Savvy investors will always be on the lookout for the next breakout stock, and venture capital trusts (VCTs) offer a way to back small British companies with high-growth potential.
However, the prospect of great returns comes hand-in-hand with high risks, so, as an extra incentive, VCTs also come with generous tax benefits – as long as you follow the rules.
Here, Telegraph Money explains what you need to know about VCTs, and the risks that come with them.
- What are venture capital trusts?
- How do venture capital trusts operate?
- Benefits of investing in venture capital trusts
- Risks associated with venture capital trusts
- Types of venture capital trusts
- How to invest in VCTs
- How VCTs differ from EISs and SEISs
- FAQs
What are venture capital trusts?
Venture capital trusts (VCTs) are a type of investment that backs small UK businesses, offering investors the chance to back potentially high-growth companies.
VCTs typically invest in a basket of 50 to 80 privately-owned companies that are often hard to access on listed markets.
These range from tech businesses to consumer brands, including alcohol-free beer manufacturer Lucky Saint, fashion retailer ME & EM, skincare technology company Lyma Life and cyclewear brand Le Col.
Many VCT-backed companies have become or are on their way to becoming household names.
To encourage support for growing start-ups in need of next stage funding, VCTs come with generous tax benefits to investors.
They enable you to offset 30pc of your investment against income tax liabilities, as well as receiving tax-free dividends and no capital gains tax (CGT) to pay.
Success stories include the 10 firms that have earned “unicorn” status – private companies with a valuation of $1bn or more. These include online car retailer Cazoo, meal kit business Gousto, which is backed by Joe Wicks, and most recently Quantexa, the AI start-up.
So far this tax year (to 22 September 2024) £118m has been invested in VCTs overall, up 59pc year-on-year, according to figures from Wealth Club.
How do venture capital trusts operate?
The VCT itself is a fund in which you buy shares. The VCT manager will choose businesses to invest in according to where they think opportunity lies.
Most VCTs target an annual dividend (sometimes around 5pc) and can pay a special dividend when they have good exits – in other words, when they’re sold or list on the stock market.
From September each year, VCTs raise funds by issuing new shares, allowing investors to pledge their savings. VCT shares are bought on the stock market but can trade at a discount to the underlying value of the fund’s investments.
For long term investors – who will receive the majority of their return through tax-free dividends as well as underlying growth – that shouldn’t be an issue. But it’s another reason these should be treated as a long-term commitment.
Crucially, to qualify for the tax breaks on offer you must hold the investment for at least five years.
Benefits of investing in venture capital trusts
Investing in VCTs may be risky, but there are a lot of benefits to be had:
Tax benefits
The tax benefits are compelling. VCTs offer income tax relief at 30pc – so for every pound you invest in a VCT you can get up to 30p back in tax relief. They offer tax-free capital gains and tax-free dividends too.
The dividends can therefore act as a useful source of income, though if you don’t need the income for now reinvested dividends qualify for tax relief too.
Generous thresholds
You can invest up to £200,000 into a VCT each year and get up to £60,000 back in tax – though you can’t claim back more tax than you owe.
Suited to wealthy investors
VCTs, with their allowance of £200,000 a year – compared to £20,000 for Isas and £60,000 for pensions – are a compelling option for wealthier investors. They are a tax-efficient option if you have already maxed out your Isa and pension.
Potential higher returns
VCTs can potentially give you higher returns – especially once tax relief is factored in. If a company held in the VCT is very successful and exits the VCT either because it is sold or listed on a stock exchange, there will be special dividends paid.
Chance to diversify
Exposure to high growth, smaller companies also offers the potential to diversify a conventional portfolio.
Support for start-ups
By investing, you are helping to provide support to the next generation of UK start-ups, driving innovation and creating jobs.
Nicholas Hyett, investment manager at Wealth Club said: “For experienced investors, especially those who have already used their Isa and pensions allowances, VCTs offer an excellent next port of call.
“The potential for 30pc income tax relief upfront and tax-free dividends is increasingly attractive to the tens of thousands of people being dragged into higher tax brackets by frozen annual allowances.”
Risks associated with venture capital trusts
There are risks, of course, which you’ll have to weigh against the benefits.VCTs invest in early-stage businesses which are much more likely to fail, and the companies they invest in can be harder to sell.
Most VCTs offer a buy-back facility where they aim to buy your shares from you though it’s at a discount to their value. Though there’s no guarantee that shares will always be sold on request.
