There is always speculation about who will open offers and how much they will raise, with early indications there will be in the region of £650m of available product this year, around £80m less than was raised last tax year.
The shortfall in capacity of VCTs will pose a problem for many investors. A number of popular VCTs have always filled very quickly – some within as little as 10 days – how quickly will they go now?
What is really interesting, however, is the contrast in supply and demand between the VCT and Enterprise Investment Scheme (EIS) sectors. There is no shortage in supply of open EIS offers or capacity within the products. There are probably double the number of EIS providers, compared with VCTs.
This year, more than ever, advisers and clients need to get ahead with their research and due diligence, as it is likely the best offers will fill well before the end of March.But, in stark contrast to VCTs, there is actually a reduction in demand for EIS from advisers. This is due to the perception of a dramatic increase in EIS risk-profile, an outcome of the shift towards ‘growth capital’ led by the Patient Capital Review.
Therefore, in the EIS space, investing in a provider with proven deal-flow quality and deployment capability is essential.
This year, more than ever, advisers and clients need to get ahead with their research and due diligence, as it is likely the best offers will fill well before the end of March.
So if you’re considering investing in a VCT or EIS what questions should you ask to spot a good manager?
1. What is your process for spotting potential?
EIS and VCTs are designed to encourage investment in SMEs and their tax benefits compensate for the increased risk associated with investing in smaller, less liquid companies. So a good investment manager needs lots of experience and specialist expertise to spot real potential for success in a small business.
There are lots of SMEs looking for funding, so it is vital to be able to sort the wheat from the chaff.
The manager will be following a robust, disciplined and proven investment process founded on relevant experience in the underlying asset class in question, whether that be the Alternative Investment Market Aim) or growth capital, for example.
Often this involves meeting the management team and getting under the bonnet of the business. So the investment team must be well resourced, as this company research can be very time consuming.
Many of the qualifying businesses are now less mature than in previous years due to the seven-year rule and therefore are potentially unable to justify significant initial investment because they are at an earlier stage in their development.
This limits the initial investment ticket size, which in turn puts pressure on managers’ deal flow.
One indication of whether the manager ‘has what it takes’ is by looking for a proven deal flow, with a track record of positive investment outcomes – where the underlying companies have achieved or exceeded market expectations.
That way you’ll know if they can spot a business that has the potential for success, even perhaps to become a future household name.
2. How do you follow the rules?
The rules the manager must adhere to in order to maintain qualifying status (for the tax breaks) are becoming increasingly complicated. It is important to choose an experienced manager who understands the rules to the letter and manages the portfolio accordingly.
The rule changes have had implications on which investee companies will qualify for investment. This has narrowed the potential investment universe, which may have an impact on a manager’s deal flow.
Finding a VCT with an income profile matched to your client’s requirements is crucial.A manager must have the ability to deploy new monies into appropriate qualifying investments that fit the product’s individual investment mandate.
So check whether a manager’s deal flow is appropriate to the level of fundraising they are seeking.
Ensure they are not overstretching themselves and putting themselves under pressure to invest the capital, which may lead to poor investment decisions.
3. How do I know your VCT/EIS is right for me?
Each VCT and EIS will have its individual investment approach, risk and return profile, so will suit different investors according to their needs and their risk appetite.
It is important to consider the investor’s requirements and match their investment objective to the type of product selected. The manager’s strategy and the structure of their product must fit the investor’s requirements.
For example, VCTs are sometimes mistakenly considered as being solely focused on achieving returns through capital growth, but in reality many VCTs deliver regular income via tax-free dividend payments.
Finding a VCT with an income profile matched to your client’s requirements is crucial.
Investors considering a VCT as a supplementary pension planning tool may be better suited to a VCT with a track record of consistent dividend payments, especially the older investor.
Younger investors who are less reliant on regular income might prefer something that offers the opportunity of some special, but less consistent, dividends.
At the end of the day it’s up to the client and their requirements, but looking at a dividend track record of any VCT should help.
Consider the merits
Finally, an experienced manager focused on a specific sector often builds a high level of expertise that can translate into investment success.
Without doubt there have been a number of significant changes to VCT and EIS legislation in the past two years, putting additional pressures on managers and their deal flow, while at the same time demand continues to grow.
Advisers need to carefully consider the merits of a VCT or EIS product and its manager, to ensure both match investor needs.
So knowing how to spot a good VCT or EIS manager is a definite benefit.
Jack Rose is head of tax products at LightTower Partners
