Venture capital trusts

What is a venture capital trust?

Venture capital trusts (VCTs) are investment companies that are listed on the London Stock Exchange and set up to invest in small UK businesses that meet certain criteria. To encourage support for these businesses the Government offers generous tax benefits for VCT investing. This also reflects the higher-risk nature of the companies they invest in.

VCT tax rules and relief

Venture capital trusts offer several tax benefits to encourage investment into higher-risk companies. These tax benefits make VCTs popular among higher and additional-rate taxpayers:

• Income tax credit - 30% income tax credit on investments of up to £200,000 each year when you buy shares in a new VCT share offer - but you need to have paid at least as much tax as the rebate and must hold the shares for at least five years.
• Tax-free dividends - There is no Income Tax to pay on dividends from venture capital trust shares.
• Capital gains tax (CGT) - You won't be liable to CGT when you sell your venture capital trust shares.

How does a venture capital trust work?

The UK government introduced a series of venture capital schemes in 1995. These include the enterprise investment scheme, seed enterprise investment scheme and venture capital trust scheme. All three of these schemes were designed to encourage private sector growth and generate investment from individual investors.

What are the different types of VCT?

There are a variety of strategies to be found on the VCT market. They all invest in smaller companies and give you tax relief, but they are different in their approaches to managing risk and reward.

Retail investors can purchase shares in venture capital trusts that are traded on major exchanges like the London Stock Exchange (LSE). This allows investors to take part in the growth of smaller, private, up-and-coming businesses indirectly.  The money from investors is pooled together and distributed to these businesses to help them grow.

Certain criteria must be met in order for a fund to be classified as a VCT. Some of the main qualifications include:

• Listing on a major exchange in the UK
• Companies that receive capital through VCTs must employ no more than 250 individuals
• Companies under the VCT must have less than £15 million in gross assets before the investment and less than £16 million right after the investment.

Generalist VCTs

Most Venture Capital Trusts are Generalist VCTs. These typically invest in unquoted companies across a range of sectors, although some larger VCTs will also hold AIM-listed shares. Generalist VCTs use a range of different approaches. Some focus on young companies that aren’t yet profitable but have strong potential. Others look at more mature businesses and some take an asset-backed approach similar to Limited Life VCTs. (Limited Life VCTs are designed to return funds to shareholders after a limited period of time, usually soon after the 5-year holding period required for investors to retain their Income Tax relief).

Investments are usually made through a combination of loan notes or preference shares alongside equity in the business. Loan notes and preference shares give the VCT a potential income source. They also have greater security than equities as they rank ahead of ordinary shareholders in the event of a potential company wind-up.

VCT management teams often place directors on the boards of unquoted companies they invest in, especially when they are the main shareholder. They monitor the investment and guide the business to an eventual exit – usually a sale to another investor or trade buyer, but sometimes a stock market listing.

AIM VCTs

AIM VCTs focus on companies that are listed on the Alternative Investment Market (AIM) – the London Stock Exchange’s market for smaller growth companies. Their management teams usually have a background in fund management rather than private equity investment. Unlike Generalist VCTs, investments are normally made through ordinary shares rather than loan notes or preference shares, and it is rare for the VCT to seek board representation.

As these shares will fluctuate in value, AIM VCTs can potentially be more volatile than Generalist VCTs, especially as unquoted companies are valued periodically rather than daily. However, they do have more flexibility since ordinary shares are more easily sold on the market – unlike a position in an unquoted company.