SJP - VCT Guide

19 18 RULES FOR VCTS RULES FOR VCTS Structure of VCTs VCTs are specialist investment companies that list their shares on an EU regulated market. An EU regulated market is one in which the relevant competent authority is recognised as meeting the commission’s definition of a regulated market. There are currently seven recognised regulated markets in the UK, including the London Stock Exchange, EDX, and ICE Futures Europe. All existing VCTs are currently listed on the LSE. Because VCTs are investment companies, they have a closed-ended structure. This enables the VCT fund manager to take a long-term view and invest in less liquid assets than open- ended structures would normally do, as they do not have to worry about selling assets to meet redemptions. The flip side to this is that if demand for their shares is low (because the upfront tax relief is not available when buying VCT shares on the secondary market), then it is likely that they will trade at a discount to their Net Asset Value (NAV). Many VCTs offer to buy back shares from the investors who originally subscribed for them, at a predetermined discount to the NAV (usually between 5% and 10%). This helps address the issue of the lack of liquidity in VCT shares and gives investors a potential exit; however the VCT is not obliged to buy back shares and it is not guaranteed. VCTs will typically allocate a Rules for VCTs Simple VCT Structure Investors Non-qualifying investments Qualifying investments Equity / Debt Equity Venture Capital Trust The investment vehicle (up to 20%* non-qualifying investments allowed) (80%* deployed within 3 years of raise) *For accounting periods beginning before 6 April 2019 this was 70%/30%. In addition, at least 30% of all new funds raised in accounting periods beginning after 5 April 2018 needs to be invested in qualifying holdings within 12 months of the end of the accounting period in which the VCT issues its shares. X budget for buy backs, and may suspend the service if the budget is exceeded. As investment companies, VCTs also have an independent board of directors who are responsible for looking after the VCT’s interests. Investors are shareholders of the VCT itself (not customers of the fund management company as is the case with open-ended funds) and therefore, in theory, they have a say on how the company is run in accordance with their voting rights and company law. Unlike open-ended funds, VCTs can use gearing (borrowing money to invest), which can magnify both gains and losses. However, the use of gearing is rare. VCTs can also retain some of their profits and pay them out later, which can allow VCTs to “smooth” dividend income. Fundraising Bearing in mind the closed-ended structure of VCTs, there are several different types of fundraising that VCTs might engage in. 1. A brand new VCT issuing shares for the very first time. There is no existing portfolio for investors to buy into. 2. A new share class in an existing VCT that will invest in a new portfolio of investments that will be kept separate from the existing portfolio. The investor will only enjoy returns from the assets allocated to that share class. The benefit over a new VCT is that the VCT’s performance thus far can be assessed (although the new share class investors won’t share in the performance of other VCT share classes, unless they already have an existing holding in the other class or classes.) and the VCT’s costs can be spread across a larger asset base. 3. Top-up to an existing share class - Investors purchase shares that give them exposure to an existing pool of assets and can immediately start earning dividend income if income is available. The top-up will also spread the VCT’s costs across a larger asset base. VCTs do not necessarily raise new money every year, and some VCT fundraises can be relatively small and completed quickly. OPEN VCTS INVESTMENT METRICS There is a diverse range of sizes among VCT investments, as shown by the following target fundraises taken from MICAP, in relation to the 2018/19 tax year fundraising period. The smallest fundraising target is £5,000,000, which is over twenty times smaller than the largest. It is difficult to plot a correlation between a VCT’s target fundraise and other characteristics as, the varying fundraising capabilities of the managers must be taken into account. Typically, over three quarters of open VCTs do not have a sector bias and invest in General Enterprise, although there are VCTs that focus on Industry & Infrastructure and Pharmaceuticals & Biotechnology. OPEN VCTS AVERAGE MODE MIN MEDIAN MAX TARGET DIVIDEND 4.59% 5.00% 3.00% 5.00% 5.50% MINIMUM SUBSCRIPTION £4,300 £5,000 £2,000 £5,000 £6,000 TARGET FUNDRAISE £23,015,000 £15,000,000 £5,000,000 £15,000,000 £120,000,000 DIVERSIFICATION 40 30 9 40 80 SOURCE: MICAP (AT 19 FEBRUARY 2019)