VCT guide

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 income 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 30% and 70% respectively. In addition, at least 30% of all new funds raised in accounting periods beginning after 5 April 2018 need 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. Venture Capital Trusts (VCTs) have been with us since 1995 and provide ‘tax advantaged’ long-term finance (‘patient capital’) to small businesses, a key segment of the UK economy that often struggles to raise development, or scale-up capital from other sources. While VCT investment cannot guarantee a business’ success, the funding they provide has contributed to the success of many household names as well as the innovation of less familiar names but nevertheless key to maintaining UK Plc’s reputation as a key innovation hub. VCTs do not just invest then wait for returns. Through their investment managers, many VCTs engage directly with the investee companies acting as mentor and offering advice on a range of strategic and development issues. Research undertaken by the AIC identified that “66% of companies currently within the sector’s portfolio have benefited from a representative of the fund joining their board”. The success of VCTs has attracted attention and 2018 saw significant changes to the VCT regulations which narrowed the range of investment types that could be made, revised certain investment qualifying criteria and amplified that, to be eligible for the attractive tax reliefs VCTs afford, the VCTs must be providing genuine risk capital. The tightening of the qualifying criteria can make it challenging when evaluating investment opportunities and requires focused due diligence on areas such as the date of first commercial sale. So what is the appeal of VCTs? Typically, investing in early stage high growth businesses is a risky activity. A view reinforced by the recent rule revisions. Investing in a VCT lowers the risk by diversifying the risk across a portfolio of companies and the investor benefits from the expertise of an experienced professional investment manager. However, it does remain the case that the investments are in small, privately owned and young companies which may or may not succeed. They can be a much riskier investment than investing in larger, more established companies. Ultimately this is an equity investment and an investor’s money is at risk. In recognition of this risk/reward dynamic the government offers tax incentives to retail investors to place funds with VCTs to compensate for the higher risks of investing in small companies. Non-compliance If the VCT itself doesn’t comply with a range of conditions, both the VCT and the investors lose all the tax benefits. There have been a small number of instances where VCT status has been withdrawn over the years. There can be some latitude where the breach was unintentional and outside of the control of the VCT but it is essential that VCTs and their managers remain diligent and vigilant. THE IMPORTANT ROLE OF VCTs Thought Leadership ASSURANCE & ADVISORY PARTNER HEAD OF FINANCIAL SERVICES AND ASSET MANAGEMENT, CROWE UK RHODRI WHITLOCK 14 RISKS AND REWARDS