What is a VCT?
A Venture Capital Trust (VCT) is in many ways similar to an investment trust. It is a company listed on the London Stock Exchange, which raises money from wealthy or sophisticated investors and uses it to invest in young, innovative, and often privately-owned companies.
The government wants to help those companies grow, so it offers VCT investors generous tax relief. VCTs were introduced in 1995. Since then more than £7.7 billion has been invested.
When you invest in a VCT, you become a shareholder of the trust, not of the individual companies in which the trust invests. This is important, because it means you will get exposure not only to any investments the VCT makes after you subscribe, but also to the VCT’s existing portfolio.
What do VCTs invest in?
VCTs mostly invest in small, entrepreneurial businesses in a wide variety of sectors, from early-stage tech companies to high-end niche manufacturers, retailers, clothing brands and many more.
Some VCT-backed companies have become household names, including Zoopla, Graze, Virgin Wines and Everyman Cinemas.
The companies can be privately owned or listed on AIM, the Alternative Investment Market of the London Stock Exchange.
HMRC has set strict criteria a company must satisfy to qualify for VCT funding:
- It must carry out a ‘qualifying trade’. Most trades are included; the main exclusions are businesses HMRC doesn’t believe to be in need of extra support, such as land dealing, financial activities, forestry, farming, running hotels and energy generation.
- It must be relatively small – typically with gross assets of £15 million or less and fewer than 250 full-time employees.
- It must be relatively young – usually less than seven years old.
The rules might be more flexible in some circumstances.
A VCT must invest at least 80% of the money it raises in companies that meet these criteria.
It is important to note VCT rules have changed – and become progressively stricter – over time. For instance, 10 years ago a VCT could fund the management buyout of a relatively large and established company, or invest in a solar farm which benefitted from government subsidies. Investments of this kind are no longer permitted. However, if such investments are still part of the portfolio, any investors buying shares in the VCT should get exposure to them.
The larger and longer established the VCT, the more likely it is to have a large and diversified portfolio, with a mix of equity investments and loans, larger and smaller companies.
What are the different types of VCT?
VCTs differ according to their lifespan, whether the companies in which they invest are privately owned or listed on AIM, and their investment focus.
- Investment focus: most VCTs are ‘generalist’, meaning they invest in companies in a variety of sectors. Others – ‘specialist’ – focus on a particular industry or sector.
- AIM exposure: VCTs always invest in smaller companies, but they could be either unquoted or listed on AIM. VCTs that make the majority of their investments in AIM-listed companies are known as AIM VCTs.
- Lifespan: most VCTs are set up to last indefinitely. A minority, called ‘limited life’ VCTs, are wound up after a minimum holding period. When a VCT is wound up, the assets are sold and capital distributed amongst the shareholders.
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. The minimum investment will vary depending on the VCT; typically it is around £5,000.
What are the tax advantages?
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 benefit if you hold your VCT shares for at least five years and the trust maintains its VCT status.
How can I claim VCT tax relief?
Most people will normally claim the income tax relief when they file their tax return. This will result in either a lower income tax bill, or a refund if you’ve already paid the tax.
You don’t need to declare any tax-free dividends you receive.
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.
The latest available figures show VCTs paid a total of £398 million in tax-free dividends in the 2017/18 tax year.
It is not uncommon for a VCT’s target dividend yield to be in the region of 5%. This is equivalent to a taxable yield of around 8% for an additional-rate taxpayer.
Please note, though: dividends are variable and not guaranteed. Past performance is not a guide to the future.
VCT vs EIS: What are the main differences between VCTs and EIS?
Despite investing in broadly similar types of companies, there are significant differences between VCTs and EIS investments.
Firstly, the tax reliefs on offer, the maximum you can invest and the minimum holding period are different.
Unlike EIS, VCTs offer no carry back facility: the tax relief can only be offset against the income of the same year in which your shares are allotted. There is also no inheritance tax advantage, nor is it possible to offset losses against capital gains made elsewhere.
Secondly, when you invest in a VCT, you acquire shares in the trust, not in the underlying companies. So, theoretically, you could sell your shares any time and realise your investment, although there may be restrictions.
When you invest in an EIS fund, instead, you acquire shares in the underlying companies. As those are not typically listed, you cannot usually sell your shares on the stock market. You can only realise your investment when there is an exit, i.e. the company is sold, listed on a stock market or refinanced.
Thirdly, unlike EIS investments, VCTs tend to pay tax-free dividends, which form the majority of any return to investors. By contrast, EIS investments usually require holdings to be sold before any cash can be returned to investors.
What are the charges?
VCTs require more management than more mainstream investments. Structuring a deal can take up to six months; due diligence is harder and more laborious; fund managers tend to be much more involved in the business.
The costs reflect this.
VCT initial charges can be as much as 5%. However, when you invest through Wealth Club, we usually discount our initial commission, which reduces this. In addition, in many cases we offer an annual rebate for three years.
The annual management fee is normally in the region of 2%. There are additional directors' fees, transaction and custodian fees and other costs associated with being a listed company. Finally, if the trust performs well, there is often a performance fee. All fees are listed in each VCT’s Key Information Document.
How can I buy VCTs?
Buying shares in new offers
VCTs raise funds periodically by issuing new shares through an offer for subscription. VCT offers typically open once a year and are available until the fundraising target is met or a set deadline, whichever is sooner.
Investors can buy shares in new offers through a broker like Wealth Club.
Buying VCT shares on the secondary market
Some investors don’t have the income tax liability to justify buying a new issue of VCT shares, and therefore look to buy them via a stockbroker on 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 could still benefit from tax-free growth and tax-free dividends, plus you can typically buy them at a discount. There is one more benefit: there is no minimum holding period.
There isn’t often a significant volume 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: the maximum annual investment of £200,000 includes both new issues and secondary purchases.
How can I sell my VCTs?
VCTs are less liquid than mainstream investments such as listed 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.
Many VCT managers periodically offer to buy shares back at a preferential rate – 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 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.
How are VCTs valued?
It is normally accepted that the closest measure to the value of a VCT is its NAV (Net Asset Value), namely the value of the companies in which it invests.
However, because these companies are not typically listed on a stock exchange, they don’t have an exact market value.
The VCT’s board of directors will estimate a value using established valuation methods and principles. These valuations are usually produced twice a year.
However, these can only be estimates. The true value of a company is the price someone is willing to pay when and if the VCT sells its shareholding.
VCTs that invest in AIM-listed companies tend to be easier to value because the AIM market provides a more liquid market for the underlying shares. However, as a result, they tend to be more volatile.
How are performance and investor returns calculated?
The most accurate performance indicator for a VCT is probably the NAV Total Return figure, rather than the share price. The NAV Total Return is a combination of the VCT’s NAV and the value of any dividends paid over the period.
Whenever possible, we publish performance figures on our website, as part of our VCT reviews.
Each VCT normally provides performance figures when it publishes its Annual and Interim reports.
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.
This risk is much greater with VCTs than with other stock market investments because they invest in small companies, which 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 experienced 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.
What happens to my VCT shares when I die?
VCT shares are treated like any other shares you buy on the stock market. This means when you die they can be passed on but might be subject to inheritance tax. If the shares are transferred to your heirs, they will continue to receive dividends free of tax.
If you die within five years of investing in a VCT, any tax relief you received will not be withdrawn.