Venture Capital Trusts have become a key source of funding for UK start-ups. VCTs currently manage £6.1 billion worth of investment in UK start-ups through around 80 funds co-owning over a thousand companies, according to the Venture Capital Trust Association.
What are Venture Capital Trusts?
A VCT is a company whose shares trade on the stock market and aims to make money by investing in other companies with the potential for rapid growth. As well as providing businesses with capital, a VCT will often provide strategic guidance and business advice.
VCTs were introduced in 1995, designed to encourage investment into small UK businesses by incentivising investors with tax relief.
Andrew Wolfson, CEO of market leader Pembroke, admits that in the early days, VCTs were put together by accountants primarily driven by their tax advantages. Since then, he says, the parameters of what VCTs are allowed to invest in have changed.
“The potential for capital returns have improved significantly because of what VCTs are now allowed to invest in,” says Wolfson.
For more than two decades, VCTs have created jobs, encouraged innovation, and helped stimulate the UK economy.
Nearly £12 billion has been invested through VCTs since 1995, with £1.1 billion worth of investment being raised in 2021-22 alone.
VCTs mostly invest in fast-growth businesses in a variety of sectors, from early-stage tech companies to high-end niche manufacturers, retailers, clothing brands and others.
Some VCT-backed companies have become household names, including Zoopla, Gousto, Secret Escapes, Virgin Wines and Graze. Brands currently backed by VCTs include jewellery brand Monica Vinader and food subscription service Oddbox.
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Venture capital trusts in the UK
VCTs differ according to their investment focus:
- Generalist VCTs invest in a wide range of small, usually unquoted companies in different sectors – from retail to healthcare and technology. The idea is to diminish risk by diversifying, so if one sector suffers setbacks, another might shine. Around three-quarters of all VCTs belong in this category. “We think being a generalist VCT is a good place to be,” says Wolfson. “It doesn’t limit us to having to be in one sector all the time, we can move around from year to year.”
- AIM VCTs invest in new shares issued by AIM-quoted companies. The Alternative Index Market (AIM) was set up by the London Stock Exchange, again in 1995, to provide a market for companies which do not wish to – or cannot – meet the more demanding and expensive listing requirements of the main stock market. These are not necessarily small or startup companies, although many will be.
- Specialist VCTs invest in specific industry sectors such as energy, infrastructure, or biotechnology. Octopus Titan VCT, for instance, focuses on tech-enabled businesses with high growth potential, whereas funds like Pembroke VCT specialise more in consumer-driven companies. Concentrating on a single sector typically involves more specific investment risk, but it could also offer higher returns if the chosen sector does particularly well.
What kinds of businesses can raise money through VCT?
HMRC has strict criteria a company must satisfy to qualify for VCT funding:
- It must carry out a ‘qualifying trade’. Most trades are included; the main exclusions are businesses HMRC doesn’t believe to be in need of extra support, such as land dealing, financial activities, forestry, farming, running hotels and energy generation
- It must be relatively small – typically with gross assets of £15 million or less and fewer than 250 full-time employees
- It must be relatively young – usually less than seven years old
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How much can my company raise through a VCT?
A VCT can invest up to 15 per cent of its fundraise in a single company. Each company is allowed to receive up to £5 million of VCT or other tax-efficient funding in any 12-month period, with a cap of £12 million over its lifetime.
To support the tech sector, the Government relaxed VCT funding rules for “knowledge-intensive companies”, which can have up to 500 employees, up to 12 years in which to receive their initial VCT funding and a more generous lifetime investment cap of £20 million.
Venture capital trust tax relief
When VCTs are bought at launch, or during subsequent share class issues, investors receive up to 30 per cent tax relief on their VCT subscriptions of up to a maximum of £200,000, subject to holding the investments for a minimum of five years.
Dividends are tax free
Contrary to popular perception, investing in a VCT is not just about long-term growth but they also pay dividends.
Most VCTs target dividend payments of around 5 per cent and are not subject to income tax. A dividend yield of 5 per cent is equivalent to a taxable yield of around 8 per cent for an additional-rate taxpayer.
This benefit will become even more attractive when the general tax-free dividend allowance is halved in April 2023 to £1,000, and again to £500 from April 2024.
Data from Wealth Club, published in the Financial Times, showed that the average dividend yield was 7 per cent across VCTs in the year to the end of September 2022, with a range of 0 to 17 per cent.
No Capital Gains Tax
Any capital gains are also free of Capital Gains Tax (CGT).
VCTs can complement other long-terms investments, such as pensions and ISAs, as well as help to diversify an investment portfolio.
Venture capital trust shares
Once shares are listed on the London Stock Exchange, there is no tax relief on buying VCT shares. However, any gains are free of CGT and, as we have seen, no tax is payable on dividends.
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