Venture Capital Trusts VCTs are tax efficient funds that allow for investment diversification. They offer investors considerable tax breaks. In this article, we take a look at the benefits on offer and ask the question are VCTs a good investment scheme for qualifying investors?
What are Venture Capital Trusts?
A VCT is a company whose shares trade on the London stock exchange just like Shell, AstraZeneca, or Lloyds Banking Group. Though instead of investing in oil, pharmaceuticals, or banking, a VCT aims to make money by investing in other companies.
Venture Capital Trusts are structured similarly to investment trusts in that they are closed ended investment funds. However VCTs are unique in that they only invest in very small companies which are looking for additional investment to expand their business.
VCTs are one of three major venture capital schemes that the UK government offers to high-net-worth and sophisticated investors. The other two schemes are the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
This is a vital area of the economy, and without funding from venture capitalists many companies we consider household names would never have been able to grow their businesses.
What types of companies do VCTs invest in?
Venture Capital Trusts invest in young innovative companies that meet the VCT criteria to allow them to retain their generous tax reliefs.
All recipient companies have common characteristics. They are young entrepreneurial companies who are aiming to grow.
The three types of VCTs
VCTs differ according to their investment focus.
- Generalist VCTs. These invest in a wide range of small, usually unquoted companies in different sectors. The idea is to reduce risk by diversifying, so if one sector suffers setbacks, another might shine. This is the most common form of VCT.
- Specialist VCTs. These focus on one sector, such as fintech or telecoms. The lack of any sector diversification means they have a higher risk profile compared to other VCTs.
- AIM VCTs. These invest in new shares issued by AIM-quoted companies. The Alternative Index Market (AIM) was set up by the London Stock Exchange in 1995. AIM offers additional flexibility for companies that do not wish to, or cannot meet the more, stringent and expensive listing requirements of the main stock market. AIM listed companies are not always small or start-up companies, although many will be. AIM VCTs typically target tax-free growth as well as income.
What is the qualifying criteria for companies?
HMRC has strict criteria a company must satisfy to qualify for VCT funding:
- It must carry out a ‘qualifying trade’. Most trades are included; the main exclusions are businesses HMRC doesn’t believe to need extra support, such as land dealing, financial activities, forestry, farming, running hotels and energy generation.
- It must be relatively small. Typically with gross assets of £15 million or less and fewer than 250 full-time employees.
- It must be relatively young. Usually less than seven years old.
What are the tax benefits of venture capital trusts?
The tax reliefs available through VCTs are generous. Below we list the tax reliefs available to qualifying investors.
- Income tax relief. VCTs qualify for 30% income tax relief. This means the net spend is 70p in the pound.
- Capital gains tax exempt. Investments into VCTs are exempt from capital gains tax CGT, assuming an investor holds shares for a minimum period of five years.
- Tax free dividends. This is a benefit to high income earners. As an example, a VCT that pays a 5% dividend means a 40% taxpayer would have to find an investment with a yield of 8.33% to match the dividend payment. And this excludes the fact that the investor only had to pay 70p in the pound to receive this yield through a VCT.
Comparing the three venture capital schemes
The table below gives an overview of the key features of the three venture capital schemes on offer in the UK.
|Annual investment limit||£200,000||£1,000,000||£200,000|
from April 2023
|Income tax relief for investors||30%||30%||50%|
|Minimum investment period||5 years||3 years||3 year|
|Capital gain tax relief||None||CGT deferral||CGT Exception 50%|
|Tax free dividends?||Yes||No||No|
|Tax free capital gains?||Yes – after 5 years||Yes – after 3 years||Yes – after 3 years|
|Tax relief for losses?||No||Yes – against gains or income||Yes – against gains or income|
|IHT business property relief?||No||Yes – after 2 years||Yes – after 2 years|
Are VCTs a good investment?
Yes. Venture Capital Trusts offer good tax breaks. Another benefit of this scheme is an investor can diversify risk. Typically, VCTs invest on average in 20 companies at a time. So if some of the companies are unsuccessful the fund can absorb the losses.
However, the other two venture capital schemes offer superior tax relief. Both EIS and SEIS offer loss relief whilst VCTs don’t. Consequently, if a company fails in a VCT that company’s loss costs an investor 70p in the pound. Although, this is generally absorbed by other companies which outperform. In contrast, the maximum risk exposure for a 45% taxpayer in EIS and SEIS is 38.5p and 27.5p in the pound respectively. If an investor is using either of these schemes to mitigate a CGT bill then their risk exposure is lower still.
Famous companies that have raised capital through VCTs
Zoopla, Gousto, and Cazoo have all used VCTs to raise capital. Interestingly all three of these companies have also used EIS to raise equity finance too. This shows that companies who understand finance can utilise venture capital schemes to attract the necessary investment to scale their company. Whilst from an investor’s perspective venture capital schemes are a way to generate significantly higher returns due to the tax breaks on offer.
At Esper Wealth we are targeting rapid growth. This is why we are using venture capital schemes to offer our equity investors a better investment. Venture capital schemes help investors by reducing the risk and potentially increasing the returns on investment. You can find out more about our equity offering by clicking on the link provided.