It’s been quite a time for the Venture Capital Trust (VCT) industry, which turned 20 earlier this year. Another outstanding year of fundraising (the fourth highest ever total, according to the Association of Investment Companies) has been followed by perhaps the most significant raft of changes to VCT legislation yet.

Here’s a quick breakdown of the main announcements affecting VCTs:

• VCT money can no longer be used to fund management buyouts and acquisitions.
• The maximum amount of VCT funding a company can receive over its lifetime has been capped at £12 million, or £20 million for ‘knowledge-intensive’ companies.
• A timeframe in which companies can be eligible for their first VCT funding has also been introduced. Firms must have made their first commercial sale in the past seven years, or ten years for knowledge-intensive companies, to be VCT-qualifying.

How much impact will these changes have?

While you could be forgiven for thinking that VCTs have been put under increasing – and perhaps unfair – scrutiny recently, nothing could be further from the truth. First, VCT rule changes are nothing new.

Over the past 20 years, successive governments have made legislative tweaks designed to ensure funding remains focused where needed, and have continued to offer tax incentives  namely to help compensate for the higher risks involved in investing in smaller companies. VCTs, after all, must continue to fulfil their policy objectives.

Second, the changes are not unreasonable. The restriction on VCT money being used to fund management buyouts and acquisitions is part of European Union (EU) legislation.

>See also: Venture capital – Evaluating the risk profile of investments

It wants ‘state aided’ money – such as investments that qualify for tax reliefs – to be used only to fund new growth rather than to acquire existing shares or businesses. Therefore, Government compliance in this area hardly came as a shock, indeed it is a refinement of existing legislation introduced in 2012.

Third, although the cap on fundraising is an additional constraint, it should also be put into perspective. VCTs have never been able to ‘follow their money’ indefinitely.

There comes a point at which every successful VCT-qualifying company should be able to raise funds from other sources, at which point it should no longer find VCT funding necessary. We are supportive of changes that ensure funding is directed at those small companies, and sectors, most in need of support.

Fourth, while the new investment eligibility timeframe will impact those companies that take longer than usual to expand, we do not expect it to be significantly detrimental. In fact, the Government has carved out an exception for companies looking to raise a large amount of capital, relative to their historic revenues, in order to allow VCT money to be used for significant expansion of an older business.

Where does this leave VCT investors?

VCT investors are unlikely to feel too much of an impact, as the legislation does not materially affect the way VCTs work. It will only help to ensure that high-growth and innovative businesses continue to benefit from investment.

A VCT won’t look any different to investors after the changes come into effect and, crucially, the new rules won’t apply to investments already made. Investors will still hold portfolios of what they hope will prove to be well-performing businesses that meet the VCT eligibility criteria.

Business as usual

Following the changes to pension’s legislation over the last year which further restrict the amount individuals can invest into their pensions, there has been increased interest, for those willing to take on the higher level of risks associated, in investing in VCTs.

As the largest VCT provider in the UK¹, Octopus is responding to this growing demand from financial advisers and their investors. We offer a range of VCTs which target different investment objectives and invest in different types of smaller companies; and two of our VCTs have recently launched new share offers in response to growing demand.

>Related: Pulling the right strings – a guide to SME finance

Octopus Titan VCT has launched a new share offer intending to raise £50 million. This VCT offers investors access to a portfolio of around 50 early-stage high growth companies, for example the online furniture business Swoon Editions, and other well-known names including members-only holiday company Secret Escapes.

We also intend to raise an additional £30 million into Octopus Apollo VCT. Apollo has a portfolio of around 25 companies. It aims to invest in more established, profitable businesses with attractive positions in their respective markets, such as support services firm SCM World and Countrywide Healthcare Supplies.

Investors need to bear in mind that investing in VCTs will place their investment at risk. Also, tax treatment on these investments depends on personal circumstances and may change in the future, while any tax reliefs offered are dependent on the VCT maintaining its qualifying status. Furthermore, VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange, and they may also be harder to sell.

VCTs still have a bright future

The VCT-qualifying universe might now be slightly smaller, but it’s still pretty vast, with a great number of companies in need of financial support. And that’s where VCTs come in.

Regardless of the recent rule changes, VCTs are still recognised as being a vital source of funding for companies that make a significant contribution to our economy and generate thousands of jobs. With investor demand showing no signs of abating I have little doubt that the industry will keep finding innovative and dynamic smaller companies to invest in.

For more information about Octopus VCTs, please visit octopusinvestments.com or call 0800 316 2295.

Further reading: Show SME the money – funding options explained

For journalists in their professional capacity only. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. This advertisement is not a prospectus. Investors should only subscribe for shares based on information in the prospectus, which can be obtained from octopusinvestments.com. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 3942880. Issued: December 2015.