Mike Piddock, Business Line Manager for Venture Capital Trusts at Octopus Investments, explains what investors should look for when they’re choosing a VCT.
The amount of money flowing into Venture Capital Trusts (VCTs) has been rising steadily in recent years, as more investors take advantage of the generous tax benefits they offer. The government gives these incentives to reward you for investing in smaller companies that create jobs and growth for the country’s economy.
You can claim 30% upfront income tax relief on your VCT investment, as long as you hold on to it for five years, any dividends you receive from your VCT will also be tax-free, and you won’t have to pay any capital gains tax if you sell your VCT shares at a profit. A key point to remember is that the income tax relief is only available on VCT shares when they are first issued by the VCT – if you buy your shares second-hand from another investor, you won’t qualify.
Choosing your VCT
All VCTs invest in relatively small businesses. As long as you’re comfortable with the fact that you face more risk with smaller companies than with larger ones, your next decision will be what sort of VCT is best for you.
Some VCTs focus on early-stage businesses – these tend to be at the higher end of the risk spectrum, but they can also offer spectacular growth potential. Household names such as Secret Escapes and Zoopla, for example, both first received VCT finance when they were ‘early-stage’, but they are still available to new investors through the VCTs that backed them.
On the other hand, you could go for a VCT focusing on larger, more established companies listed on the Alternative Investment Market (AIM). Or you may be able to find a VCT that targets capital preservation – perhaps by investing in renewable energy companies qualifying for guaranteed long-term government-sponsored subsidies.
Have a good look at the brochures issued by the management companies to check what each VCT offers, and pick one that’s a good match for your investment goals and your view on risk.
Looking to the future
Assuming you’re happy with the five-year time horizon for VCT tax relief, you essentially have two options when you reach the five-year landmark – keep your shares or sell them.
Some VCTs have a finite life and plan from the start to wind themselves up after five years. But you need to bear in mind that it may take some time for the fund manager to sell all the VCT’s investments.
With a VCT that plans to stay open indefinitely, you’ll be able to keep your shares and benefit from any further growth it achieves. This is particularly relevant when you’re investing in early-stage businesses, as many VCTs are just getting into their stride after five years. It will be clear which of the companies in the portfolio have got what it takes to succeed and the fund managers may have had a chance to make further investments in them.
Another possible reason for holding on to your VCT shares is for the tax-free dividends. These could be a useful supplement to your income – if you are retired, for example. Or your VCT may give you the option to use your dividends to buy more shares and boost any long-term growth your VCT achieves.
However, if you’ve made the decision to sell – or that was always your plan – your first port of call should be the company managing the VCT. They may well have a scheme for buying shares back from investors. The price you receive will be less than the net asset value of the shares, though the discount could be as little as 5%. On the other hand, this will almost certainly be more than you would receive on the open market.
After selling your shares, it is possible to invest the money you receive back into a VCT and claim another helping of tax relief, though you’ll have to wait six months if you want to put it straight back into the VCT you’ve just left.
All of this has a bearing on your initial choice of VCT – not only should you pick one with an investment strategy that matches your goals, but it should give you the options you’re likely to need when it comes to decision time after five years.
This article reflects the views of Mike Piddock on 19 February 2014. It should not be viewed as legal, tax or investment advice. The value of an investment can go down as well as up and you may not get back as much as you invest.