VCTs can help the UK’s productivity problem 

In the “mini” Budget earlier this month, the chancellor signalled the sunset clause that would stop the tax breaks available to VCT investors will be extended beyond 2025.

VCTs invest in higher risk unquoted companies and come with a 30 per cent tax relief if the investments are held for five years, with any dividends earned also tax free.

The sunset clause was created as part of European Union state aid, and rules that VCT relief is only available to subscribers in the VCT for shares issued before April 6, 2025.

Head of tax advantaged strategies at St James’s Place, Luke Barnett, said: "[The point of these tax breaks] is that they help to facilitate investment into early stage companies who would probably struggle to get that money otherwise, at a point before they can access private equity funding or take part in an IPO.”

The UK has a long-term productivity problem, and the key to solving that is investingAlex Davies, Wealth Club

Furthermore, he said, this money will mean startups are able to invest not just in creating jobs, but in research and development.

“The clarity and certainty [of the government’s commitment to VCTs] will bring both to entrepreneurs and investors will help to support research and development, job creation and ultimately growth within the UK economy.”

Turning off the taps of VCT funding when the economy is most in need would have been “disastrous” for British business, said chief executive of Wealth Club, Alex Davies.

“The UK has a long-term productivity problem, and the key to solving that is investing in business and technologies that can deliver products and services more efficiently and more profitably. 

“These are exactly the kinds of businesses that VCTs support,” he said.

Research from Wealth Club in July showed that some £990mn in start-up funding could be put at risk if VCTs were shuttered.

A survey of 1,309 VCT investors, undertaken by Wealth Club between July 3 and 8 this year, showed that 90 per cent of respondents would either stop or be less likely to continue investing in VCTs if the income tax relief was reduced to 20 per cent.

An economic downturn provides good conditions for start-ups, said Will Fraser-Allen, managing partner at Albion Capital.

“In a recession you see a lot of good businesses set up, as the large corporates downsize their workforces you end up with a lot of good talent…these people are not necessarily going to jump into another corporate environment so that gives rise to people wanting to set up their own businesses.”

Pressure growing

Pressure had previously been growing on the government to confirm its stance on VCTs, warning that any further delay could impact the level of funds invested into the vehicles.

In his "mini" Budget, chancellor Kwasi Kwarteng said the government is supporting companies to raise money and attract talent, and remains supportive of enterprise investment schemes (EIS) and VCTs.

I would expect there to be a smaller market this yearWill Fraser-Allen, Albion Capital

The Treasury also announced that it will increase the generosity and availability of the seed enterprise investment scheme.

From April next year, the amount companies can raise through SEIS will rise from £150,000 to £250,000, and the annual investor limit will be doubled to £200,000.

The gross asset limit will rise to £350,000, and the age limit extended from two to three years.

Investing boom

Data from the VCTA, which represents 90 per cent of the industry, showed that over the last financial year, VCTA-backed businesses delivered £12.5bn in revenues, generating £3bn in exports. 

Since 2018, VCTs have made 1,000 investments in 530 companies, totalling £1.7bn, according to the Association for Investment Companies.

Some 55 per cent of this was in the form of follow-up investments, those to companies already in a VCT’s portfolio.

VCTs invest in companies at an early stage, meaning they require many years of funding before they make a profit, and usually provide multiple rounds of investment over a number of years.

“Of course there is no certainty for an entrepreneur that a VCT will follow on with their investment, however with the sunset clause looming, this uncertainty is even more acute and might make entrepreneurs less ambitious in their long term plans,” Davies said before the extension was announced.

In total, companies backed by VCTs since 2018 employ over 14,000 staff, and 14 per cent of these have female founders.

One benefit raised by a number of VCT investors and managers is the impact these companies have on the level of research and development in the UK.

Nearly four-fifths (79 per cent) of VCTs invest in R&D, with the amount put into the area hitting hitting £2.4mn per company.

The investment into VCTs has boomed in recent years, with data from the AIC showing that a record £1.13bn was invested into the vehicles in the 2021/22 tax year, a 63 per cent increase on the previous year.

The industry is expecting a slight slowdown this year in comparison, but managers are not predicting a big drop in money flowing into the products.

“I would expect there to be a smaller market this year…[though] I hate making predictions, I think people will be more cautious,” said Fraser-Allen.

However, he added, against that is the backdrop of the drop in value of tech companies, which makes it an attractive market to invest in at the moment.

Tax cuts

The one unknown is how government tax cuts could impact funding. The freezing of income tax thresholds and the pension lifetime allowance has meant that higher earners have had to look elsewhere for tax efficient investing.

The soaring levels of VCT investment since the start of the pandemic was also partly attributable to the cash saved during lockdowns, which may well dwindle as household incomes are squeezed by rising inflation.

VCTs are all about growthWill Fraser-Allen, Albion Capital

One way the sector might change, and may well have already been changing, is the pinch on valuations.

“One difference [compared to] 18 months ago is more realistic valuation expectations from entrepreneurs, so valuations have come down,” said Shane Gallwey, Head of Ventures, Guinness Global Investors.

“That is probably a healthy development.”

Ultimately, Fraser-Allen said, the question is about the long-term future for the investments.

“VCTs are all about growth. 

“You’ll have short-term blips in markets but VCTs should be looked at as a long-term investment that will deliver above-average target returns.”

sally.hickey@ft.com