many VCTs have a policy of buying back their own shares so as to control the extent to which their shares are discounted. The operation depends on the VCT having generated sufficient liquid returns from its investments, and they are only able to do so for certain periods during the year.
These investments may be suitable for investors who are looking to:
- Any UK taxpayer over the age of 18 is eligible for the tax breaks
- Make effective use of VCT reliefs
- Are looking for a medium to long term investment
- Take advantage of income tax relief
- Harness the potential for significant capital growth in today’s financial markets
- Diversify their existing investment portfolio
- Find a complementary solution to pensions
- Potentially diversify their investment portfolio by including a fund which typically does not follow stock market cycles
VCTs are considered to be long term investments designed primarily for high net worth individuals or sophisticated investors who understand the higher risks which they may carry and have the capacity to sustain any losses. You should answer the question section to gauge your understanding and whether you match either status regarding this investment but ultimately it is your decision, and responsibility, if you chose to proceed.
There are significant risks associated with investing in venture capital backed companies. They will generally be at an earlier stage than more developed quoted companies and will often carry a higher risk of failing. VCTs are long-term investments and you have to hold your investment for at least five years to take advantage of the 30% income tax rebate. Most VCT managers would suggest you have an outlook of at least 5 to 10 years regardless of this.
You can sell VCT shares if you needed money quickly. However, there would be the significant possibility of a capital loss, especially in the early years. In addition, if you sell within five years, you will have to repay the reclaimed tax.
A further issue arises from smaller VCT funds who fail to raise sufficient money at launch. The resulting portfolio of investments may be more concentrated and this will increase the risks.
Each VCT will issue a prospectus at launch which gives details of specific risks, you should read this thoroughly before making any investment.
VCTs are only really a consideration for sophisticated investors with significant investment portfolios or experience who can afford to take a long-term view and are comfortable with the risks of investing in smaller companies. VCTs are therefore not suitable for all investors.
We feel that at most they should account for 5 to 10% of your equity portfolio, but obviously if you can both afford, and are prepared, to take more risk this percentage can be increased. They are designed to pay out any profits only when the companies in which they invest are sold, and so you must take a long-term view (5-10 years plus).
The FCA suggest that a sophisticated investor is somebody who has invested in these products before or works in the industry. They may also be suitable for high net worth individuals with an annual income in excess of £100,000 or investable assets of more than £250,000. However as an execution only service, WealthMe will allow you to make your own assessment of your expertise and the suitability of a VCT for your circumstances. If you have any doubts you should seek expert advice.
VCTs invest in some of the most dynamic, entrepreneurial, high growth companies therefore they are high risk. They are long term speculative investments which give you the chance to get in on the ground floor of fledgling investment opportunities. This speculative nature means they are aimed at sophisticated investors. This means they are unlikely to be suitable for mainstream investors who may need access to their money in the short term or loss of the investment may cause financial hardship.
VCTs are one of the most tax efficient investments available where a £10,000 investment could cost as little as £7,000 with the prospect of tax free dividends and tax free growth. The tax benefits associated with investing in VCTs is subject to change and the exact value depends on your circumstances.
Key Risks of VCT
- Deemed by the FCA as a higher risk investment
- Companies are at an earlier stage of development and will often carry a higher risk of failing than larger quoted companies
- VCTs are long-term investments (5-10 years)
- Early encashment may lead to losses and removal of tax benefits
- No guarantee of success
- Speculative in nature
- Only pay out profits when companies are sold
- Rates of tax, tax benefits and allowances may change from time to time and are not guaranteed
- Tax treatment is dependent on individual circumstances and may be subject to change in the future
- Past performance is not a guide to future performance and may not be repeated
- The value of shares can go down as well as up and you may not get back the full amount invested
- Investment in unquoted companies involves a higher degree of risk than investment in a quoted portfolio
VCTs can be categorised depending on the type of companies in which they invest, the investment focus of the VCT and the lifespan of the VCT.
AIM or Unquoted
AIM VCTs invest in new shares in companies that are admitted to trading on the Alternative Investment Market (AIM) or PLUS markets. Both AIM and PLUS are exchanges on which smaller companies’ shares are traded.
Only new shares can be bought by VCTs, and only the smaller AIM listed companies are likely to fall within the maximum size of enterprise that VCTs are permitted to subscribe to. Unquoted VCTs focus on investing in companies that are not quoted on any exchange.
Specialist or Generalist
Specialist VCTs invest in companies focused in specific sectors, such as technology or healthcare, where the VCT manager has an expertise. Specialist VCTs are perceived to be at the riskier end of the spectrum, but can potentially offer higher returns.
Generalist VCTs will not focus on specific sectors and so will have a broader portfolio of companies. This gives some risk mitigation but also could limit the upside of being focussed on the sector that outperforms the market during the period.
Evergreen or Limited Life VCT
Until fairly recently all VCTs were evergreen funds, and many new funds still are. These expect to exist forever and provide a long-term stream of tax free dividends. If an investor wants to sell the VCT then there is a market for VCTs that have demonstrated a good dividend track record.
Limited Life VCTs aim to wind-up and repay capital back to investors as soon as possible after the minimum five year holding period. This usually demands a different investment strategy to evergreen VCTs. Long term investment return isn’t as significant an objective, and the initial tax rebate is a more significant part of the overall benefit to the investor.
A VCT could therefore be described as an unquoted specialist limited life VCT, while all combinations are possible.