VCTs, or Venture Capital Trusts, are a higher risk alternative to stocks and shares ISAs and SIPPs. These vehicles offer even more attractive tax breaks than the standard savings and pensions wrappers with 30% deductible from income tax on investments up to £200,000. However, that comes at a different risk to reward ratio.
VCTs are for investors keen to invest a portion of their assets into smaller, private companies – a bit like EIS and SEIS investments. However, VCTs spread the risk by investing in a basket of such companies. They also have a manager who makes the investment decisions so you don’t have to rely on your own judgement and ability to analyse young companies in sectors you are unfamiliar with. VCTs also trade on the London Stock Exchange so you can also buy and sell shares in them with much more easily than making an EIS or SEIS investment.
If you are lucky enough to be a high earner, you may have already used up your annual ISA and SIPP allowances in advance of the end of the current tax year deadline of April 5th. In that case investing into a VCT might be an attractive way to take advantage of additional tax breaks. And even if you haven’t used up your entire ISA and SIPP allowances, a VCT might appeal as an attractive higher risk investment that you allocate a small percentage of your overall portfolio to.
What Exactly Is A VCT?
A VCT is a little like an EIS/SEIS fund. The EIS and SEIS acronyms stand for Enterprise Investment Scheme and Seed Enterprise Investment Scheme. They were set up to encourage high net worth and sophisticated investors to invest in young, growing ‘knowledge-based’ companies. Investors in companies that qualify for these schemes get generous tax breaks, with 30% of the initial investment deductible against income tax. If the investment doesn’t work out, part of the losses can also subsequently be deducted against income tax. And if the company invested in goes on to be successful and shares are sold at a profit, it is free of capital gains tax.
The downside of EIS and SEIS investments is that, like investment in any young, private company, they are risky. Even if a lot, but not all, of the risk is tax deductible. It takes experience and knowledge to be able to accurately assess the merits of this kind of investment.
VCTs invest in the same kind of companies but with the advantage that an experienced manager and team perform the due diligence and choose the companies. And with VCTs investing their capital in a basket of companies, the risk is spread. VCTs will typically invest in between 50 and 100 companies.
VCTs can also invest in AIM companies as well as private companies. AIM is the Alternative Investment Market of the London Stock Exchange. It’s a sub-market for smaller companies with less strict criteria.
VCTs usually have a particular raise target, such as £25 million, £100 million or £200 million and will close to new investors once that has been achieved. However, if interest is particularly high the sum will usually be raised to accommodate that and not turn too many investors away.
VCT Investment Tax Relief
VCT investments of up to £200,000 per tax year qualify for income tax relief of 30%. So if you invested £100,000 into a VCT fund, you would pay £30,000 less in income tax, if your total due for the tax year is high enough for that to be deductible.
Any dividends received from VCT investments up to the £200,000 a year allowance are also exempt of income tax liabilities. And if a profit is realised on the sale of VCT shares, that is free of Capital Gains Tax.
One important difference between a VCT investment and an EIS or SEIS investment is that any losses realised are not tax deductible. Another drawback is that if you choose to sell your VCT shares before the end of a 5-year ‘lock up’ period, they 30% income tax credit received at purchase will be repayable. As such, a VCT investment should be accepted as locking up your investment capital for at least five years. And while it is theoretically possible to sell VCT shares at any time, they are usually far less liquid than other exchange-tradable shares, especially if the Trust you have invested in is not doing particularly well.
Different Kinds of Venture Capital Trust
Like any category of trusts or funds, there is a degree of variation within VCTs and different trusts have different investment strategies. These can be broken down into three main groupings:
General VCTs: most VCTs will fall into this category which means they will invest in young, growing companies across a range of sectors. However, they do often have a leaning towards certain sectors such as life sciences, medical services or fintech. This will usually be influenced by the experience and preferences of the VCT’s manager and/or sectors that are currently hot, which is important for the trust’s eventual exit strategy.
The investments of Generalist VCTs will usually consist of a mix of equity and either preference shares or loan notes. The latter two are a kind of hedge against the business not proving a success as if the company has to wind up they take preference to ordinary shareholders if assets are liquidised.
Limited Life/Planned Exit VCTs: the most conservative approach to VCT investing. Limited life/planned exit VCTs commit to exiting their investments shortly after the 5-year minimum hold period that means shares qualify to retain the original 30% income tax credit. They are focused on capital preservation rather than significant gains and the main aim is that investors keep their 30% tax relief. That’s not to be sniffed at as it adds up to an annual return of 10% over 3 years and any additional gain is considered a bonus. Of course, the strategy doesn’t always work and losses are still a possibility.
This kind of VCT also tends to focus on investing in companies that hold tangible assets such as real estate as an additional insurance policy that helps lower risk.
AIM VCTs: invest exclusively in AIM-listed shares rather than private companies. This can make them more volatile than general VCTs but also more flexible as it’s much easier to sell shares in AIM-listed companies than it is equity in private companies.
Buying Into a VCT
Shares in VCTs can usually be bought through your usual online investment platform or stockbroker, though some have a wider selection of choice than others. Bestinvest and Hargreaves Lansdown usually offer the widest choice.
The most popular VCT in the UK is currently the Octopus Titan Venture Capital Trust. It is estimated that as much as 40% of the entire circa. £500 million that will be invested into VCTs this tax year by UK investors will flow into it. Its popularity is down to a history of strong returns and investments have included the property portal Zoopla. Of course, that is no guarantee that future returns will match the success of previous years. Current holdings of the trust include Depop.com, the fashion marketplace.
Fees for VCT investments are, however, typically quite high at between 2% and 5% per annum.
VCTs are certainly a higher risk investment vehicle and may not be suitable for every investor. But the additional tax allowance does make them a potentially interesting addition to an investment portfolio for higher earners who have used up other wrapper allowances or as a higher risk/higher return allocation as part of a generally more conservative portfolio.