When they were created in 1995, venture capital trusts (VCTs) were positioned as a way of encouraging investment into small UK growth companies.
With generous tax breaks, they help investors generate a potentially attractive return on capital, while providing much needed capital for small businesses that are looking to grow. Their upfront tax relief of 30 per cent, tax-free dividends and no capital gains tax (CGT) on the proceeds can be a major draw.
For the most part, VCTs have been viewed as investments only for the wealthy who already have large, balanced portfolios, but the minimum investment is often at a level that can make them attractive for those who have money to invest but are not among the super-rich.
Making an investment into venture capital comes with its risks given the focus on small, fledgling companies, so here are our tips for making the right choice.
1. It is right for the client and have they exhausted other investment avenues first? The tax benefits of investing in VCTs are generous and attractive, but if the client does not already have a large investment portfolio, consider if this is the right move. However, if the Isa allowance has been met, the pension has been topped up and there is still a desire to use a tax-efficient investment, this could be another option. Generally speaking, VCTs are better suited to higher-rate taxpayers who have the money to invest.
2. Does the VCT match the client’s attitude to risk? Make no mistake, because of the focus on small businesses, VCTs come with a certain amount of risk that must be taken into account. While the tax relief helps to reduce the overall risk to a certain extent if it fails to generate a decent return, a complete failure from the underlying investment would be unfortunate for an investor with modest means.
3. Align the VCT’s investment strategy with the client’s interests. A VCT can invest in any number of different companies, so it is a good idea to make sure the strategy achieves what the client wants. This means finding out about the companies in which it invests and the overall sector on which it focuses. Again, risk profiles can vary widely among VCTs, so if the client wants one that is a less wild ride, it is necessary to look at the manager’s strategy to make sure it is suitable.
4. Look at the management company’s track record. It goes without saying that some fund managers are better than others, so when an investment is about to be made, it is best to make sure the manager does a good job. It is incredibly difficult to value a VCT in its early stages and predict how it may perform, so it is best to opt for managers that have a reputation for producing for successful results.
5. Take note of the charges. Like any other investment fund, VCTs can come with annual charges and performance fees. Because this sector requires specialist investment management, the fees can actually be much higher than other funds, such as investment trusts and Oeics. Some VCTs also cost more than others, which means the portfolio will have to perform better than cheaper funds in order to generate an attractive return. Performance fees are also a popular feature, which can eat into returns if they are particularly high.
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