What is a VCT?
A VCT is a professionally managed investment company listed on the London Stock Exchange. It helps small, unquoted, entrepreneurial companies grow by providing them with capital (i.e. money) and expertise.
VCTs were launched in 1995 with generous tax incentives that have been changed many times since. To date more than £6 billion has been invested in them (2015/16).
Their focus on small companies makes VCTs a risky, long-term investment only suitable if you are a wealthy and sophisticated investor.
What do VCTs invest in?
It is the type of enterprise they invest in that makes VCTs so interesting. They tend to be some of the smallest and most exciting UK businesses: from early-stage tech companies, to leisure clubs, high-end niche manufacturers, well-known wine retailers and many more.
Some companies that attracted VCT funding have become household names, including Virgin Wines, Zoopla and Picturehouse Cinemas.
A VCT has three years to choose companies in which to invest. Within that period, at least 70% of the money raised must be invested in 'qualifying' holdings.
What constitutes a ‘qualifying’ holding? The rules are complex, but notably a company must have fewer than 250 employees (500 if it is classed as knowledge intensive business), assets of up to £15 million and be less than seven years old when the investment is made.
What are the different types of VCT?
VCTs differ according to their lifespan, whether the companies in which they invest are unquoted or quoted on AIM, and their investment focus.
- Lifespan: some VCTs are set up to last indefinitely and are often called ‘evergreen’. Others, 'limited-life', are wound up after the minimum five-year holding period. When a VCT is wound up, the assets are distributed amongst the shareholders.
- Which type of company they invest in: VCTs always invest in small companies, but they could be either unquoted or listed on AIM.
- Focus: some VCTs invest in companies from a diversity of industries – they’re called ‘generalist’. Others - ‘specialist’- focus on a particular industry or sector. They can be more risky, but also offer the potential for higher returns if the sector does particularly well.
How much can I invest?
The maximum amount you can invest is £200,000 per tax year. In theory you could invest more, but you wouldn’t qualify for any of the tax benefits on the excess.
What are the tax breaks?
You may benefit from a mix of upfront and ongoing tax reliefs:
- Up to 30% upfront income tax relief
- Tax-free dividends
- Tax-free growth
Please remember: tax rules can change and benefits depend on your circumstances. You can only get a VCT’s tax benefits if the trust maintains its VCT status.
What returns can VCTs offer?
Since VCTs invest in small companies, you might assume returns are mostly in the form of capital growth, rather than dividends.
This is not so. Regular, tax-free dividends are actually one of the chief perks of investing in VCTs.
Most managers invest in companies through a mix of owning shares and lending money. The loans are generally used to help with the running costs and provide investors with dividends.
What are the charges?
VCTs require more management than many other investments. Structuring a deal can take up to six months; due diligence is harder and laborious; fund managers are much more involved in the business.
The costs reflect this: VCTs tend to be more expensive than easier to manage, more mainstream investments, such as unit trusts.
VCT initial charges can be as much as 5%. However, when you invest through Wealth Club, we discount our initial commission, which reduces this initial charge.
The management fee is normally in the region of 2% a year. There are additional directors' fees and other costs associated with being a listed company. Finally, if the trust performs well, there is often a performance fee too. All fees are listed in the prospectus upon launch and in the annual report.
How can I buy VCTs?
VCTs are traded on the stock market. New offers are typically launched once a year around October and usually available until the end of the tax year unless they sell out before – often the case with the most popular VCTs.
Investors can buy shares in new offers through a broker like Wealth Club.
However, if the fund raising target is hit before the official deadline, the offer closes.
Some VCT companies open earlier for the new tax year. This could be of particular interest if you seek tax-free income. That’s because investing at the start rather than the end of the tax year could give you extra months of tax-free dividend payments. What’s more, by investing early you can benefit from the tax relief through an adjustment to your tax code instead of paying the tax and later claiming a rebate.
Please note, though, that to retain the income tax relief you must hold the shares for at least five years.
What if I want to sell my VCTs?
VCTs are less liquid than mainstream investments like shares or unit trusts. They can be sold on the open stock market, but normally at a share price lower or significantly lower than the value of the underlying assets. They trade at a discount to Net Asset Value or NAV.
However, many VCT managers periodically offer to buy shares back at a better price than available on the open market – often at a 5% to 10% discount to NAV.
Please note, the minimum holding period to retain the income tax relief is five years.
Who could consider investing in VCTs?
VCTs have been around since 1995 and have steadily grown in popularity.
However, they are only suitable for some investors as part of a diversified portfolio.
You may find VCTs particularly attractive if you want to invest in small growing businesses and would like to reduce your income tax bill and receive tax-free income. A VCT portfolio, for instance, could be a valuable source of income if you are preparing for retirement or have already retired.
Buying VCT shares in the secondary market
Some investors haven’t got the income tax liability to justify buying a new issue of VCT shares, and therefore look to buy them via a stockbroker in the secondary market. There are benefits and drawbacks to doing this.
The main drawback is that you don’t get the upfront 30% tax break. However you still benefit from tax-free growth and tax-free dividends.
But you may well appreciate one benefit: there is no minimum holding period.
As we just mentioned, all new issues of VCT shares must be held for a minimum of five years to retain the upfront income tax break. This doesn’t apply when you buy in the secondary market.
There isn’t often a huge amount of trading in second-hand VCTs. As a result large orders may take a while to fulfil and dealing fees are often higher.
One final point: to receive all the tax breaks the maximum annual investment allowance is £200,000. This includes new issues and secondary purchases.
What are the risks?
As with all investments, the value and income from them can fall as well as rise so you may get back less than you invest.
But this risk is much greater with VCTs than with other stock market investments because they invest in small companies. Such companies are more volatile and likely to fail than their larger counterparts.
For this reason, VCT investments are long-term investments and are not for everyone. They are for investors who have no need for immediate liquidity and can withstand a potential total loss.
In addition, VCTs are less liquid than other stock market investments, i.e. they will be harder to sell.
And as another reminder: to retain all the tax reliefs available, you must hold the investment for at least five years and the companies must retain their qualifying status. Otherwise, you may have to pay back the income tax relief you have received.
And please remember: all the tax and product rules mentioned here are those currently applying but could change in future.