How the Patient Capital Review is driving VCTs to champion innovation
3 February 2018
Will Fraser-Allen, deputy managing partner, Albion Capital looks at how the recent changes to VCT rules are focussing VCT managers minds on the Treasury’s innovation agenda for the tax efficient structure.
VCT demand has risen significantly in recent years, largely driven by advisers adapting retirement savings strategies in response to reductions to the lifetime and annual pension savings allowances. Demand has also been driven by advisers seeking an alternative income source for their clients at a time when traditional income investments are generating negligible yield in this prolonged low interest environment.
Rule changes announced in November 2015 restricted the scope of VCT investments and led some managers not to launch VCT offerings. Reduced supply at a time of record demand sparked initial fears that advisers wouldn’t be able to access the capacity needed to satisfy clients’ requirements. However, the early autumn of 2017 saw the launch of a number of offers including from managers who had previously held back.
Despite these new offers, concerns emerged about longer term supply as the Government prepared to announce its stance on the small business funding landscape following its Patient Capital Review. The Review was, in part, designed to health check tax efficient investment schemes like VCTs and EISs, and ensure they deliver on the Treasury’s objectives.
It had potential to restrict the availability of VCT offerings further limiting both support to exciting smaller businesses and the ability of advisers to pursue retirement planning strategies using VCTs.
Minimal tax changes
The findings from the Review were announced in the Chancellor’s Autumn Budget, which contained a number of changes that will impact VCTs going forward. As expected, the changes were designed to boost investment in innovation and growth; encouragingly, there were no changes to the tax reliefs available to new investors.
Other rule changes will be introduced incrementally so managers have time to adapt. From 6 April 2018, VCTs must invest 30% of the money they raise within 12 months of the end of the accounting period during which they received the funds. From 6 April 2019, 80% of VCT portfolios must be invested in qualifying companies, an increase from 70%.
Fortunately for the VCT industry, the rule changes of November 2015, had already gone a long way to refocus investment strategies on innovation and growth. As a result, many VCTs – including ours – can say that the majority of their recent investments are already in line with the new requirements.
Innovation and growth
The Review also heralds a reduction in the ability of VCTs to invest in asset based investments. The changes prevent VCTs investing in “old money” businesses such as hotels and care homes. Investment in other asset based investments such as wedding venues will be determined by a principles based approach, which requires growth and development over the long term.
Such investments will also need to demonstrate they are not structured to provide a low risk return. The 2015 rule changes have already reduced the ability of VCTs to invest in asset based businesses and this trend is set to continue.
The Budget also contained some potentially beneficial changes for knowledge intensive companies carrying out significant levels of research and development. The annual maximum investment from VCTs increases from £5m to £10m, providing useful flexibility to structure larger deals in exciting companies.
Evolving investment strategies
Going forward VCT managers will focus their investments in growth companies, with knowledge intensive firms likely to be significant beneficiaries. We have developed sector specialism in areas where we see particularly strong opportunities, including digital healthcare, automation, cyber security and data analytics.
Consequently, over a number of years, the weighting of asset based investments in our VCT portfolios will reduce and be replaced by a corresponding increase in technology enabled businesses. This is an area we are already heavily involved with and will be expanding over the course of 2018. We expect the majority of the industry to follow suit and believe that a greater focus on innovation and growth will enable VCTs to deliver attractive and inflation beating returns.
This changing focus will intensify competition for high quality, high growth companies. Some commentators are concerned this will reduce the pool of overall investments available to VCTs and result in less VCT offers being launched for investors to access.
We are seeing the opposite – an entrepreneurial boom delivering lots of potential new deals. The UK’s entrepreneurial landscape is healthier than ever, and there are more and more innovators seeking funding across a range of technology enabled businesses.
VCTs, as evergreen investment trusts with added tax incentives, are ideally suited to the patient capital approach. The new rules have given managers more support to grow investments over time to deliver scale and profitability, and we expect this to translate into more business success stories.
Government policy has also been very supportive of start-ups, and the Review raised both the investment limit and tax relief available through EISs. We expect VCTs will also start to seek younger companies, and we are increasing our exposure to earlier stage “seed” investments to access interesting business themes.
A supply crisis?
VCT managers are unlikely to face an investment pipeline crisis and, as such, a supply crisis is unlikely. More high growth businesses are seeking funding than ever before. And while quantity doesn’t always equate to quality, opportunities are abundant in tech-enabled areas of innovation.
Managers may need to think more strategically about the amounts they seek to raise in the future, but this is positive for the industry and will ensure VCTs raise sustainable amounts that they are sure they can invest. It will help redirect money and push the ongoing evolution of VCT investment strategies in line with the Treasury’s innovation agenda.
Consequently, VCTs will be able to continue giving investors the opportunity to support young, dynamic British businesses through a tax efficient structure.
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