RSS feedsThanks to an especially generous tax concession in Gordon Brown’s 2004 budget, the venture capital trust (VCT) market has rocketed back into the limelight. Sales jumped from £60m in 2003/04 to over £500m in the last tax year, proving that investors can’t resist a juicy tax incentive.
The choice of VCTs has also increased, with diverse offerings such as wind farm investment appearing alongside more conventional funds.
To recap, Brown replaced the original 20% income tax rebate and capital gains tax deferral concession with a 40% income tax rebate, and doubled the £100,000 annual allowance to £200,000 (available only on new issues, which must then be held for at least three years).
As before, investors continue to benefit from tax-free growth and no tax to pay on dividends received. With the new incentives due to end next April, pundits are predicting another bumper VCT season.
While VCTs offer exceptional tax breaks, and potentially good long-term investment opportunities, the venture capital path is not always paved with gold. The gulf between the best and worst performers is large. Understanding the nature and types of trust is key.
VCTs have an investment trust structure, meaning shares will usually trade above or below a trust’s net asset value (NAV). This is perhaps the biggest pitfall; VCT shares typically trade at a high discount compared to their net asset value because of low demand in the ‘used’ market (the 40% income tax rebate is only available on new issues). In mid-October 2005 the average discount to NAV was 14.8% with the largest being 38%.
Some VCT managers try to control the discount, usually via share buy-backs, but this is not always successful. Therefore an important part of the investment decision is assessing the measures proposed to deal with discounts and the manager’s track record.
More positively, VCTs are allowed to distribute their realised capital profits, which can result in tax-free windfalls for investors. One of the most successful VCTs so far, Foresight Technology, paid a dividend of 100p per share in 2001 and a further 52p in 2004.
VCTs must invest in unquoted companies (although AIM is permitted) with gross assets of less than £15m before investment and less than £16m immediately afterwards. Investors should therefore try to ensure that buying a VCT does not make their portfolio top-heavy in smaller companies. They should also diversify by investing across a spread of AIM, generalist, asset-backed and specialist VCTs.
Bear in mind that only 70% of the fund must be invested in qualifying investments within three years. The balance may be held in safer assets, such as fixed interest investments. This means that many VCTs, especially those investing in private equity, may have a high cash-to-fixed interest weighting during the early years. This provides some security but can also drag on performance in a buoyant climate.
Beware of small VCTs. With the exception of the management fee, annual costs are largely fixed. Realistically, a trust needs to be £10m or more in size to be economically viable. During the past tax year, six VCTs failed to launch because they lacked sufficient funds.
Whether the 40% income tax rebate is extended remains to be seen. If not then sales will likely fall off a cliff, so the industry is lobbying for an extension or attractive replacement. Meanwhile investors should seek advice before leaping into a VCT; the potential benefits are very attractive, but the scope for making an unsuitable choice is wide.
Justin Modray is an investment adviser with Bestinvest. Details of VCT launches at www.bestinvest.co.uk
Pick of the VCT best
Baronsmead VCT 3 C Share
Invests predominantly in established private companies. Benefits from a very
experienced management team and is due to convert into the parent VCT in January
2008. ****
Close IHT AIM VCT
Established VCT group. Invests in AIM shares. Option of transferring the shares
to the holder after three years to benefit from business property relief.
Question mark over whether management team changes will impair performance. ***
Foresight 3 VCT
Generalist technology investors. Management team comprises 12 people
with over 100 years’ investment experience. Focuses on established businesses
and insists on board representation when investing. Highly recommended if you
can accept the risk due to its specialist nature. *****
