Tax incentives for investors to take a risk on smaller ventures Your finances
TO FIND a financial acorn which has the potential to become a mighty oak is appealing, particularly when there are major tax benefits. A venture capital trust is just such a vehicle with the further attraction of giving access to small unquoted companies and thereby strong diversification for a portfolio.
Each trust is a stock exchange listed investment company that provides finance to fledgling growth firms. They are not start-ups which are supported by a different initiative, the Seed Enterprise Investment Scheme.
The Government is keen to encourage enterprise and since there are added risks in backing a venture capital trust (or VCT) than more established firms, it gives several tax incentives.
For a direct investment up to £200,000 – as opposed to purchasing a VCT some way into its life on the secondary market – 30 per cent initial income tax relief is given. This means that for every £10,000 invested, a £3,000 rebate is given, assuming the investor has paid that amount in income tax. To qualify, the shares must be held for five years.
However, there are two further tax benefits, available to any VCT investor, whether the purchase was made when the offer was first available or later: ■ Tax-free dividends
■ Tax-free capital growth.
Whilst the UK is renowned globally as a home for early stage technology, the personal tax carrots are not well known. “This is surprising when these tax incentives are among the most generous reliefs of their kind worldwide,” says Nick Keenan, Barclays wealth director.
He says private individuals now have access to areas which were the preserve of institutional venture capital funds.
Demand for VCTs has grown in recent years, partly because of the lifetime limit in funding a personal pension but also the tapered personal allowance for high earners and crackdown on forms of tax planning.
These funds are certainly popular. Since their introduction in 1995 by Chancellor Ken Clarke, 173 have been successfully launched, raising almost £7bn. Currently there are 61 running with £4.4bn assets.
To be eligible for VCT backing, firms can have up to 250 staff and £15m assets. VCTs have around 15 per cent in the Alternative Investment Market (AIM), amounting to £669m.
By sector, over five years, environmental has outperformed AIM-quoted and generalist: 53.1, 50.6 and 41.4 per cent.
The increase in turnover experienced by a company following a VCT investment is remarkable at £2.7m on average, an increase of 183 per cent. This means such an input is a springboard for development by smaller firms.
Private investors can struggle to find small enterprises to back but this is the task of a professional VCT manager. An investment can therefore “have excellent growth potential”, says Kelly Kirby, chartered financial planner at Chase de Vere. Despite 2018 being a tough year for savers, the average VCT returned 2.7 per cent and is up 42 per cent and 163 per cent over five and ten years respectively.
Since 2015 VCTs have not been able to support management buyouts and can now only invest in companies under seven years old after their first transaction has taken place or under 10 years if it is a knowledge-intensive firm. Companies backed by major assets, such as land or property, are now ineligible.
Such changes are designed to return VCTs to their original purpose which is to offer capital to support the growth in entrepreneurial businesses.
There are risks to consider. Autopsy research discovered that the main reasons why start-ups failed were 19 per cent wrong business model, 14 per cent wrong product, 11 per cent no market demand and eight per cent poor marketing.
Small firms often lack liquidity which is why most VCTs are offered at a discount to their net asset value. “This discount acts as an exit penalty for investors and, even though some VCT providers offer to buy back shares, investors can usually expect to face a charge if they want to get out,” explains Kirby.
Savers should understand not only the risks but that their money needs to be locked away for several years.
Whilst the manager, past experience and likely asset purchases should be the main decision, consider charges which range initially from three to 5.5 per cent but are often discounted by brokers or platforms. Expect annual fees of 2.5-3.5 per cent which may rise if there is a performance-fee arrangement.
The advisory firm Bestinvest has been reviewing VCTs since their inception and applies a rating up to five stars for new offers based on management experience, portfolio (including the level of concentrated risk), performance and value for money.
Jason Hollands at Bestinvest tips Octopus Titan (which previously discovered Zoopla), ProVen (whose successful exits include an online second-hand watch dealer) and Albion.
The latter often favours technology such as a provider of ultra-fast optic broadband but its investments even include an independent school.
Frequently, investors like to back VCTs which support regional initiatives. British Smaller Companies have helped two Sheffield-based firms. It put £1m in December 2015 into President Engineering, which makes energy valves, and exited five years later, having multiplied the investment 8.5 times.
In March 2012 its original VCT and British Smaller Companies VCT 2 invested £1m in Selima, a payroll and HR software services firm, exiting in June 2017, securing a return of 3.7 times.
Darius McDermott, of Chelsea Financial Services, says that British Smaller Companies VCT is “one of the longest running and best performing VCTs currently available”.
Its other Yorkshire investments include Checkmate Fire of Elland, noted for fire protection installation, and Brighouse-based TEV, which develops cooling, heating and refrigeration equipment.
Pembroke and Proven are two other generalist VCTs tipped by McDermott. The former launched just five years ago and favours firms already producing profits. Its holdings include burger chain Five Guys and Alexa Chung’s womenswear range. Proven likes firms with a global footprint and strong demand.
Chase de Vere prefers to use generalist VCTs, run by experienced and proven management teams and where investments are spread across different sectors. They tip Foresight 4 whose management started in 1984 and has made over 200 investments. Since 2010, it has arranged 50 exits and recaps with an average 2.9 times return.
Merian Chrysalis VCT is tipped by Redmayne Bentley. This diversified VCT has returned over 150 per cent in the past five years.
Despite the uncertainty generated by Brexit, many managers echo John Glencross of Calculus Capital that “exporting to the rest of the EU is not an important market.
“It has always been difficult for small businesses to sell to European countries. The US, Asia and Middle East are more important.”
VCT fundraising last year was the second highest on record and this year is forecast to be at least as large. Attractive VCTs sell out quickly.
With under seven weeks to the end of the tax year, do not miss a good opportunity.
■ Conal Gregory is AIC Regional Journalist of the Year.