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Venture Capital Trusts

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What are Venture Capital Trusts?

Venture Capital Trusts (VCTs) were introduced to encourage investment into young, developing companies. VCTs are companies in their own right, quoted on the London Stock Exchange and so are tightly regulated. Most seek to attract sufficient funds to allow the manager to spread the investment across many companies (typically 30 – 50).

For an investment of up to Ł200,000 in any one tax-year an investor receives:

An income tax reduction, in the year of investment, of 30% of the investment

Exemption from tax on any capital gains made on the investment

Tax-free dividends. To qualify for these tax-breaks the investment must be held for at least 5 years.

Broadly VCTs will be either AIM, Generalist or Specialist. With an AIM VCT the manager will look to spread the investment risk by targeting a range of promising companies, most are likely to be listed on the Alternative Investment Market ( AIM ), but could include shares quoted on OFEX (the Off Exchange market) quoted shares and unquoted companies approaching a quotation. Generalist VCTs tend to invest mainly in unquoted companies in the hope of making large profits when these companies are floated or sold. Specialist VCTs, as the name suggests, target a specific sector or type of business. To reduce risk, they aim to substitute spreading investments with an in-depth knowledge of a sector with high growth potential.

The investment team will take considerable care in the selection process. Due diligence, particularly of unquoted companies, will include analysis of the accounts and key contracts, understanding the business and its market, evaluating competition and of course assessing the management team. Some VCT managers favor repeat investments in companies. Their knowledge of the company is greater having worked with them and the company may benefit from further funds at critical times in its development. Other managers will increase the spread of the portfolio to reduce risk. Few VCTs invest in start-up companies these days. Memories of the failure of too many dot.com companies are still fresh in the minds of managers and investors.

Choosing between the varying types of VCT may be difficult. Their differences in investment style and strategy can work to their advantage or against. Ideally an investor should attempt to build a portfolio of AIM and Generalist VCTs with some Specialist exposure as well.

Although VCTs are quoted on the main stock exchange shares in them may be difficult to sell. This is mainly because the greatest tax advantage ( the initial 30% tax relief ) only applies to the purchase of new shares and so an active secondary market has not developed. Consequently most VCTs now offer a buy-back facility, which should mean you realize about 90% of the underlying asset value.