Friday Highlight  

VCT rules to bring more change in approach to raising money

VCT rules to bring more change in approach to raising money

The current tax year looks to be another strong one for venture capital trusts (VCTs) after a bumper 2018/19 that saw the tax-efficient vehicles raise a record £731m for small UK businesses.

As it stands, there are 17 products seeking approximately £500m from investors to invest in.

Whether or not this figure will be raised in full or even exceeded, such ambition is a strong indicator for both the VCT sector and the UK as a whole.

It not only means that the products are being used for their intended purpose – supporting the next wave of British start-ups – but it also shows strong confidence the UK economy in spite of Brexit fears.

However, with regulators tightening the rules governing VCTs considerably in recent years, these lofty cash targets also raise concerns.

With fewer firms qualifying for VCT investment and products facing stricter limits on the cash they can hold, a record amount of client money is now chasing a shrinking pool of potential deals, particularly if VCTs are competing in similar sectors. 

Fundamentally, we believe that it has never been more critical for VCT managers to ensure they have a clear pipeline of excellent investment ideas before they raise money so they are ready to deploy that cash sooner and investors can begin to benefit from the off. 

Shifting landscape

Changes to the rules governing VCTs have arrived in two waves over the past five years. 

Firstly, in 2015, the government limited the maximum amount a VCT-qualifying company can receive over its lifetime to £12m or £20m for knowledge-intensive start-ups.

It also limited investment to businesses that have made their first commercial sale in the past seven years (or ten years for ‘knowledge-intensive’ firms) and banned investments into management buyouts and acquisitions.

Following this, several critical changes to the rules governing VCT cash allocation were unveiled in the 2017 Finance Bill.

Notably, from the current tax year, 80 per cent - rather than 70 per cent - of VCT funds have to be invested in qualifying companies, and 30 per cent of funds must be allocated within the first accounting period following fundraising.

The raft of changes was designed to achieve several clear aims.

First, they ensure that VCTs provide genuine risk capital to British-based growth businesses.

Second, they lead managers to give money to an adequate spread of start-ups (granting investors additional diversification benefits along the way).

Finally, they prevent VCTs from holding too much uninvested cash, where it incurs punitive management fees and cannot be used to advance Britain’s entrepreneurial spirit.

These are all admirable aims that steer VCTs back to their original purpose and force the industry as a whole to check itself.

However, a potential consequence of legislating the speedier investment of larger sums of cash into a more limited pool of investments is that an increasing amount of competition will arise for each deal.