Venture Capital Trusts: Save Taxes While Supporting Small Businesses
For investors who have exhausted their annual Isa allowance, venture capital trusts (VCTs) are another tax-efficient option to consider. In fact, VCTs offer more generous tax breaks than Isas, as well as a larger annual investment allowance; the other side of the coin is that the underlying investment has a higher risk.
VCTs are funds managed by a professional manager who chooses a portfolio of eligible companies. They must be companies less than seven years old, with assets of less than £15 million and less than 250 employees. Often they will be private, although some publicly listed companies are eligible.
These businesses – small start-ups – inevitably carry more risk than their more established counterparts. There is exciting growth potential if the business takes off – famous VCT alumni include estate agent Zoopla, holiday company Secret Escapes and meal kit company Gousto – but there is also a very real danger. complete failure. VCT managers mitigate this risk by building portfolios of companies rather than putting all their eggs in one basket. But investors also have some protection from the generous tax breaks the government is offering to encourage support for this part of the economy.
Best of all, investing in new VCT shares – as opposed to those trading on the secondary market – comes with an upfront 30% relief from income tax and you can invest £200,000 a year . All income and capital gains generated by VCTs are tax exempt. The only caveat is that you must keep your VCT shares for at least five years; otherwise, the initial tax relief must be refunded.
Make sure you choose the right fund
The fact that only new shares offer the 30% relief forces VCT managers to launch new issues every fiscal year. Sometimes managers launch entirely new funds; in other cases, they launch new issues of shares on their existing funds, allowing them to expand the portfolio or supplement the investments already made.
Either way, it’s important to understand that even with the generous incentives, you’re making a high-risk investment when you invest in a VCT. And that makes it imperative to choose the right fund from the right manager. In practice, VCTs come in different shapes and sizes. The most common funds are generalist funds – they invest across the economy based on the opportunities the manager sees to support exciting businesses. Then there are the specialized VCTs, launched with a mandate to focus on particular sectors. These include funds investing in technology companies, healthcare companies and – for the first time in the 2021-2022 tax year – companies with a sustainability theme. Finally, there are also a number of VCTs focused solely on Aim actions.
The right fund for you therefore partly depends on the category you are most interested in. Generalist funds can be a good starting point, while more specialized funds are riskier. Goal-based VCTs have the advantage that the underlying portfolio is simple to value, since each issuing company has a publicly available share price. Valuations of unlisted companies, on the other hand, are more opaque, so it can be more difficult to assess the performance of these VCTs.
Yet the most important determinant of all for the success of a VCT is the capabilities of the manager. This is one area of the investment market where specialist expertise really matters. Obviously, you need a manager who can select companies that offer the best possible combination of attractive prospects and realistic chances of success. But in addition, managers must have the necessary skills to work with the companies they support; VCTs tend to be direct shareholders. A manager’s business must also have strong networks and contacts in order to find good companies in the first place. This latter capability is particularly important in today’s market, with VCTs poised to raise record sums this year. The strength of a company’s deal flow will determine whether it has enough good opportunities to invest all that money.
Based on all of these criteria – and the performance of VCTs in the past – industry experts favor several managers as worthy of support. The Wealth Club investment platform, for example, selects Albion VCTs, Pembroke VCTs and Northern VCTs. Bestinvest adds Unicorn Aim VCT to this selection.