VCTs (venture capital trusts) and EISs (enterprise investment schemes) are becoming an increasingly important part of a high-net worth (HNW) individual’s investment portfolio. This is mainly due to the following reasons: the attractive tax advantages, the investment diversity on offer and the changes in pension legislation.
The changes in pension legislation have been designed to reduce the maximum amount that can be saved in a pension, before significant taxes are applied, otherwise known as the lifetime allowance. An increasing number of HNW individuals expect to surpass the new lifetime allowance in their pension pots, which means that to lower their tax liabilities, alternative investment vehicles such as a VCT and EIS can be used.
VCTs are often thought of as high-risk investments, although this is not always the case nowadays. For a long time, the VCT market has offered many types of risk and return, ranging from high-risk types such as those that operate as specialist venture capitalists, sometimes specialising in one particular sector, to more generalist offerings including asset-backed and a wider range of companies in different sectors and stages of development.
These include top-up offers, whereby investors have access to existing investments and are offered regular dividend payments almost immediately. Companies listed, or about to become listed, on the Alternative Investment Market can be invested in via AIM VCTs. On the whole, EIS offerings are more risky. Historically, there is less diversification in institutional offerings in an EIS. However, there are EIS providers that now offer asset-backed as well as venture capital and private equity opportunities too.
VCTs and EISs offer income tax relief to investors, which means the state is effectively funding partial investments. Following pressure from Brussels and the European directives on state aid, new rules and guidelines were introduced last year to cut back on this de facto subsidy. The biggest change concerns the age of the company receiving the investment. The company cannot now be more than seven years old. This has ruled out investment in management buyouts of older companies, where in most cases the founding family shareholders sell their business to existing management and VCT schemes help finance the buyouts.
There is a perception of lower risk around this style of investing because there is an existing business, with revenues and often a long trading history and stable management. Some would argue that the changes are very healthy because the point of these investments is to stimulate growth in small companies with an accompanying creation of jobs. This has not always materialised with management buyouts.
The net result is that there are far less VCT offerings this year. At present, there are about £325m, whereas in previous years the figure was closer to £450m. There are no available figures for EIS because the market is so diverse. It ranges from large retail offerings from venture capital houses to the thousands of EIS companies being created by entrepreneurs every day up and down the UK whose business ideas are best suited to EIS rules with the accompanying tax reliefs. Since VCTs were first introduced in 1995 there have been many rule changes, mostly concerning the allowable underlying investments. To date, they have been fair and there have been no retrospective rule changes, which is something to be applauded.