Retuning is the key to VCTs’ success

FOR PROFESSIONAL ADVISERS ONLY. NOT TO BE RELIED UPON BY RETAIL INVESTORS.

Here’s a question for you: can you name the year when these events took place?

  • The first ‘Toy Story’ film came out.
  • François Mitterand ended his second term as French President.
  • Blackburn Rovers won the Premier League.
  • Michael Jackson had the Christmas Number One with ‘Earth Song’.
  • Tennis player Fred Perry died.

 
Give up?

It was 1995.

That year also saw the launch of venture capital trusts (VCTs), a government-backed scheme to encourage investment in small, higher-risk companies with strong growth potential. The world has changed a lot since 1995, and VCTs have evolved accordingly. Successive governments have regularly changed the rules governing VCTs in order to maximise their benefit to the economy and drive investment to companies where it will have the most impact. Throughout this time, the desire to use tax reliefs to drive capital to early stage businesses has remained strong.

The 2017 Autumn Budget saw further tweaks to these rules, which again underlined the Government’s commitment to supporting the UK’s most exciting businesses. Before we get into what they were, though, it makes sense to have a quick recap of what VCTs are and what they offer investors.

Since 1995, VCTs have raised around £7 billion for investment into high growth UK businesses – including more than £500 million in the last tax year alone1. They’ve also fuelled job creation – businesses currently receiving VCT backing employ 50,000 staff2.

VCTs offer attractive tax reliefs for investors prepared to put money into higher risk smaller companies for at least five years:

  • 30% upfront income tax relief, up to a maximum investment of £200,000.
  • Tax-free dividends.
  • Exemption from capital gains tax should the shares rise in value.

 
It’s important to note that dividend payments are not guaranteed, and an investor’s tax treatment will depend on their individual circumstances and may change in the future. The tax reliefs also depend on the VCT maintaining its VCT-qualifying status.

And, of course, because they invest in small businesses, VCTs put capital at risk, so the value of an 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.

Since they were launched over two decades ago, successive governments have been very supportive of VCTs. This has included making regular changes to legislation to ensure they continue meeting policy objectives, including helping VCTs continue to support companies as they grow.

For example, 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 2011-12 tax year, the requirement that a business carry on its trade wholly or mainly in the UK was removed. Recognising the growing importance of export markets, the government replaced this with a requirement that the issuing company have a permanent establishment in the UK.

A year later, the 2012-13 tax year increased the maximum size of company that could qualify for VCT investment. 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 (and £8 million immediately afterwards) to £15 million or less before investment (£16 million immediately after).

In 2015, the Government introduced higher investment and headcount limits for knowledge-intensive companies. These are companies that 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 qualify for additional funding support.

The 2017 Autumn Budget included measures to direct even more investment into businesses with high growth potential:

  • Knowledge-intensive companies will now be able to raise up to £10 million each year from VCTs, up from £5 million at present.
  • The amount of time VCTs have to reinvest or distribute gains when they sell a company will be extended from six months to twelve months. This gives a VCT more flexibility and time to re-invest money properly into deals that fit its mandate.

 
Additionally in 2017 the Government introduced technical changes aimed at encouraging investment managers to deploy a larger portion of VCT funds into high-growth businesses:

  • At least 30% of all new funds raised after 5 April 2018 will need to be invested in qualifying holdings within twelve months of end of the accounting period in which the VCT issues its shares.
  • From 6 April 2019, the proportion of funds that VCTs must hold in qualifying investments rises from 70% to 80%.

 
The entrepreneurial scene in the UK is thriving, giving VCT investors access to great opportunities. The UK now has over 20 companies that are so-called ‘unicorns’, with valuations of $1 billion or more.  That’s up from just one in 2010. One of the most notable of these 20 companies, Zoopla (now Zoopla Property Group), was significantly supported by VCT funding prior to listing on the London Stock Exchange. The volume of venture capital deals in the UK is three times what it is in the next biggest European market3.

However, the UK still lags behind the US when it comes to supporting growth companies with long-term investment. VCTs have a vital role to play in closing the gap, so it was encouraging to see the 2017 Autumn Budget confirm their position as part of the Government’s growth financing framework.

Indeed, it’s worth noting that even in these cash-strapped times, the Treasury continues to support investors who put their money into VCTs. This is in stark contrast to recent restrictions in areas like buy-to-let and pension contributions.

For over two decades, VCTs have been a story of frequent change while staying fundamentally the same: an investment option that offers attractive tax reliefs to those who take on the higher risks of supporting the next generation of British businesses.
 
More about VCTs
 

Paul Latham, Managing Director of Octopus Investments

1 Association of Investment Companies, April 2017

2 Association of Investment Companies, August 2017

3 Markit 2010; GP Bullhound Titans of Tech Report 2017

Personal opinions should not be seen as advice or a recommendation. VCTs are not suitable for everyone. Any recommendation should be based on a holistic review of your client’s financial situation, objectives and needs. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: January 2018. M2-CAM06376-1801.