VCTs are becoming increasingly popular. The sector raised £685mn in the tax year 2020-21, which is an increase of 11 per cent on the previous year and double what it was a decade ago, according to data from the Association of Investment Companies.
Part of the attraction for investors is the opportunity to support early-stage, high-growth companies – a survey by the AIC earlier this year showed 84 per cent of investors in VCTs stated it was important to them to help UK enterprise and that by using VCTs they would achieve this.
The investors also felt the Covid-19 pandemic made supporting smaller UK businesses more important.
In addition to their support of early-stage businesses, a key appeal for VCT investors was the tax breaks, which include income tax relief up to 30 per cent of the investment amount, as well as zero capital gains tax and tax-free dividends.
The rationale for this favourable tax framework is that it incentivises investment in riskier early-stage businesses.
The government’s planned dividend tax increase of 1.25 percentage points from April 2022 could drive yet more investors’ money to VCTs.
Research released in September from Wealth Club, a tax-efficient investment platform, showed £61mn had been invested in VCTs in August, four times the amount invested in the equivalent period last year.
VCTs have not only provided essential capital – unforthcoming from other sources – to UK enterprise, but also provided a way for investors to access some of the most exciting and innovative companies in the UK. An important role of a VCT manager is to find the very best early-stage growth companies to invest in.
Once in its portfolio, the VCT can help support the company’s growth, maximising its performance and hence eventual return to the underlying VCT investors.
When a portfolio company is successfully sold, cash is paid to the VCT by way of special dividends.
Charges
As with any such investment, there are some fees and charges involved. Typically, this is a management fee of 2 per cent for investors, though some VCTs also charge their underlying portfolio companies fees for costs such as supplying support, legal fees and due diligence fees.
As well as the management charge, VCTs also charge a performance fee that is typically 20 per cent of profits. Some only charge this fee on net realised investment gains, which includes making up any losses in the portfolio.
A key advantage to investing in a VCT is that the investor gets immediate access to its entire portfolio, including existing investee companies as well as those yet to be added. This provides diversification, which is considered significantly lower risk than investing directly in individual companies.
VCT fundraising is expected to be higher than usual this year, and several popular VCTs have already opened their offers, filled to capacity, and closed again. If investors do not move quickly, they may lose the opportunity to invest in the top-performing VCTs.
Raising money
How does a VCT decide how much money to raise from investors?
In order to raise cash to invest in new and follow-on opportunities, a VCT launches an ‘open offer’ or fundraise, the size of which is governed by the investment opportunities the VCT believes it has.
We believe it is important not to deploy too much cash into a growth business at an early stage.Once the funds have been raised, a VCT must adhere to strict rules that set out how long it takes to invest the money, as well as the age and type of businesses it may invest in.
We aim only to raise an amount that we believe we can deploy over the following 12 months, which is well within the rules. As a result of this approach, our investors are not paying us a management fee to hold cash.
The aim of a VCT is to support the growth of its portfolio companies and to help maximise their potential for the benefit of the shareholders in the VCT.
We believe it is important not to deploy too much cash into a growth business at an early stage. Instead, we use a stepping-stone investment approach, preferring to invest £1mn to £2mn into a company at a time, allowing the management team to grow the business before investing more as they scale.
When VCTs were introduced in 1995, they were designed to encourage investment into new UK businesses. Since then, they have not only provided essential capital – unforthcoming from other sources – to UK enterprise, but also provided a way for investors to access some of the most exciting and innovative companies in the UK.
In addition to the benefits they bring to individual early-stage businesses, VCTs have also helped support economic growth through tax receipts and increased employment.
By way of example, Pembroke’s current portfolio of companies has 1,800 staff; more than double from the point of our first investment. This is in addition to Five Guys, which itself has grown headcount by more than 7,000 since Pembroke first invested in 2013.
We believe that the VCT market will continue to grow and will remain a vital means by which the investing public can support our growing UK entrepreneurial culture.
Simon Porter is investment director at Pembroke VCT
