What is a VCT?
A Venture Capital Trust (VCT) is a fully listed, tax advantaged, investment company providing equity and loan finance to unquoted companies, typically small to medium sized private companies in the UK, including those listed on the Alternative Investment Market and PLUS market.
In establishing VCTs and detailed VCT regulations, the government aimed to promote enterprise, growth and job creation in smaller companies by incentivising private individuals to invest in such small and relatively high risk companies through targetted tax reliefs. Shares in VCTs may be traded on the Stock Exchange while dividends generated from income and capital gains realised from investments are paid free of any tax liability.
The investment criteria of a VCT vary depending on the investment objectives of the particular VCT. Many VCTs are generalist investors, while others specialise in particular areas such as AIM listed companies, early stage technologies, media and solar power generation.
Under VCT regulations, VCTs cannot invest in certain specified business activities such as property, farming, leasing and financial services.
How should I select the most suitable VCT for me?
Depending on their personal attitude and approach to risk and reward, investors may decide to subscribe in one or more VCT in any one tax year.
By virtue of their diversified portfolios, Generalist VCTs may offer more regular returns through dividends at lower risk whereas Specialist VCTs may offer potentially higher returns but at higher risk. The performance of AIM VCTs will generally track that of the AIM market and benefit from higher levels of public disclosure of the underlying investments.
Although past performance may not reflect future performance, investors should assess inter alia the VCT fund manager's track record, the performance and dividend history of all its funds and the quality and experience of the management team.
An investor may also want to ensure that regular updates are made on the fund's progress, that the VCT fund manager provides an investor relations service and that the fund offers a share buy-back scheme for shareholders who may wish to sell their shares.
What will happen to my investment?
- The VCT fund manager has three years in which to invest more than 70% of the funds raised in qualifying investee companies and maintain that level of investment thereafter to retain the VCT's tax status and the tax benefits for investors.
- A VCT can invest up to £1 million in any one company in any one tax year.
- During this three year period, the uninvested cash is normally held on deposit or in money market funds.
- Between 10% and 20% of the funds raised will usually be retained by the VCT fund manager in order to make follow-on investments as appropriate. A VCT may also utilise this cash reserve to offer to buy back shares in the market.
- Investors should consider VCTs as a long term, tax free dividend yielding investment. Foresight believes that a minimum holding period of five to seven years should be considered when investing in a VCT. Dividends can arise from either net income generated from the portfolio (e.g. interest earned on loans) or from net capital profits arising on a trade sale or listing of an underlying investment
How may VCTs be categorised?
VCTs may be categorised into three main types: AIM, Generalist and Specialist.
- AIM - investments are made in companies which are either already listed on the Alternative Investment Market or about to become so listed. As these investments are in public companies, information is readily available and valuing the investment portfolio can be done quickly using the latest daily share price for each company.
- Generalist - investments are usually made in unquoted companies across a wide range of industry sectors, investment stages (e.g. early stage/seed capital or development capital) and structures (e.g. management buy-outs, management buy-ins and equity release).
- Specialist - Investments are made by a VCT fund manager specialising in a defined investment sector (e.g. healthcare, solar, environmental and media).
What risks should I consider before making my investment?
- The value of shares in a VCT and dividends paid thereon can fluctuate, so investors may realise less than the amount originally subscribed. In addition, there is no certainty that the market price of VCT shares will fully reflect the underlying net asset value or that VCT shares can be sold at that price. Share buy-back schemes are offered by some VCTs, enabling you to sell your shares back to the fund, usually at a 10%/15% discount to the Net Asset Value.
- VCT funds will be used to finance small and medium sized businesses with a relatively high risk profile. Such risks are mitigated by creating a portfolio of such investments. Some of the underlying investments will inevitably fail, some will perform adequately but the principal objective of a VCT fund manager is to make a number of investments which will produce excellent returns for shareholders, more than compensating for losses.
- Investors should regard an investment into VCTs as a long-term investment, particularly as VCT shares need to be held for a minimum period of five years to retain the initial income tax relief.
- The levels and basis of VCT tax reliefs available to investors may change or be withdrawn at a future date.
- VCT status is only maintained if a VCT satisfies a number of continuing tests and there can be no guarantee that this can be achieved at all times. In particular, a VCT must satisfy a requirement that, by the end of a period of three years from raising capital, its investments in qualifying companies represent at least 70 per cent of its total investments. A loss of VCT qualifying status within five years would result in investors having to repay tax reliefs obtained.
