Venture Capital Trusts (VCTs) are 20 years old. Since their launch, the internet has gone from blinking infant to dominant adult. Over the same period, VCTs have gone from 12 funds and £160m in 1995/96, to 94 funds with a record £435m in 2014/15.
New fundraising has been rising steadily from £267m in 2012 to £450m in 2016. In part, this is down to long-term performance. For a number of years, the best VCTs have delivered tax-free yields of 6 per cent to 8 per cent, while maintaining capital value; comparing favourably to headline interest rates on long-term savings and a more volatile stock market performance. More recently, the changes to pension rules, caps applied to contributions and latterly the freedom to access your pension fund have seen an increased search for alternative investments.
With all these changes to the economic backdrop, it is not surprising that the rules surrounding VCT investments have also undergone a number of adjustments. Having been announced in July 2015, the latest set came into force last November. Based on these, is there anything in the latest tranche of rule changes that investors should note?
The revised rules are designed to only allow investment in younger companies seeking funds to grow instead of those more developed companies whose growth is blocked or constrained by its existing shareholders. The biggest change is the age restriction. Now, companies, or their trade, have to be less than seven years old (with some exceptions, still to be clarified as these are part of the draft guidance). Additionally, VCTs are no longer allowed to hold non-qualifying investments, other than for liquidity purposes prior to them being made in qualifying investments.
Following the July 2015 Budget, there was some uncertainty as to when the rules would apply – guidance to the VCTs was a little unclear, but suggested that any investments would have to comply with the new rules – which had not yet been written. Not unsurprisingly, this meant that investment rates last year were lower than had been expected – as it turned out, investment was about 30 per cent lower than the previous year, despite funds raised being broadly constant at £420m to £430m.
The other difference from previous changes was their retrospective nature. The new rules apply to money that had previously been raised but not yet invested and they also apply to all existing portfolio businesses as if they had been made under the new rules.
In this latter case this means that there is a risk some businesses that require further funding from the VCTs will not be able to access it. The impact for investors of lower investment rates in 2015 was principally that the mix of VCT choice in the 2015/16 tax year was a little different. However, this did not dampen demand; in fact, the main impact was less diversification available, with one-third of funds raised going to one manager.
In the short term, there has been more of a struggle to implement the new rules. Guidance on how to operate within them did not appear until early May and then only in draft form, six months after the introduction of the Finance Bill, and there has been a noticeable slowing of advanced assurance. As a result, the lower investment rates experienced in 2015 have been further suppressed. The first quarter of 2016 was particularly affected, with rates 85 per cent down on the previous year. It is to be hoped, that as with any transitional arrangement, this will eventually work its way through the system, but there has to be some risk that this puts unnecessary pressure on VCTs nearing the end of their three year investment periods. There is also a likelihood that this could impact the number and range of VCTs seeking to raise funds in the current tax year.