As a a vital source of support for the UK’s growth businesses, VCTs should continue to attract investment in post pandemic economic environment, argues Bill Nixon, managing partner at Maven Capital Partners
Approaching the end of the tax year, VCTs look set to match their fundraising figure from 2019-20 despite the impact of Covid-19. As of 3 March, VCTs had raised £470m so far this tax year, up 6.8% on the same point in the 2019-20 fundraising season when the market raised £685m overall. This confirms the increased popularity of VCTs over the past decade, in great part thanks to their 25-year track record of delivering robust tax free returns for investors.
Rule changes requiring VCTs to target earlier stage companies have allowed the underlying fund managers of this specialist, niche product to back the highest investment potential, often tech enabled, businesses which stand the greatest chance of success. The tax efficiency of VCTs is an additional draw for investors and VCTs should continue to attract investment as the economy hopefully stages a sustained recovery from the pandemic in 2021.
Vital capital for SMEs
VCT backed companies have proven to be a vital source of support for the UK’s growth businesses. A healthy VCT ecosystem will be crucial for kick-starting economic recovery led by the SME economy, which accounts for 61% of employment and 52% of turnover in the private sector. VCTs therefore perform a vital function, where specialist investment managers use their expertise to identify the next generation of high growth businesses and help them to fulfil their potential.
With more than 70 VCTs, and large portfolios actively managed by several hundred experienced executives, the VCT industry has raised more than £9bn of funding for SMEs, supporting approximately 1,000 private and AIM listed companies, and creating more than 27,000 jobs. In addition, VCTs have generated more than £1.4bn of exports,with a third of VCT-backed businesses trading internationally.
VCTs have been able to supplement the Government support made available to early stage businesses during the pandemic. For instance, while the Future Fund provides finance for firms which have raised at least £250,000 in equity from third party investors in the last five years, VCTs can act as a source of funding for those early stage businesses which have not been around long enough to qualify for Future Fund support. Indeed, VCT managers have been proactive in protecting value in their portfolios by supporting existing investees, as well as backing new businesses. For example, Maven’s four VCTs have made 11 new private company investments in the past twelve months.
Key to securing the most effective funding for SMEs across the UK is the ability to identify and support businesses throughout regional markets, as suggested by a recent report from the ScaleUp Institute and Innovate Finance. This is a capability that only a few VCT managers possess. For example, Maven has a national network of local offices and well-resourced investment teams, as well as managing a number of regional development funds, such as parts of the Northern Powerhouse Investment Fund (NPIF) and the Midlands Engine Investment Fund (MEIF), so Maven’s executives have a unique insight into the local market and business dynamic in their regions.
Attractive proposition for investors
VCTs have proved a successful and popular vehicle for investors. Established VCTs offer exposure to well researched, actively managed and diversified portfolios of smaller companies which can generate a strong flow of tax free dividends. Also, crucially, VCT-qualifying companies can offer the potential for greater returns as they can be pioneering some of the most disruptive, game-changing technologies and services, which if successful, can lead to accelerated growth for the businesses involved.
Then there is the tax-efficiency, with those investing in new VCT shares entitled to 30% income tax relief on investments up to £200,000 per tax year. In addition, dividends paid out to VCT shareholders are tax free while the profits made from selling VCT shares are not liable for capital gains tax.
Returns have remained strong despite a change to the rules in 2015, which obliged VCTs to make all new private company investments in younger businesses seeking growth capital. The most experienced and best resourced VCT managers have been able to adapt their investment strategies, allying their existing knowledge of the SME market with early stage and tech expertise to ensure continued strong returns for investors. For example, Maven’s most recent realisation involved exiting a post-2015 investment in Edinburgh based Symphonic Software through a sale to a NYSE listed US technology business, achieving a 2.9x money multiple return and 90% IRR for investors after less than two years.
According to a survey by the Association of Investment Companies, VCTs showed extraordinary resilience in 2020 despite the challenges of the pandemic, with two thirds of managers saying that trading conditions for their investee companies had improved or been unchanged.
Previous experience of global economic challenges also suggests that the VCT sector is well equipped to play a strong role in future economic recovery. VCT activity recovered remarkably quickly from the financial crisis of 2008. Although fundraising fell 35% year on year to 2008-09, it jumped to £340m in the following financial year and maintained a general upward trend right up until the eve of the current pandemic. This bodes well for VCTs as investors consider the prospect of SMEs contributing to a rapid economic recovery from the current crisis.
Nurturing the next Uber
Some of the highest profile ‘unicorn’ companies currently valued at more than £1bn have their roots in the 2008 crisis. These disrupters such as Uber, Airbnb, and Deliveroo, illustrate the potential for innovators to forge opportunity from adversity. VCTs equip investors with a highly tax-efficient means of funding this innovation, and the ability to invest in a highly tax efficient product, with an exciting underlying portfolio of private companies, often across multiple different emerging sectors.