How to invest in smaller companies
Investing at an early stage is key to achieving the greatest growth, as this often occurs at the fastest rate before a company reaches IPO or is sold. However, this has typically been the realm of venture capital firms, or private equity investors.
It is near impossible for individual investors to source the diamonds from the coal. With so many fledgling companies out there, it is not easy to spot those worth exploring further, let alone to undertake detailed research into their potential risks and rewards.
Access to these types of investments is limited, however, certain types of investments offer a gateway into this world. Some of these also come with tax benefits to counterbalance the higher risks involved.
Two great ways clients can access smaller companies are through Venture Capital Trusts (VCTs) or supporting a company that qualifies for the Enterprise Investment Scheme (EIS).
VCTs are pooled investments comprising a diversified portfolio of early-stage companies at different positions on the growth curve. To encourage support of these young businesses, a range of tax benefits is offered, with relief on investments up to £200,000 each tax year.
VCT investors can claim up to 30% upfront income tax relief, provided they hold the investment for five years, with no tax to pay on any dividends received or on any capital growth.
Another option for experienced investors is a portfolio of EIS-qualifying investments. Up to 30% income tax relief is available on an investment, provided investors hold shares for at least three years and the company remains EIS-qualifying. Because of the risks involved, investors can also benefit from tax-free growth, loss relief, capital gains tax deferral and relief from inheritance tax.
Risk and reward
Small, early-stage companies have the potential to grow significantly.
Where tax benefits exist, however, these tend to compensate for some of the additional risks taken by investing in small companies.
The value of the investments discussed, and any income from them, can fall as well as rise. Investors may not get back the full amount they invest.
VCT shares and the shares of smaller companies are by their nature high risk, their share price may be volatile and they may be hard to sell.
Tax treatment depends on individual circumstances and tax rules may change in the future. Tax relief depends on portfolio companies and VCTs maintaining their qualifying status. Relief from inheritance tax is assessed by HMRC on a case-by-case basis when an estate makes a claim.
Where to learn more
If you’d like to learn more about the types of clients who could benefit from VCTs or EIS, please watch the Tax Planning Show on demand here. You’ll receive 90 minutes of CPD too.