Your Guide to Venture Capital Trusts (VCTs)

This article is not an investment recommendation and does not constitute investment advice.

What are Venture Capital Trusts (VCTs)?

Venture Capital Trusts (VCTs) are listed, closed-ended, tax-efficient investment vehicles, designed to give investors exposure to young, trading businesses in the UK, which meet certain qualifying criteria, to support the early stages of their growth. 

The UK Government introduced VCTs in 1995 as a way of encouraging investment in Britain’s entrepreneurial businesses and in the years since, they have been instrumental in building and growing small businesses that underpin the UK economy. 

How do VCTs work?

VCTs are similar to investment trusts. They are listed on the London Stock Exchange and raise money from investors who receive shares in the trust with the shares having significant tax benefits for the investor. In turn, VCTs use the money from their investors to invest in VCT-qualifying companies. 

VCT-qualifying companies must meet a number of criteria to receive investment. These include that they must: 

• • • have no more than £15mn in gross assets at the time of investment, and £16mn afterwards 
    • be no older than seven years (ten years for knowledge intensive businesses)
    • have fewer than 250 employees at the time of investment (or fewer than 500 for a ‘knowledge-intensive’ company) 
    • receive investment of no more than £5mn per year, per group from UK Government tax-related investment schemes (i.e. a combination of the Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts)
    • raise no more than £12mn (£20mn if a knowledge intensive company) in total over its lifetime from a combination of the EIS, SEIS and Venture Capital Trusts 
    • use the money for growth and development purposes only 
      

What does a VCT invest in?

A VCT invests in small or early-stage businesses active in a wide range of sectors. To receive VCT investment a company must be qualifying (see above).  

VCT investees are typically privately owned although they can also invest in companies that are listed on the Alternative Investment Market (AIM) of the London Stock Exchange.  

Why invest in VCTs?

There are a number of reasons why people invest in VCTs but some of the benefits include: 

• • • Income tax relief of 30% of the subscription amount invested in new shares provided that the shares are held for at least five years
    • Tax-free dividends 
    • Tax-free capital gains on the sale of shares (after five years of the new shares being issued)

Who are VCTs for?

VCTs are high-risk in nature and as such are typically only suitable for people who hold other significant investments. VCTs are often suitable for people who have already made use of their maximum pension contributions, who have used their annual ISA allowance and who have used up their annual capital gains tax allowance.  

VCTs tend to be suitable for very high earners and those who pay income tax. An investment in a VCT can act as a helpful diversifier for an investor who wants to broaden their investments further without worsening their capital gains tax position. 

What are the VCT investment rules and limits? 

Investors must be at least 18 years of age. The tax reliefs are only available for the first £200,000 of VCT shares acquired in any tax year. 

This enables investors to receive income tax relief at 30% of the amount invested. In order to retain the income tax relief investors must hold the shares for a period of at least five years. 

A VCT will issue a tax certificate to its investors which enables them to claim the income tax relief. 

What are the risks of investing in a VCT?

Any investment is subject to risks, here we outline some of the risks. Investors should always read a VCT’s prospectus, Key Information Document and other offer information to fully understand the potential risks and rewards associated with a decision to invest in a VCT. 

Loss of capital

The value of a VCT depends on the performance of the underlying assets. The value of the investment and dividend stream from a VCT can rise and fall.  

As their capital is at risk, shareholders may get back less than originally invested, even taking the tax reliefs into account. 

Smaller companies

Investing in smaller companies is considered a high-risk investment. VCTs invest in smaller companies that are usually privately owned. Investments in smaller companies can fall or rise in value much more sharply than shares in larger, more established companies. They also have a higher rate of failure. 

Liquidity

VCT shares can be difficult to sell (and buy) on the secondary market as they are not widely traded. VCT investors can sell their shares on the market the VCT is listed on. Up to 20% of the VCT’s assets may be held in cash, or certain other liquid assets. VCTs have to meet strict criteria on the proportion of qualifying companies held relative to cash and liquid balances.

The Boards of VCTs often offer share buyback schemes to enable divestment, but these are usually at a discount (typically 5%) to the underlying asset value and are not guaranteed. 

Loss of tax reliefs

The tax rules, or their interpretation, may change at any time and these changes could be retrospective. As a result, a failure to meet the qualifying requirements could result in the loss of tax reliefs previously obtained, resulting in adverse tax consequences for investors, including a requirement to repay the income tax relief obtained. 

Investors who dispose of shares within five years of issue will be subject to clawback by HMRC of any income tax reliefs originally claimed on subscription.  

Changes to governmental, economic, fiscal, monetary or political policy 

Any change to governmental, economic, fiscal, monetary or political policy, in particular any changes to taxation, tax reliefs, tax status and other rules or regulations associated with VCTs, could materially affect their performance, the value of and returns from their shares and/or the ability for the VCTs to achieve or maintain VCT status. 

Are there different types of VCT? 

VCTs fall into three broad sectors: 

• • • Generalist – by far the VCT biggest sector, home to VCTs that invest in all kinds of small, unquoted UK companies. 
    • AIM – for VCTs that invest in AIM-quoted companies. 
    • Specialist sectors, for example technology or healthcare.

The Baronsmead VCTs are hybrid VCTs investing in both unquoted and quoted AIM companies.