How the VCT market continually evolves

Venture capital trusts (VCTs) were first launched nearly a quarter of a century ago. Over that time, the rules governing the type of company they can invest in and the tax reliefs they offer have been regularly retuned.

So if you’re considering a VCT investment, you’d be well advised to pick a provider with experience of adapting to such rule changes.

In a moment I’ll explain how the latest set of changes, announced in the 2017 Autumn Budget, led us to adapt our own Octopus Apollo VCT.

Before that, it makes sense to look at where VCTs have come from, and what they offer investors willing to take on the risk of backing early stage companies.

 

A potted history of VCTs

 
Venture capital trusts (VCTs) were set up in 1995 as a government-backed scheme to encourage investment into small companies with strong growth potential. They’ve since helped the UK become a leader in nurturing entrepreneurial talent and created a fertile environment for growing smaller companies that create jobs and contribute to the economy.

To achieve this, the rules governing VCTs have been changed regularly by successive governments. But in this time, the willingness to use tax reliefs to encourage investment into young businesses has remained strong. Rule changes have been implemented time and again, always with the intent of maximising the benefit VCTs have on the economy, directing capital to where the government feel it will have the greatest impact.

 

What are the tax reliefs?

 
Before going into some of the changes to VCT legislation, it makes sense to recap the tax reliefs they offer today. They offer tax reliefs to incentivise investors to take on the risks involved in backing early stage companies that are beneficial to the UK economy.

For investors who are comfortable with the risks of investing their money into smaller companies for at least five years, VCTs offer:

  • 30% upfront income tax relief, up to a maximum investment of £200,000 per tax year.
  • Tax-free dividends.
  • No tax to pay on capital gains, should the shares rise in value.

 

What are the risks?

 
Remember that VCT tax reliefs are offered to encourage investors to take on the risk of investing in smaller companies.

Since they invest in small businesses, VCTs place capital at risk. The value of a VCT investment, and any income from it, can fall as well as rise and investors may not get back the full amount they put in. VCT shares could fall or rise in value by more than other shares listed on the main market of the London Stock Exchange. They may also be harder to sell.

It’s also important to note that an investor’s tax treatment will depend on their individual circumstances and may change in the future. Tax reliefs will also depend on the VCT maintaining its VCT-qualifying status.
 

Strong support for VCTs

 
Successive governments have been supportive of VCTs for nearly two and a half decades. Part of this support has involved appropriate changes being made to legislation to ensure they continue to meet policy objectives.

Here are a few historic changes in support of VCTs:

  • From the 2004-05 tax year, the maximum investment that qualified for income tax relief was doubled from £100,000 to £200,000.
  • From the 2012-2013 tax year, the maximum investment a VCT could make into a single company within a 12-month period was increased to £5 million, up from £1 million.
  • The 2012-13 tax year saw the maximum size of company that could qualify for VCT investment increase. The maximum number of employees went from 49 to 249, while the limit on gross assets the company held rose from £7 million or less before investment to £15 million or less before investment.

 

Driving investment into young and innovative companies

 
More recently, changes to VCT legislation have focused on encouraging investment into earlier stage companies and those that are ‘knowledge intensive’.

The Government introduced higher investment and headcount limits for knowledge-intensive companies. These companies meet certain conditions about how many skilled employees they have and how much innovative activity they undertake. They tend to have high research and development costs, which is why they now qualify for additional support.

In 2015, age limits on the companies VCTs invest in were introduced. A report from 2015 discovered that one in four high growth small businesses found it difficult to attract capital [1]. It was in this environment that age limits were introduced to channel investment into younger businesses which find it hard to attract capital. Currently, the limits are ten years for knowledge intensive companies and seven years for other companies.

Following this, the government expanded on these rules in the 2017 Autumn Budget. Knowledge intensive companies can now raise up to £10 million each year from tax advantaged means (which includes VCT funding). That’s twice as much as VCT-eligible companies that are not deemed knowledge intensive. Additionally, the Government introduced some technical changes aimed at encouraging VCT managers to deploy a larger portion of funds into high-growth businesses. One example of this is that from 6 April 2019, VCTs must have 80% of their funds invested in VCT qualifying companies, up from 70%. This might not sound like much, but because VCTs manage £4.3 billion [2], that’s an extra £430 million being driven into UK businesses.

 

Adapting our investment approach

 
As the UK’s largest VCT manager with over £1 billion of VCT money under management, we are no stranger to adapting our approach in response to these regular rule changes. Take, for example, Octopus Apollo VCT.

Since January 2018, Octopus Apollo VCT has been investing in some exciting new companies to add to its already diverse portfolio of more than 50 companies. These investments are a little different to the kind of deals the team has made in the past. They reflect the team’s adapted approach following changes to VCT legislation announced in 2015 and 2017.

The team are still looking for quality, proven businesses that have a competitive edge. These are businesses that have already brought a product or service to market successfully, businesses that have shown they can win and retain customers.

For example, Rotolight export their innovative lighting for photographers to 41 countries. While SimplyCook are already retaining impressive numbers of customers who buy their subscription meal kits time and again.

Where these recent investments differ from the kind Apollo has made in the past, is the stage of growth they’re at when we invest and how the investments are structured.

Apollo has adapted its investment approach to back companies at an earlier stage in their growth journey. The team are now typically investing in companies between seven and ten years old, using a flexible mix of equity and debt.

What’s exciting about these new deals, is that while the investments Apollo is now making have been pushed up the risk scale, they have greater growth potential as a result. By investing at an earlier stage and taking on more risk, there is greater room for revenue growth following our investment.

 

Where to find out more

 
You can learn more about Apollo’s new approach and the team behind the VCT on our webpage. You’ll find key documents, including the brochure, and a short video in which the fund managers explain their approach.

Visit the Octopus Apollo VCT page

 

Paul Latham, Managing Director of Octopus Investments

 

[1] Source: High Growth Small business report 2015, Octopus

[2] Source: Industry Overview 30 April 2019, AIC

This advertisement is not a prospectus. Investors should only subscribe for shares based on information in the prospectus and Key Information Document (KID), which can be obtained from octopusinvestments.com/apollo. Personal opinions mentioned in this blog may change and should not be seen as advice or a recommendation. VCTs are not suitable for everyone and any recommendation should be based on a holistic review of your client’s financial situation, objectives and needs. Additionally we do not offer investment or tax advice and we recommend that investors seek professional advice before deciding to invest. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: June 2019. CAM008375-1906