A new Financial Services Authority (FSA) consultation is threatening the tax relief that investors directing their money into venture capital trusts (VCTs) are receiving. GrowthBusiness sits down with Simon Rogerson of Octopus Investments to find out more.

1) How do VCTs work?

VCTs were created by the government in 1995 with tax benefits to encourage investment into UK smaller companies. Today VCTs remain the key provider of finance for SMEs and play an important role in supporting the growth of smaller companies and entrepreneurship in the UK.

The tax incentives are compelling: up-front income tax relief of 30 per cent, plus tax-free dividends and no CGT. Shares need to be held for at least five years.

VCTs are listed on the London Stock Exchange and are highly regulated investments. In addition to being regulated by UK Listing Authority rules, each VCT is also governed by an independent board of directors who hold the VCT manager, such as Octopus, fully accountable on behalf of investors.

2) Why are they a good funding mechanism for fast growth businesses?

VCTs were created specifically with small business funding in mind, and as a result are structured to attract retail investment into that sector by giving tax breaks to investors to help mitigate some of the risks associated with investing into smaller companies. As a result, VCTs help to fill the ‘equity gap’ that many businesses typically face when looking for investment between £250,000 and £5 million.

Since 1995, VCTs have provided £4.6 billion of SME investment – £1 billion in the last three years. They supported more than 1500 companies employing more than 32,000 people between 1998 and 2011.

3) How has Octopus shaped its investments through the system?

Octopus develops its product range in response to its customers’ needs. As awareness of VCTs has grown, we have seen an increasing number of advisers and investors using VCTs and we have expanded our range of VCTs accordingly. The broad choice of VCTs on the market ranges from those that invest into early stage, small businesses to those that invest in those AIM stocks that qualify for VCT tax reliefs.

Each of our families of VCTs has a different investment strategy with the intention of offering investors a choice of benefits across the range of VCTs. Investors have the option of VCTs that offer dynamic growth, or capital preservation and regular dividends, or a blend of growth and consistent dividends.

More on VCTs:

• EIS and VCTs changes get green light from EU
• VCTs – The good, the bad and the ugly
• VCTs produce strong showing in 2011

4) What are the details of the government’s proposed changes?

The FSA’s Consultation Paper CP12-19 proposes to ban the promotion of unregulated collective investment schemes (UCIS) and ‘close substitutes’ to ordinary UK retail investors, and although VCTs are not directly referenced in the Consultation Paper it became clear that the FSA intended to see them included within the scope of the proposal.

It is a curious approach given that the Consultation Paper lays out six criteria which the FSA will use to assess what should be included under the new restrictions, which revolve around consumer protection, and VCTs barely touch any of them.

5) Why might that be detrimental?

If VCTs were to become subject to marketing restrictions, UK SMEs would lose a vital and reliable source of funding at a time when they need it most. Future fundraisings for VCTs would fall by 75 per cent, and VCTs would become unsustainable. The industry would diminish, and hundreds of millions of pounds’ worth of SME investment would be lost.

That hardly tallies with the government’s small business-led growth strategy and its focus on supporting enterprise and innovation in the UK – not to mention what people might make about them making returns and tax breaks from VCTs the preserve of the rich. Why should they be the only group able to access the average 61 per cent tax-free return that VCTs have shown in the last ten years?

6) What would you like to see done?

We’d like to see VCTs taken out of the basket of restricted products the FSA’s Consultation Paper covers. By the FSA’s own criteria, the current proposals make no sense. Unlike other investments the FSA is considering restricting, VCTs already have strong governance, are highly regulated, and operate within a controlled public environment. And they are accountable in a way that the sort of products that should be in the FSA’s sights are not, with their independent boards of directors and independent audits.

The latest update from the FSA says it will reconsider its proposal, but until that is confirmed in April we will keeping fighting the cause. Some 80,000 ordinary retail investors are currently enjoying the benefits of VCTs. We don’t think future potential investors should be denied the right to get involved.