All You Need to Know About Venture Capital Trusts

On Apr 17, 2022

Small businesses have a hard time raising investment capital because they have little in the way of assets, branding or financial support needed to develop and expand.

A Venture Capital Trust (VCT) is a fund created by the government in the 90s to support investment directly the small and private businesses, with some generous tax incentives for shareholders.

The downside is that the associated risk of a firm failing is fairly high. However, global names such as Twitter, Microsoft and Amazon have become enormously successfully listed companies with the help of VCT funding.

For investors, the big plus is the tax relief, with 30 per cent upfront relief against income tax, tax-free dividend payments, and Capital Gains Tax (CGT) exceptions.

HMRC Venture Capital Trust statistics indicate that in the 2019/20-tax year, investors claimed £575 million in income tax relief against £645 million of issued shares.

How A VCT Works

Although a VCT company has to meet several conditions, the fund works in much the same way as a conventional investment trust with added shareholder tax relief.

The concept is that the fund pools investor money and uses that collective investment to provide financing in qualifying companies, usually purchasing shares.

Investors often choose a VCT over other incentivised investments because the funds provide access to a broader portfolio of shares.

Note that investors hold shares in the VCT, not the businesses the VCT buys a stake in, and you need a formal tax certificate to claim tax relief.

VCTs are listed companies, traded on the London Stock Exchange, and must:

Publish an annual set of financial accounts and reports.
Host meetings of the independent directorship board to protect shareholder interests.
Invite shareholders to meetings, including a yearly Annual General Meeting (AGM).
Comply with corporate governance regulations.

Trusts need to adhere to HMRC rules to ensure the VCT meets the governmental objectives and directs capital to small companies within the targeted remit.

To be eligible for VCT investment, companies must have permanently established UK premises and undertake a qualifying trade, excluding a few specific sectors that the tax office feels don’t require additional capital financing.

Excluded trades include financial activities, farming, hotel management, energy production and forestry.

Benefits Of Investing In A VCT

VCTs have considerable growth potential and make it possible to invest in smaller businesses that aren’t listed.

While risk analysis is essential, a micro or start-up organisation has greater potential to scale quickly than a less agile company.

The main advantage is the tax relief, which applies to investments up to £200,000 a year, including:

Up to 30 per cent income tax relief, provided you retain VCT shares for five years – so a £10,000 investment gives you an immediate £3,000 reduction in your income tax bill.
Tax-free gains, whereby a sale of VCT shares with a resultant profit will not create a CGT liability.
Tax-free dividends – VCT dividend income does not need to be declared and is not taxable.

Investment cycles in smaller businesses are somewhat different from more established companies, so many investors decide to buy VCT shares partly for the tax relief and partly as a diversification exercise.

The risk profile is inevitably higher, but VCT shares can counterbalance pension products or long-term investments as a valuable retirement planning strategy, particularly if you’re reaching the annual pension contribution cap or the Lifetime Allowance.

Understanding The Risk Of VCT Investments

Every investment carries an element of risk, although the nature of an unlisted company makes it more of a guessing game than buying stocks with a long performance record.

There are no guarantees that you’ll make a profit or that each investment company will succeed, so taking financial advice is strongly recommended.

Potential pitfalls to VCT investment can be:

The long-term nature of the investment, with a minimum five-year retention period. If you sell the shares beforehand, you must repay the income tax relief.
Difficulties in selling VCT shares without an active market. It can take time to find a buyer or demonstrate the value of your shares, often meaning you get a lower price than the net asset value.

Changeable tax rules, with the potential for HMRC to amend qualification criteria.

VCT status isn’t granted indefinitely, and if your investment fund owns shares in a company that ceases to maintain VCT classification, all the tax advantages are withdrawn.

Should that happen in the first five years, any reliefs you’ve claimed will need to be repaid.

Different Types Of Venture Capital Trust

There are three types of VCT, although most fall into the first category.

Generalist VCT Investments

Approximately 75 per cent of VCTs are generalist funds, which invest in a range of businesses across different sectors, creating a strongly diversified investment portfolio.

Every VCT will have an overriding objective, so it might concentrate on start-ups that haven’t yet made a profit or perhaps will select organisations with a specific maturity.

Alternative Investment Market (AIM) VCTs

The AIM is the junior counterpart to the London Stock Exchange and launched alongside VCTs to similarly support small business growth.

Companies listed on the AIM must meet regulatory conditions with a daily market share price.

AIM is a stock exchange, so it’s easier for investors to purchase or sell shares than through other VCT structures.

Specialist VCT Funds

A specialist VCT is a fund with a more defined purpose and usually invests in sectors such as biotech, infrastructure or energy.

The investment risk is higher because there isn’t diversification across different industries, but returns can be better if the specified sector performs well.

All You Need To Know About Venture Capital Trusts FAQ

What are the qualification rules for companies seeking VCT investment?

Businesses looking to raise capital need to meet several conditions and must have traded for at least seven years since making the first sale.

There are caveats where more established businesses might be eligible if they wish to raise a considerable amount of money to develop a product or enter into a new market.

Companies must have gross assets of no more than £15 million at the time of VCT investment, or up to £16 million when the raise completes, plus have fewer than 250 full-time employees.

VCTs can choose to invest up to 15 per cent of the total trust value in one company. The receiving business can accept up to £5 million in tax-efficient funding (through VCTs or schemes such as SEIS or EIS) a year, with a £12 million overall cap.

How to claim tax relief against a VCT investment

Once you’ve made your share purchase, you receive two different certificates:

A share certificate needed if you decide to sell your stock
A tax certificate you need to claim income tax relief on your next HMRC return.

PAYE taxpayers can contact HMRC and request an immediate tax code adjustment to reflect the lower liability in their monthly payroll deductions.

Alternatively, they can leave it until the tax year-end and submit a Self-Assessment Tax Return to claim a rebate for the 30 per cent relief.

What is the easiest way to buy VCT shares?

Investors have two primary options. One is to apply for shares in a VCT when it’s open for new investments, called a new share offer.

After reading through the share offer, you’ll need to submit an application form and remit payment, usually via online banking.

Another option is to invest through a financial adviser or online investment platform – most digital platforms will ask you to sign a waiver confirming you’ve sought independent advice before making your investment.

It’s also possible to buy VCT shares through the open market since the VCT itself is a listed company. Most investors buy through a broker, although second-hand shares won’t have the same level of tax relief.

Second VCT purchases remain eligible for tax-free dividend payments and the CGT exemption and still count towards the £200,000 maximum limit for each tax year.

What is the best way to balance an investment portfolio with VCT shares?

Your portfolio balance will depend on your risk appetite, other assets, whether you have a concentrated investment in a specific sector or asset class, and what you’d like to achieve.

VCTs have to invest at least 80 per cent of their portfolio in eligible companies. They can hold the balance as cash or equivalents, so it’s important to understand the purpose of your selected VCT and what types of assets or businesses it prefers to invest in.

Can I sell VCT shares?

You can, but it may be tricky because a previously owned VCT share won’t offer income tax relief.

Most investors dispose of their VCT shares when the business directors decide to buy back the equity from the VCT, usually at a discount on the net asset value.

If you sell before five years of ownership, you need to report this to HMRC and pay back any tax relief you’ve claimed.

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