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If your client could benefit from investing in a VCT, Jessica Franks, Head of Tax, Octopus Investments highlights some key things to bear in mind when doing your research.
Venture Capital Trusts (VCTs) have become an important part of many clients’ portfolios. Where clients use their full ISA allowance and are restricted in making pension contributions, VCTs offer a complementary way to invest for the future tax-efficiently.
VCTs are listed investment companies that support innovation in the UK by encouraging patient investment in early-stage unquoted or AIM-listed companies. Because the smaller companies a VCT invests in can struggle in their early years, and some will not be successful at all, VCTs offer tax reliefs to compensate for some of the investment risk.
These incentives include 30% upfront income tax relief on the amount invested up to £200,000 in each tax year, and tax-free dividends. To keep any tax relief claimed, VCT shares must be held for a minimum of five years.
So what are some important things to consider when researching a VCT for a client?
Does the client understand the risks involved?
It’s important to recognise that VCTs will not suit all individuals because, even with the tax reliefs in place, there is risk involved.
A client will need to appreciate that the value of a VCT investment, and any income from it, can fall as well as rise. VCT shares are by their nature high risk, their share price may be volatile and they may be hard to sell. That means the client may not get back the full amount they invest.
Also, tax treatment depends on individual circumstances and could change in the future. The ability to claim tax reliefs depends on the VCT maintaining its VCT-qualifying status.
How well does the VCT manage concentration risk and volatility?
When investing in VCTs, there are two elements to consider from a performance perspective, first is the growth in Net Asset Value, and the second is the dividend stream. It’s worth bearing in mind that VCTs typically pay out much of their growth as income, and that dividends paid by a VCT are tax free.
A lot of investors really like the tax-free income that a VCT can provide. If this is true of your client, it makes sense to recommend a VCT with a large and well-established portfolio. That’s because this can give a greater degree of confidence that the client will see a steady dividend stream.
Of course, there are never any guarantees, especially since VCTs are high risk products. That said, a large and long-running portfolio brings certain benefits.
The larger the VCT, the more companies it is able to invest in, which increases diversification and simply spreads risk across a larger number of companies. This can also deliver greater diversification by sector and brings the potential for steadier performance across market scenarios.
More established VCTs will also tend to hold companies at various stages of maturity. Some companies may have been held for a number of years and therefore be more established businesses, others will be very early stage, and therefore have greater growth potential. These young companies are also likely to be at a higher risk phase in their journey. This mix of maturities can bring the potential for steadier performance.
VCTs with a smaller number of investments might see a spike in their share price if one of its companies does well, but the reverse is also true in a downside scenario.
What is the capability and experience of the investment team?
Along with diversification, investing with a manager who has experience of making early-stage investments and works closely with the companies it invests in is critical.
Like any investment, when researching VCTs it’s important to understand the management team. VCT managers need to have vision beyond a company’s current standing and focus on the long-term potential that could be realised with the right funding.
So a team’s history of performance, their track record of successful exits (and failures they’ve learned from), and how well they’ve supported the growth of the companies invested in are all extremely important.
A VCT is taking a minority stake in an early-stage company, so the fund management team are coming in to support the business and help it to grow. But it’s not just the investment of money that smaller companies benefit from. Companies benefit from exposure to the experience and knowledge of a specialist investment management team.
You’ll want to see evidence of a team that has worked with the companies they back to make their success more likely. This might be looking at a business plan and seeing where things could be changed for the better, based on many years of working in a market. It might also include taking a seat on the company’s board, helping them expand overseas or introducing them to industry experts.
There’s also the scale and reach of the fund management team to consider.
Does the VCT have sufficient deal flow?
To build a diversified and successful portfolio over the long term, it’s necessary to have good deal flow. Deal flow is the term investment managers in the space give to a pipeline of quality investment opportunities.
A large investment team, with a recognised profile and strong connections is better able to source a large number of opportunities to choose from.
The best teams will want to be highly selective about investment, as will the company invested in when choosing a finance partner. So it’s important for the investment team to have a good reputation for adding value beyond the finance. In fact, many entrepreneurs will seek out the best known and largest teams, because they are familiar with previous successes and the quality of the support on offer.
A team like Octopus Ventures, who manage the UK’s largest VCT(1), are highly selective. They review thousands of companies every year, but typically select less than 1% for new investments. This can only be achieved with a large team and recognised track record.
More information on VCTs
Octopus Investments has years of experience in managing VCTs, and currently manages around a quarter of all VCT money through its three VCTs.
For more information on VCTs, visit: https://octopusinvestments.com/vct
(1)The Association of Investment Companies, December 2020.
VCTs are not suitable for everyone. Any recommendation should be based on a holistic review of your client’s financial situation, objectives and needs. We do not offer investment or tax advice. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: February 2021. CAM01069
