Should you invest in a VCT? A 30% income tax break, dividends paid tax-free and the chance to back exciting growth stars… – but beware the risks

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  • VCT raises funds from investors to invest in youth, private companies
  • Investors can claim income tax relief of up to 30% on the amount invested in VCT
  • VCTs provide tax-free capital gains and tax-free dividends in exchange for higher risk
  • Performance varies widely and investors should expect some investment failures.

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Venture capital trusts have enjoyed a boom in demand as investors flock to their generous tax breaks — and the potential for up-and-coming, exciting businesses that have become hot assets in recent years.

Data from the Association of Investment Companies shows that total investment in VCTs has increased from about £350 million a year a decade ago to £685 million a year.

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While a main driver pension rules have been changed, managers have pointed out that VCT investors are getting younger – many drew both the tax relief on offer and the support of trusts of unlisted early-stage companies.

Recent high-profile successes for venture capital include online used car seller Kaizoo, fashion marketplace Depop and recipe box seller Gausto.

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British online used car seller Kazoo had run through a space this summer for a valuation of $8 billion, or £5.8 billion, by the time it listed on the US stock exchange. This is an Octopus VCT . was supported by

Tax breaks are being offered because VCTs are meant to invest in fledgling growth companies and businesses, and investors should expect some to be successful, but others to fall by the wayside.

In return for this high-risk investment in companies seen as the future drivers of economic growth, investors get up to 30 percent income tax relief and tax-free dividends.

‘I would say there are more young investors now than there were 10 years ago. “It’s becoming more of a mainstream tax planning product,” said Ken Wotton, manager of Barnmead VCT.

While tax breaks can be tempting, VCTs are not for everyone. We look at what they invest in, who should invest in them and whether they are the right addition to your portfolio.

What are VCTs?

VCTs are investment companies listed on the London Stock Exchange that raise funds from investors to invest in young, usually privately owned companies that are not listed on the stock exchange, or that are listed on the junior market.

As an investment trust, when someone invests in a VCT they become shareholders of the trust.

This means that investors can get exposure to any investments made by VCTs following the investments as well as the existing portfolio.

They were introduced in 1995 to provide generous tax relief to investors and have since become a well-established option for seasoned investors.

VCTs are enjoying a boom in demand but they remain a high-risk investment and performance varies widely

What do VCTs invest in?

There are broadly two different types of VCTs: generalist and objective.

The most common forms are generalist VCTs that invest in a wide range of small, usually private companies (that are not listed on the stock exchange) across multiple sectors. They focus on diversification in many early-stage companies, after which they will often try to actively work to help them grow and succeed.

Many early-stage companies will fail, so a diversified portfolio approach is considered essential. Often some VCTs look to proven entrepreneurs or business people with whom they have worked successfully before – and some trusts will target specific types of company or sectors.

Ken Wootton, Manager of Baronsmead VCT

Ken Wootton, Manager of Baronsmead VCT

Target VCTs invest in new shares issued by Aim-listed companies, and target income with tax-free growth. While they are investing in listed forms on the stock market, the price of these trusts can be more volatile as the companies are assessed on a daily basis from time to time with unlisted firms.

However, there is more flexibility for them to enter or exit investments, as ordinary shares are more easily sold in the market.

There are also specialist VCTs that focus on just one area, and rarely a hybrid trust such as Baronsmead VCT that invests in both generalist and AIM companies.

‘We look for high quality businesses with good potential. Although they are small, they are super high risk,’ said Baronmead manager Ken Wotton.

‘We are not supporting total start-ups and we are not supporting binary outcome concept opportunities where market opportunities are still proving to be.

“That means we won’t be investing in things like early-stage drug development or the biotech business while waiting for FDA approval.”

HMRC has set criteria that a company must meet to qualify for VCT funding.

It should be a ‘qualifying business’, which does not include businesses that HMRC does not think need additional support such as land deals, financial activities, forestry, farming, running hotels and energy generation.

The company must be relatively young – usually less than seven years old – and small, with less than 250 full-time employees and typically less than £15 million in gross assets.

VCTs have to invest at least 80 per cent of the funds raised in companies that meet this criterion.

Why invest in VCT?

Investors can claim income tax relief of up to 30 per cent on the amount invested in VCTs, provided they have held the investment for at least five years.

The amount of income tax investors claim cannot exceed the amount of income tax payable.

Additionally, if VCTs pay dividends, VCTs provide tax-free capital gains and tax-free dividends.

In addition to tax benefits, VCTs offer exposure to early-stage startups — Cashew and Depop was funded by octopus titan VCTs — as well as help diversify a portfolio.

Jess Franks, Head of Retail Investment Products at Octopus Investments, said: ‘As a result of the investments they make, VCTs are high-risk, which you need to be comfortable with, but they also have the potential to generate a tax-free income stream. provide. And growth if the portfolio companies they invest in do well.

‘Some investors will…

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