What is a VCT?
Guide to Venture Capital Trusts
Important information - Venture Capital Trusts (VCTs) invest in small, early-stage, unlisted companies and are considered high-risk investments. It’s difficult to access your money in the short term and their value can go down as well as up so you could get back less than you put in. VCTs are long-term investments and only really a consideration for larger portfolios. We suggest they form a small part of a diversified portfolio. This isn’t personal advice, if you’re unsure if VCTs are right for you, please consider taking advice. Tax rules can change, and their benefits depend on your individual circumstances.
A Venture Capital Trust (VCT) is similar to an investment trust. They’re listed on the London Stock Exchange and raise money from investors to invest in young, innovative companies that are unlisted and aren’t readily available to the public.
Smaller companies are a vital area of the UK economy. Without funding from venture capitalists, many companies we consider household names would never have been able to grow their businesses. It’s an exciting, dynamic area to invest in, but it also means they are by nature higher risk, as they are more likely to fail.
Profits are generally paid to VCT investors as dividends, which are the primary source of return. The VCT manager will also provide expertise to help their chosen firms expand and provide better returns for their investors. They normally look to sell their share of the business three to seven years after investing and reinvest the capital in the next opportunity.
To encourage investment in VCTs, the government offers generous tax incentives.
VCT shares are difficult to buy and sell – the market price may not reflect the value of the underlying investments. The value of the shares will rise and fall, income is not guaranteed and you could get back less than you invest.
What are the risks of VCTs?
VCT investments are higher risk investments and you could lose your whole investment. It can also be hard to sell VCT shares at a price close to the value of the underlying holdings or in extreme circumstances, at any price.
The amount of income tax you can claim cannot exceed the amount of income tax you’re due to pay. For example, if you only pay £2,000 in UK income tax each year but make a £10,000 VCT investment with 30% tax relief, you could only claim up to £2,000 back, not the full £3,000.
VCTs must maintain their VCT-qualifying status to keep the tax benefits for their investors. If the VCT loses this status, you could end up losing the tax benefits.
You must also hold a VCT for five years to keep the tax relief.
Tax benefits depend on your individual circumstances and tax rules can change.
Who should consider investing in VCTs?
As the companies VCTs invest in are often new, very small companies which have a higher likelihood of failure, they are higher-risk investments.
They’re therefore aimed at more experienced investors with a detailed understanding of investments, who can afford to take a long-term view. They should be held as a smaller part (under 10% of the portfolio) of a large (over £100,000), diversified portfolio.
Typically, higher or additional rate taxpayers are more likely to benefit from the tax benefits than basic rate tax payers.
We would recommend that investors have used other tax efficient investments like ISAs or pensions before looking at VCTs. Investors should also have already built up cash savings for emergencies.
What are the tax advantages of VCTs?
VCTs offer a number of tax advantages:
- Up to 30% income tax relief – up to £60,000
- Tax-free dividends
- No tax on capital gains
You can invest up to £200,000 each tax year and receive the tax benefits. For anything over this, you won’t be able to the claim relief. You also need to pay that much in tax to claim it.
You need to hold the VCT shares for at least five years to keep the tax relief, otherwise you might need to repay it.
Only investments made in new issues of VCTs qualify for the tax relief, not shares bought on the London Stock Exchange. You also can’t claim tax relief if you reinvest into a VCT you’ve sold within the last six months.
You’ll need to claim the tax relief on your self-assessment, but you don’t need to declare any dividends.
VCTs also need to maintain their qualifying status in order to keep all these tax benefits for their investors.
VCT and tax rules can change, and their benefits depend on your individual circumstances.
What are the different types of VCT?
There are three types of VCT:
Generalist VCTs - invest in a broad range of companies in different sectors and at different stages of development.
AIM VCTs - invest predominantly in companies listed on AIM, or those which are about to list on AIM.
Specialist VCTs - focus on a specific sector like infrastructure or biotechnology, which can make them higher risk as they are less diverse.
Where do VCTs invest?
There are strict rules on where VCTs can invest. This is because the companies they invest in must, in most cases, be less than seven years old when the VCT first invests in them. They have to invest at least 80% of their value in qualifying investments in order to maintain their VCT status and their tax benefits for investors.
Investments can be in unlisted private companies or those traded on AIM or the AQSE Growth Market – both stock exchanges for smaller companies. A share listed on AIM or AQSE is regarded as an unlisted company.
They must have a place of business in the UK, typically have fewer than 250 employees, with assets worth less than £15mn before investment and £16mn after. There are some exceptions for knowledge-intensive companies.
They also can’t carry out certain activities, for example, banking, dealing in land or energy generation.
What charges do VCTs have?
VCTs have a number of charges that are applied by the provider.
When you apply for a VCT they’ll usually have an initial charge, which can often be discounted if applying through a broker. They’ll also have an ongoing charge which is reflected in the share price.
Some VCTs may also have a performance fee that can be charged if the VCT performs well based on set criteria.
A VCT prospectus and Key Investor Information Document will have a full breakdown of charges and how they’re applied.
How are VCTs valued?
Like investment trusts, VCTs have a net asset value which is provided by the VCT’s board of directors, usually twice a year. The net asset value represents the value of the underlying investments.
As the investments are not always listed on a stock exchange, this means that the value may be estimated using set valuation methods.
These are, however, estimates and the price you get for selling VCTs could be higher or lower than the net asset value.
How can I invest in VCTs?
VCTs are traded on the London Stock Exchange, so can be purchased like a normal share.
But as even the largest VCTs are quite small, they can be illiquid as there are not many buyers and sellers. This means it’s often difficult to buy and sell shares on the stock exchange and the price to buy and sell may be higher or lower than the value of the underlying investments. It may even be difficult to find a price at all in some cases.
Also, you won’t get the income tax relief if you buy shares on the stock exchange, which makes it far less appealing to most investors. Though you’ll still benefit from tax-free dividends and no tax on capital gains and can sell without any minimum holding period.
So it’s less common to invest in VCTs this way.
VCT managers will typically provide windows for new investment to investors where they issue new shares in the VCT. If you apply during one of these windows, the income tax relief will be available on those new shares.
You should read the prospectus for any new offer carefully as this will contain the specific risks for that VCT.
VCT managers may also from time to time provide buybacks, where they buy shares from existing investors. This is often at a small discount to the value of the shares. They’re subject to conditions and not guaranteed.
There’s a limit of £200,000 each tax year which you can invest in VCTs and benefit from the tax benefits. This limit applies to shares bought by new issues of shares, or on the secondary market.
How do I measure VCT performance?
VCTs are a bit different from funds and investment trusts. This is because they aim to provide most of their returns through dividends to investors rather than capital gains.
Key metrics investors should look at include:
Total return: the net asset value (the underlying value of investments per share minus any liabilities) plus any dividends that have been paid in that period.
Annual dividend yield: the dividends paid each year divided by the net asset value.
Total value: the sum of the net asset value per share in pence and the cumulative dividends per share in pence for the last five years.
Investors should also look at the sales of the underlying companies, also known as exits, the VCT manager has provided over the last few years.
Remember past performance and income are not a guide to the future.
What happens to my VCT shares if I die?
The shares will form part of your estate and will be potentially subject to inheritance tax.
Your executors can choose to sell the shares or pass them on to beneficiaries. The £200,000 VCT allowance also applies to beneficiaries who receive VCT shares this way.
The beneficiaries will still be able to receive dividends tax free and not pay any tax on capital gains.
If you die before five years have passed since buying the investment, your estate won’t have to repay any income tax relief that’s already been claimed.