17 November 2022
Investing in a Venture Capital Trust
Close Brothers Asset Management
With limits in place on ISA contributions and an ever reducing ability to add to pensions, we examine Venture Capital Trusts (VCTs).
What is a Venture Capital Trust?
VCTs are high risk investments and should only be considered by experienced investors. VCTs invest in small, entrepreneurial and private (not listed on a stock exchange) businesses across a variety of sectors ranging from tech companies, manufacturing, retail and clothing brands.
Introduced in 1995 by the government to help companies grow, c.£10.5bn1 has since been invested (April 2022) in VCTs with the likes of Virgin Wines, Gusto, Zoopla, Graze and Cazoo becoming household names after starting life as VCT ventures. Indeed, VCTs had a record year in 2021/22, raising c. £1.1bn in the tax year, up 65 per cent on the previous year.
Importantly, investing in a VCT means you become a shareholder of the trust and not of the individual companies in which the trust subsequently invests in, so you get exposure not only to any new investment the VCT makes, but also to the existing more mature portfolio.
Investing in a VCT
There are a range of VCT providers in the UK, but investors need to make sure a VCT is right for them. VCT investments can bring a lot of benefits to an investment portfolio, alongside the satisfaction of knowing you might be backing a FTSE 100 company of the future, accompanied by the very attractive tax benefits on offer but they also bring increased risk.
Investors must make sure they understand the risks. VCTs are usually only more suitable for more experienced investors with high earnings, or who have already built up significant investments and are unable to contribute further in to Pensions or ISAs. If you want to explore your options, you should speak to a qualified financial adviser.
Who should consider VCTs?
After ISA and pensions allowances have been used in full, experienced investors who understand the risks and who are looking to reduce their tax bill and generate income may want to consider investing in a VCT.
VCTs can be appropriate for investors that are happy to accept a higher element of risk and do not need access to the capital in the long term. They can also be a valuable planning tool in the lead up to and in retirement.
What are the risks?
As always, investments can rise and fall, and your capital is at risk. For VCTs, there are some specific risks worth being aware of:
- Small private companies are risky investments: As VCTs invest in smaller, less mature businesses, the investment returns can be much more volatile. While investors may see big gains, they may also see big losses. Smaller companies are also more likely to fail and go bust than larger, well-established firms. However, by investing in a VCT you invest in all the companies that the VCT has currently invested in, potentially giving you access to more mature companies
- The tax benefits may not continue: Whilst VCTs are very attractive currently from a tax viewpoint, there is no guarantee this will continue. Government policies and tax rules change and it is possible that these tax benefits may be withdrawn in the future
- Private companies are harder to value: Most investment funds invest in public companies which are traded and valued every day, which makes it easier to accurately value the fund’s holdings. Private companies are often valued much less frequently, and are harder to value. Calculating the underlying value of a VCT’s portfolio may not always be easy or 100 per cent accurate
- Selling shares: Your shares may be difficult to sell as selling a VCT is not as easy as normal shares and there is a less active secondary market. This means you may receive less money than the face value of the shares if you sell. If you sell within five years, the income tax relief will be reclaimed so they should be considered as a long term investment
- Income inconsistency: The income from VCTs can be inconsistent and is not guaranteed
Should consideration of a VCT as part of your portfolio be appropriate, you should work with a qualified financial adviser to aim to identify the best solution for your personal objectives and circumstances.
What are the tax benefits of a VCT?
VCTs are a tax efficient investment product and this is often one of the key reasons why people choose to invest in them with higher earners able to reduce their income tax bills significantly in some cases:
- When you invest in a VCT, you can claim up to 30 per cent upfront income tax relief on what you invest (up to a limit of £200,000), as long as you remain invested in the VCT for at least five years. So if you invest £100k your tax bill is reduced by £30k. With tax rates up to 45 per cent currently, this is very attractive
- When you sell your shares in a VCT you won’t have to pay any capital gains tax on any profit you make
- Any dividend from a VCT is tax free These are clearly good benefits but you should never invest in a product purely on the basis of the tax benefits available. You should consider carefully why investing in a VCT will meet your broader financial aims, whether the investment is within your risk appetite, and what money you can afford to lose.
What are the other benefits?
The tax benefits may be one of the main reasons for considering investing in a VCT, especially if ISA and pensions allowances have been used for the year, but there are a number of other key benefits of VCTs to take into account:
- Diversifying your investments: Private companies, especially earlier stage private companies, can be a useful diversifier to the rest of your portfolio. It is likely that the bulk of your investments are in larger listed companies and bonds. The small, immature companies that VCT’s invest in have the ability to grow much faster than their longer-established peers but equally, can become insolvent much quicker leading to sharper rises and falls in value
- Providing an additional income stream: Whilst smaller and younger companies are usually better known for their capital growth potential than their dividends, this is not always the case. VCTs can provide an attractive source of income, where the dividends paid are tax free This is especially useful for those in or nearing retirement, where income is often more valuable than capital growth, for example, a dividend yield of 5 per cent is equivalent to a taxable yield of around 8 per cent for a higher rate taxpayer but someone nearing retirement has much less time to recover significant losses than someone younger