- Realisation of unquoted company investments may be difficult and take considerable time. Constraints may be imposed on the realisation of investments in order to maintain the qualifying status of a VCT which may restrict its ability to obtain maximum value from its investments. Failures within the portfolio tend to occur early in the life of a VCT and will adversly impact the Net Asset Value. As the portfolio matures and the successful investments increase in value, the Net Asset Value should increase enabling dividends to be paid to shareholders.
How do I sell my VCT shares and what are the implications?
- VCT shares are listed on The Stock Exchange and can be traded on that market.
- If shares are bought on the market, no initial income tax relief is obtainable unlike with subscriptions for new shares. In order to retain initial income tax relief, shares must be held for a minimum of five years. Because of these two factors, the markets in VCT shares can be relatively illiquid. To address this, most VCT fund managers operate a buyback policy to enable shareholders to sell their shares back to the VCT, typically at a 10%/15% discount to Net Asset Value.
- If an investor sells shares within less than five years of the date of subscription, the initial income relief obtained will have to be repaid.
- No capital gains tax is payable on a profit realised from a sale of VCT shares.
What are the charges connected with a VCT?
- Initial set-up costs of the fund are usually 5.5% of the funds raised from investors.
- Annual management fees are usually between 2% and 2.5% of the VCT's net assets.
- Total annual costs are usually capped at around 3.6% of the VCT's net assets.
- Performance fees may be payable to the VCT fund manager above certain return hurdles.
What happens to my VCT shares if I die?
- Your VCT shares can be passed on to your heirs but like other shares will be included in your estate for inheritance tax purposes.
- If you die within five years of subscribing for VCT shares, the initial tax relief obtained will not be withdrawn.
- Once the shares are transferred to your heirs, they will continue to receive dividends free of tax.
Glossary of terms
Net Asset Value (NAV)
The value of the fund's assets minus its liabilities, often expressed as Net Asset Value per share.
Dividends are paid by the VCT to shareholders as a result of either (i) the sale of all or part of an investment in a portfolio company (Capital Dividend) or (ii) income generated (such as interest and dividends) from the underlying portfolio companies (Income Dividend), less the VCT's operating costs in both cases.
Management Buyout (MBO)
A transaction whereby a company's management team acquires the business from the existing shareholders, typically funded by an external equity provider, such as a VCT, and bank facilities alongside a significant financial contribution from the management team. The Foresight VCTs actively support such MBOs.
Investment capital required by established companies to finance their growth. The Foresight VCTs actively provide development capital.
Alternative Investment Market (AIM)
The second tier or junior market established by The London Stock Exchange in 1995 to provide trading facilities in the shares of smaller companies.
What are the tax benefits of investing in a VCT?
From 6 April 2007, if you subscribe for new shares in a VCT:
- You can receive 30% income tax relief in the year that you subscribe, but to retain this relief you must hold the shares for at least five years. Although there is no upper limit on the amount you can invest in a VCT, the tax benefits are only available on the first £200,000 of investment in each tax year. You can only claim income tax relief on your investment up to the amount of your total annual tax bill. You need to subscribe for new VCT shares to be eligible for the 30% income tax relief - purchases of VCT shares on the Stock Exchange do not qualify for income tax relief;
- Any dividends received by you, paid by the VCT, will be tax-free but this tax benefit is only available on the first £200,000 of investment in each tax year;
- Any capital gains arising on disposal of the VCT shares will be tax-free.
- A VCT subscription of £10,000 would be eligible for 30% tax relief which effectively means the cost of the investment to you is £7,000.
- If you received £1,000 in dividends, you would keep the full £1,000 paying no income tax.
- Finally, if you sold the VCT shares for £11,000, you would not be liable for any capital gains tax on the £1,000 gain.
When you make your VCT investment, you will receive a share certificate and a tax certificate enabling you to claim tax relief through your annual tax return. Depending on the time in the tax year that you invest, you may be able to arrange for HM Revenue Customs to adjust your PAYE coding to reflect this tax relief.
These tax regulations are complex and subject to change. Accordingly you are advised to seek professional advice prior to investing in a VCT. For further information please see the HMRC website.