What’s more, while dividend targets are attractive, they are not guaranteed.
High charges are another downside. Average annual charges are 2.6pc according to data provider Morningstar, and most have performance fees on top.
Types of venture capital trusts
There are three types of VCTs to be aware of:
Generalist venture capital trusts
By investing in a generalist VCT you’ll get exposure to a spread of companies in different sectors, in all shapes and sizes. The aim is to get a well-balanced portfolio so you’re not putting all your money in one area.
Popular generalist VCTs include Mobeus VCTs and Pembroke VCT.
Specialist venture capital trusts
This term isn’t so widely used any more. But it referred to VCTs where the manager focuses on finding and investing in companies operating in a specific sector or industry such as technology or healthcare. One example is Octopus Future Generations VCT, which focuses on sustainability.
Aim venture capital trusts
Some VCT managers will focus on companies that are listed on London’s Alternative Investment Market (Aim), sometimes referred to as Britain’s “junior” stock market.
Aim is home to thousands of innovative, fast-growing companies run by entrepreneurs in sectors such as technology and healthcare. Octopus AIM VCT is one example. Its largest listed holding is construction materials group Breedon plc – which it first backed way back in 2010 and which has recently expanded into the US for the first time with a $300 million acquisition.
How to invest in VCTs
If you’re still interested in investing in VCTs, you’ll need to follow these steps:
1. Find a broker
First you will need to find a VCT broker and register or set up an account. There are a number of online VCT brokers including Wealth Club, Chelsea Financial Services and Bestinvest.
2. Make a choice
Study the VCTs on offer at the time. A prospectus is typically available a few weeks before the VCT becomes open for applications. Once the required amount is filled, the window of opportunity closes.
In some cases you need to be quick as the most popular offerings tend to sell out fast. For example, Unicorn AIM VCT’s £20m fundraising in February 2024 was available for just one week before it was oversubscribed.
3. Choose again
You might want to choose more than one VCT to back. Since they are high risk you might prefer to spread your investments over multiple managers.
4. Make sure you understand the risks
Take the time to read the information and research in what it invests. There will be information to help you gauge how risky it is. You might have to answer a set of online questions to verify you understand the riskier nature of VCTs.
How VCTs differ from EISs and SEISs
There are similarities between VCTs and Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS), but several crucial differences.
Like with a VCT, an EIS offers income tax relief at 30pc and returns are free of CGT. SEISs allow you to offset 50pc. VCTs and SEIS have a smaller annual limit at £200,000 compared with up to £2m for EIS.
The tax treatment differs. VCTs offer tax-free income from dividends – this is not so with EISs and SEISs. VCTs (and SEISs) do not allow you to offset losses against capital gains made elsewhere as with EIS.
The way they invest is different. While a VCT might hold up to 80 companies, an EIS or SEIS fund might only hold 10 to 12 companies, which is a narrower pool.
EIS and SEIS target much smaller and younger companies that tend to be riskier.
VCTs must be held for five years to enjoy the tax benefits, compared with EIS and SEIS which require you to hold them for three years.
There is no inheritance tax advantage with VCTs. EIS and SEIS investments may be eligible for relief from inheritance tax after they have been owned for at least two years.
FAQs about venture capital trusts
What is the average return of a venture capital trust?
According to Wealth Club, the average generalist VCT returned 22.2pc over five years to Dec 2023 (based on 36 individual VCTs managed by the 10 largest VCT managers). Meanwhile, the average AIM VCT lost 14.7pc over five years to Dec 2023.
Most VCTs target an annual dividend, which can be around 5pc, but some can pay significantly more and others, less.
What is the 5-year rule for VCT?
To qualify for the tax breaks on offer for investing in a VCT you must hold the investment for at least five years.
What are the disadvantages of VCTs?
VCTs are considered high risk investments and so it’s important to look beyond the tax perks. VCTs invest in early-stage businesses which are more likely to fail than larger ones and the companies they invest in can be harder to sell should you need access to your money.
Unlike most conventional funds and shares the minimum amount you can invest is comparatively high – often £3,000 or more.
If you cash in your investment before the five years is up you will lose the tax benefits.
It’s also worth noting that investments in VCT schemes are not protected by the Financial Services Compensation Scheme, the industry safety net.
Disclaimer: The copyright of this article belongs to the original author. Reposting this article is solely for the purpose of information dissemination and does not constitute any investment advice. If there is any infringement, please contact us immediately. We will make corrections or deletions as necessary. Thank you.
