A VCT, or venture capital trust, is a listed company that invests in a portfolio of smaller companies that are either unquoted or listed on small company stock exchanges such as the Alternative Investment Market of the London Stock Exchange.
VCTs were introduced by the government in 1995 to encourage investment into smaller companies in the early stages of their development. The small, private companies that VCTs invest in are looking for development or expansion capital.
To address the increased risk associated to investing in smaller companies, investors who hold shares in VCTs for a minimum five-year holding period receive three forms of tax relief.
1) Investors receive up to 30 per cent income tax relief on any investment made at launch up to £200,000, provided they pay at least that much income tax. So an investment of £20,000 would give investors £6,000 back upfront, either through their tax return or by changing their PAYE code.
2) There is no capital gains tax. Investors are not taxed for any capital growth achieved through the VCT as they are entitled to tax-free capital gains on the disposal of the shares.
3) Any dividends that the VCTs distribute - many VCTs produce these regularly - are tax-free, unlike dividends on regular shares.
Tax reliefs are only available to people aged 18 years or more who are UK income tax payers, and are only available if the trust maintains VCT status, according to the AIC.
In terms of the criteria of the underlying investments, to be a qualifying business for VCT investment a company must:
• Have an enterprise value or market capitalisation of £15m or less (up from £7m prior to April 2012)
• Employ less than 250 staff (up from 50 prior to April 2012)
• Be a privately-owned company or be traded on a small-cap exchange such as Aim or ICAP Securities & Derivatives Exchange (formerly Plus).
VCTs have been hit with several rule changes over the last few years. For example, from 2010 VCTs have the ability to invest in companies based outside of the UK.
The amount a VCT can invest in loans to investee companies as opposed to equity also changed: for older VCT funds the maximum was 70 per cent, but it is now 30 per cent.
According to the AIC, VCTs fall into three broad sectors:
1) Generalist, which covers private equity (including ‘development capital’).
3) Specialist sectors, for example technology or healthcare.
At the time of writing, the VCT sector has assets under management of £2.8bn, according to the AIC. There are 103 VCTs managed by 29 investment managers, with a further two VCTs ‘self managed’ by their board of directors.