By Rhodri Whitlock, assurance and advisory partner, head of financial services and asset management, Crowe UK
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 struggle 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 investors’ 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.
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 withdraws 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.
This piece has been published as part of the first Adviser’s Guide to Venture Capital Trusts. For the full guide go to intelligent-partnership.com/reports/an-advisers-guide-to-vct