30 years of venture capital trusts – what are the benefits and what’s next?

Back in 1994 I was gearing up to see Disney’s The Lion King for the 7^th time in the cinema.

What I didn’t know at the time was it would go onto win two Oscars and lead to straight to video spin offs, an award-winning musical and a 2019 CGI remake (with its own recently released prequel).

In fact, the original Lion King film has grossed $970mn internationally since then, with multiple rereleases. The CGI remake made over $1bn in just three weeks.

Little did I know, something else big was happening around the same time.

Venture Capital Trusts (VCTs) were announced in the 1994 Autumn Budget and brought in the following tax year in 1995.

They allowed investors to back very small, higher-risk UK smaller companies and also get tax benefits.

In their first year, they raised £160mn. Last tax year they raised £882mn, the third highest amount on record.

These are staggering numbers, but what have they done for UK businesses, the economy and investors?

VCTs are high-risk, long-term investments that should only be considered for larger portfolios held by experienced investors who have already used their ISA and pension allowances and might be higher or additional-rate taxpayers. We think they should form a small part of a diversified portfolio.

VCT investments, and any income from them, can rise and fall in value, so you could get back less than you put in. It’s difficult to access your money in the short term. VCT and tax rules can change, and their benefits depend on your circumstances.

This article isn’t personal advice. If you’re unsure if VCTs are right for you, consider taking advice.

Billions for smaller businesses

VCTs have collectively raised over £12.5bn since they first launched, investing in thousands of smaller companies.

In the past six years alone, despite some uncertainty from the pandemic, VCTs invested £2.9bn into over 700 smaller companies.

We’ve seen some companies backed by VCTs become ‘unicorns’, worth more than £1bn – household names like Zoopla, Cazoo, Gusto and Depop.

Many companies face a finance gap, known as the ‘valley of death’, when securing finance in their early stages. This is because they’re high risk, as many companies fail in their first few years, they lack collateral to secure loans and might have a short track record and limited cash flow.

High interest rates have also made it more expensive to borrow, worsening the funding gap.

VCTs can help those companies grow and find funding where it might not otherwise be possible. Since 2018, the average amount invested in each company by VCTs was £1.7mn.

In a survey of 722 VCT backed companies 43 companies reported sales of over £20mn. 54 reported sales of between £10 and £20mn.

But it’s not always successful. 76 companies reported sales of less than £500,000 and 47 reported no sales at all. Despite support, smaller companies can be unsuccessful and unprofitable.

VCTs don’t just help by offering financial support either. They can also provide support in management, giving expertise in HR, IT, operations and financial guidance. These can be critical to the success of early companies.

70% of companies backed by VCTs since 2018 have had a presence on the board by a VCT manager.

Thousands of jobs

VCTs have also created thousands of jobs in the UK economy.

Small to medium-sized enterprises backed by VCTs since 2018 employ over 44,000 staff.

Over a third of VCT-backed businesses employ between 20 and 49 employees compared to 3% of companies in the rest of the economy. Just under half employ more than 50 people, compared to 2% of the wider economy. This all leads to wider economic growth.

What are some other benefits of VCTs?

VCTs can offer support to businesses that might be underrepresented.

This can include those outside of London and the South East where most funding usually goes – some VCTs focus on other areas like Scotland, the North of England and the Midlands. This can help to act against economic disparity.

There’s also a focus on environmental, social and governance (ESG) issues, making sure that diverse perspectives are brought into decision-making processes increasing growth and inclusivity. And some VCTs focus on sustainability.

There are still massive funding gaps for women and people from minority groups when it comes to venture capital though, and while VCTs say they’re working to address this, there’s still some way to go.

A 2019 report found that for every £1 of venture capital spending, only 1p goes to all-female founder teams, and 10p to mixed-gender teams. Encouragingly though in 2021 to 22 another report found that the number of venture capital deals for companies with all-female teams rose from 6% to 9%.

What are the VCT tax breaks for investors?

To encourage investment in VCTs, investors are eligible for tax benefits, including:

• 30% income tax relief on what investors put in VCTs as part of new share issues, as long as they invest for at least five years. Subject to an investment allowance of £200,000.

• No capital gains tax on selling.

• No tax on dividends from VCTs.

In the 2022/23 tax year, over 26,000 people invested an average of £37,000 each in VCTs, claiming income tax relief on £985mn of investment.

In times where capital gains tax rates are rising, and allowances frozen, these benefits can seem more of a draw than ever.

Though it’s worth remembering, tax rules and benefits can change and depend upon your individual circumstances. VCTs should only be considered for larger portfolios held by experienced investors who have already used their ISA and pension allowances and might be higher or additional-rate taxpayers.

What’s next for VCTs?

In September 2024, the government extended the VCT scheme until April 2035.

As the third biggest venture capital market in the world, the UK could have a competitive edge over other countries if the market continues to grow and attract more investors. And this could mean we see more opportunities to invest in higher-risk smaller companies, while benefitting from the generous tax breaks.

Interested in VCTs?

HL has a new service where experienced investors can invest in new VCT issues.