Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Don’t dither if you want 30% instant return
Investors have rushed to put money into venture capital trust (VCT) offers this year. We believe they have been snapped up by higher-rate taxpayers looking for a tax-efficient place to put their money having exhausted their pension allowance.
While a good handful of offers have already closed, there are still a wide range of products available at the time of writing.
Venture capital trusts are funds that allow investors to claim up to 30% income tax relief on up to £200,000 invested in VCTs per year. You need to hold the investment for at least five years, but any dividends will be tax free and you will have a capital gains exemption on disposal.
The generous tax benefits associated with VCTs compensate for high level of risk associated with investing in these products, particularly those which put your money into privately-owned, early-stage firms.
There are three main types of VCTs
1. Mainly invests in unquoted companies – so this is your chance to get a slice of potential ‘next big thing’ businesses.
2. Invests in qualifying AIM-quoted companies – similar to a traditional small cap fund, but with added tax benefits.
3. Limited life VCTs – these invest in qualifying businesses, typically via loan notes, in a way that is structured to return investors’ capital after five years. This is essentially capital preservation with the tax reliefs providing the biggest part of the overall return.
Why have VCTs soared in popularity?
The Government has imposed a £1m ‘Lifetime Allowance’ on pensions. This is the amount of money you can put into your pension before a 55% tax rate kicks in when the excess is withdrawn as a lump sum; or 25% tax when taken as income (such as buying an annuity).
Someone could have easily amassed a pension worth £1m if they had a good savings habit from a young age. VCTs are seen a viable way of avoiding additional tax payments for those fortunate enough to have a nice retirement savings pot.
What's on offer?
At the time of writing there were 12 VCT offers still open for application. Minimum subscription tends to either be £3,000 or £5,000 depending on the product provider.
The money raised by VCTs each year is primarily used to invest in new additions to a portfolio, according to Stuart Lewis, head of tax efficient investments at VCT provider Octopus.
He says Octopus is different to the peer group as it uses a large chunk of each year’s new money to provide more finance to existing investments. ‘Most VCTs only invest on a deal by deal basis,’ he adds.
Octopus Titan VCT is raising significantly more money than other VCTs this year with a target of £120m. It has already secured two thirds of this money, so why doesn’t it set the goal even higher if there is strong demand for VCTs?
‘We are mindful of raising the right amount of money and not have a cash drag,’ says Lewis. ‘We see a lot of prospects but only do about six to 10 seed investments a year. The rest of the money is to help existing investee companies grow.’
It can often take five years for an early-stage company to reach the stage where it is either ready to be acquired or floated on a stock exchange – two liquidity events that help VCTs crystalise value in their investments.
A lot to prove
Pembroke is considered the ‘new kid’ in the VCT space as its product has only been going for three and a half years, according to managing director Andrew Wolfson. Its limited track record is perhaps one reason why it has only raised £4m out of a targeted £15m for its VCT B Share offer.
The VCT provider’s portfolio has a bias towards consumer-facing business including the UK operations of burger chain Five Guys and juicing firm Plenish.
Wolfson sees plenty of opportunities for new investments, claiming that small businesses need venture capital support as they can’t get working capital finance from banks even though the latter have plenty of money available
‘Pembroke’s team are experienced private equity investors,’ comments wealth manager Killik & Co. ‘However Pembroke is a new venture and there is no guarantee that performance can be replicated on the VCTs.’
In contrast, Octopus can point to numerous examples where it has made decent profit on its VCT investments. The fact some of its investee companies have subsequently been acquired by Amazon, Google, Microsoft and Twitter helps to attract entrepreneurs who view Octopus as the ideal partner, claims Lewis.
Invest and repeat
Octopus says its track record often means it works with the same entrepreneurs over and over.
For example, it is backing the same team behind LoveFilm (now part of Amazon’s film service) and Graze snacks business for the third time with
tailor-made dog food seller Tails.com. All three have the same model of using the internet to accept orders and delivering by post.
VCTs can be a good way to get exposure to tomorrow’s next big companies. However, it seems inevitable there will always be some casualties in the early-stage company space. Even Octopus isn’t immune from failures.
Booking platform Yplan was last year acquired by Time Out (TMO:AIM) for a small fraction of the money pumped in by its venture capital backers, including Octopus.
HOW TO BUY AND SELL
INVESTORS SHOULD buy any type of VCT direct from the fund manager or a specialist VCT broker during the offer periods to get all the tax benefits. You can buy VCTs on the open market (also known as the secondary market) but you would lose the 30% income tax relief.
And don’t forget the VCT rule that you lose the tax benefits if you sell before the first five years of ownership is up.
If you do sell before the first five years is up, you would need to tell the taxman HMRC and reimburse the relevant income tax relief amount.
Some VCT providers offer to buy back shares at a 5% to 10% discount to net asset value.
What else is on offer?
Amati and Albion both still have ‘live’ offers for their VCTs, so too Hargreave Hale whose product invests in AIM stocks.
‘We rate the Hargreave Hale management team highly and think this offering provides a useful way to diversify a long-term VCT portfolio with quoted AIM investments,’ says Killik.
VCTs can only buy new shares in a company and not existing stock that already trades on the market. Therefore they must either buy AIM-quoted shares when a company first joins the stock market or when it raises additional money by issuing new shares.
Qualifying AIM companies need to be a proper business making stuff or providing a service – activities like investing in property wouldn’t count, for example. Furthermore, there are rules about the age of a business and the size of its assets – once they reach a certain point, a VCT can no longer buy new shares.
The beauty of AIM VCTs is that they can sell holdings on the open market, unlike generalist VCTs which may be stuck with an investment in an unquoted company until they can a) find a buyer for the investment b) the investee company is taken over, or c) the investee company floats on a stock market.
A portion of new money going into Hargreaves’ VCT is expected to be invested in the group’s Marlborough Special Situations (GB00B907GH23) fund, says Killik. This will enable it to obtain initial exposure to small companies and avoid a cash drag, pending new investment in qualifying companies.
Other VCT offers still open to investors include technology-focused Foresight; and Triple Point Income which targets businesses with predictable revenue streams and strong asset bases.