1. Which Investors Are They Suitable For And What Tax Relief Do They Offer?
  2. What Exactly Are VCTs?
  3. Key qualities
  1. What Kind Of Companies Do VCTs Invest In?
  2. Different Kinds Of Venture Capital Trust

Venture Capital Trusts – Which Investors Are They Suitable For And What Tax Relief Do They Offer?

 

The UK government offers investors in Venture Capital Trusts (VCTs) generous tax breaks in the form of income tax relief, loss relief and Capital Gains (CGT) and Inheritance Tax (IHT) exemptions. But what exactly are VCTs, why are they supported and incentivised by the UK government and what kind of investors, or what role in a broader investment portfolio, is the investment vehicle suited to?

Venture Capital Trusts Explained – What Exactly Are VCTs?

 

Venture Capital Trusts (VCTs) are a kind of closed-ended fund with a fixed pool of capital that invest in promising UK-based growth companies of the kind often referred to as start-ups. Because the British government is keen to incentivise private capital being invested in young companies with potential, because a thriving start-up and SME economy is a major boost to the whole UK economy, it offers investors in these companies some attractive tax reliefs and exemptions.

Venture Capital Trusts invest in smaller, usually relatively young private companies that qualify for either the Enterprise Investment Scheme or are listed on the London Stock Exchange’s AIM exchange, which is a sub-market for smaller, growing companies.

Because VCTs invest in smaller companies which are either still privately owned or AIM-listed (the sub-market generally has lower liquidity levels than the main LSE), they are considered higher risk investments. That’s partly why VCT investments are supported by attractive tax reliefs and exemptions. It’s also why they are not suited to standard private investors and are a fit for higher net worth and sophisticated investors who are considered qualified to make an informed decision on the level of risk they are taking on.

However, one advantage of VCTs over investments in individual EIS companies or AIM-listed companies is that they are actively managed and spread capital across equity stakes in a number of companies. That means an experienced professional is assessing the companies VCTs invest in and the risk is spread across a number, with the expectation not all will realise their potential and grow in value.

To sum up, the key qualities of Venture Capital Trusts are:

VCTs are supported by the UK government in the form of generous tax incentives and reliefs because venture capital supporting promising, growing companies is important to the British economy

VCTs invest in smaller UK companies that are either still private or listed on the LSE’s sub-market AIM exchange.

Because VCTs invest in smaller, private companies whose equity is less liquid than public companies, they are a higher risk investment than conventional funds.

VCTs are long term investments as they must be held for at least 3 years for tax reliefs and exemptions to be valid. And the equities they invest in are not highly liquid.

VCT investments come with attractive tax breaks but investors should not invest in the solely to reduce their tax bill. The opportunity to realise gains through putting capital at risk should always be the main incentive.

The underlying value of the companies VCTs invest in is less certain than those traded on liquid main stock exchanges because they are often privately owned or less liquid AIM-listed companies.

While it is often possible to sell VCT shares on the secondary market this should not be considered a guaranteed possibility. Secondary markets are far less liquid than main stock exchanges. Some VCTs do offer conditional buy-back facilities.

As a higher risk investment, VCTs are most suited to more experienced investors who can make an informed decision on the level of risk they are taking on and can tolerate a higher risk to reward ratio.

A return is not guaranteed and VCT investments can drop in value as well as realise gains. It is possible, if rare, that the entirety of a VCT investment could be lost.

Any investor who is not completely sure if a VCT investment is right for them should seek out qualified professional advice.

What Kind Of Companies Do VCTs Invest In?

As a result of the attractive tax regime Venture Capital Trusts offer investors, these closed-ended funds can only invest in specific kinds of companies. They should either by private companies that qualify for the Enterprise Investment Scheme or AIM-listed shares. Key qualities the kind of companies VCTs invest in are:

They promote innovation, industrial change and modernisation of legacy work processes

Their current cash flow and assets means they would struggle to access traditional forms of bank finance

A relatively significant amount of capital, more than individual investors would ordinarily be able to afford, needs to be raised. As a rule of thumb, that is usually between around £250,000 and £5 million.

Different Kinds Of Venture Capital Trust

Different VCTs have different investment strategies. They might invest in only private companies, only AIM companies or a combination of both. Some VCTs also focus on a particular sector such as technology or health.

Tax Benefits For VCT Investors

Investing in a VCT comes with some significant tax advantages designed to compensate for the fact that investing in the private or less liquid AIM shares of smaller companies is higher risk than mainstream retail investments.

VCT tax reliefs include:

Income tax relief on up to 30% of the value of the VCT investment as long as the shares are newly issued and not acquired on secondary markets.

Dividends are not taxed.

Capital Gains Tax is not applicable to any gains realised through a VCT investment.

These tax benefits apply to amounts of up to £200,000 invested in VCTs in any given year. VCT shares must also be held for at least 5 years to take advantage of tax relief. If sold before that point, any tax relief already taken advantage of will be repayable. Income tax relief can only be set off against a tax bill, so investors must pay enough income tax to be offset to take full advantage.