Your IndustryOct 15 2015

Changes to VCT rules and impact

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

The changes announced as part of this year’s Budgets relate to the amount invested, age of qualifying companies and use of investment funds.

The maximum amount a venture capital trust-qualifying company can receive over its lifetime has been limited to £12m, or £20m for knowledge intensive companies.

In order to be eligible for VCT investment, companies will normally have to have made their first commercial sale in the past seven years, or ten years for ‘knowledge intensive’ companies.

Also, the EU is keen to ensure that ‘state aided’ money, such as investments that qualify for tax reliefs, should be used where companies require funds for new growth, rather than to acquire existing shares or businesses.

As a result, the 2015 Finance Bill proposes that VCT money can no longer be used to fund management buyouts and acquisitions.

Paul Latham, managing director at Octopus Investments, says these changes do not materially effect the way in which VCTs work – indeed they help to ensure that high-growth and innovative businesses can continue to benefit from VCT investment.

The government launched a consultation on tax-advantaged venture capital schemes back in July 2014, which Mr Latham says he worked on closely with them, so the majority of the proposed changes were in line with expectations.

Mr Latham says: “As the largest provider of VCTs in the UK, we are used to the government making changes to VCT legislation.

“The range of companies that now qualify might be slightly smaller, but there is still a thriving and fertile market full of the type of fast-growing smaller companies that VCT managers like Octopus look for.

“We are satisfied there will continue to be a good pipeline of potential investment opportunities.”

As a result, Mr Latham says the changes to the legislation should have no impact on the investments already made by the VCT, and so there should be no immediate impact on those holding VCTs in their portfolio.

Finance Bill legislation comes into effect with Royal Assent, which at the time this guide was produced was expected this month or November, and managers will be assessing the impact on each of their VCTs at this point, according to managers FTAdviser spoke to.

Chris Hutchinson, manager of the Unicorn Aim VCT, says these proposals have potentially some quite serious implications for the VCT market.

He says: “The proposed changes are therefore likely to put the brakes on VCT fund raising this year, although to what extent remains to be seen.

“At this stage, it would seem unlikely that we will see funds raised this year reach anywhere close to the £429m raised last year, which co-incidentally is the largest amount raised since 2005 to 2006 as demand for VCTs continues to increase with the restrictions to pension allowances and tax relief for high earners forcing advisers and investors to look for alternatives.”

While the ultimate effect of these changes is not yet clear, Hugh Rogers, business development director at Puma Investments, says VCT managers will continue to innovate as they have done in response to previous changes to the industry.

However, he says it does seem clear that the forthcoming legislation will prevent generalist VCTs from funding management buy outs, which were a popular investment theme for many managers.

But Octopus’ Mr Latham says while some managers may need to alter the investment mandate of certain VCTs he is confident there will still be a strong pipeline of investment opportunities for investors.

He says: “At Octopus we do not expect the changes to significantly impact this year’s fundraising.”

In terms of reassessing suitability, Unicorn Aim VCT’s Mr Hutchinson says the changes are likely to alter how many VCTs approach the sourcing and selecting of qualifying investments.

This will likely have a knock on effect to the risk profile and therefore suitability of VCTs, he adds.

As always, Mr Hutchinson says this will vary depending on the specific VCT strategy and indeed on how the rules are interpreted and enforced.

However, at this stage, he says the proposed measures are likely to narrow the potential investment universe quite significantly.

Annabel Brodie-Smith, communications director of the Association of Investment Companies, agrees the rule changes will have an impact on the investments that VCTs make and this could also affect some VCTs’ risk profiles.

Some VCTs will be significantly affected by the rules changes whereas for others the impact will be limited, she notes.

Ms Brodie-Smith says: “VCT are listed companies and the boards of directors and their managers will be considering the impact of the rules on their investment policies.

“When the final rules have been published in the autumn we will hear more from VCTs on the impact of the rule changes. So then, yes, advisers should be able to reassess the suitability of VCTs recommended in the past.”

In terms of the timing of reassessments, Puma’s Mr Rogers points out for the first five years of investing into a VCT, the investment cannot be changed without affecting the initial income tax reliefs.

But he says the performance of the NAV per share and dividends paid should be monitored.

Once held for five years, the shares in a VCT can be sold and reinvested without affecting the initial tax reliefs for investors.

However, as mentioned previously in this guide, Mr Rogers says generalist and Aim VCTs should be looked at with a seven to nine year investment horizon, to allow the underlying companies sufficient time to realise their potential.

If investors wish to exit shares in a generalist or Aim VCT, they need to sell their shares in the secondary market via a stockbroker.

Investors must be aware that the price of VCT shares, set on the London Stock Exchange, often trade at a discount to the NAV per share of the VCT.

The NAV is regularly referred to as the “true” value of the shares if the VCT portfolio were to be liquidated and returned to investors.

The extent of the discount between the NAV per share and the share price varies from manager to manager, as some can buy back their shares in the market to control the level of discount between the NAV per share and the share price.

Mr Rogers says it is therefore crucial for investors to investigate the VCT manager’s buy back policy before putting money with a particular VCT manager.

Limited life VCTs typically offer investors an opportunity to vote on winding up the VCT after the fifth anniversary, which means not having to worry about selling their shares in the VCT on the secondary market.

Mr Rogers says it also should provide an exit for investors at the prevailing NAV per share or very close to it.