Venture capital trusts’ growing popularity is being underpinned tax advantages and growth, says Ewan MacKinnon, Partner at Maven Capital Partners.
Sharply higher bond yields, rising interest rates and upward inflationary pressures, along with a currency on the slide and the spectre of recession – these are not a recipe for a stable market or decent investment returns in stocks, bonds and cash. But other asset classes, notably alternatives, still offer good investment opportunities, with the prospect of high returns and tax efficiency making venture capital trusts (VCTs) increasingly popular.
The global alternatives sector’s assets under management (AUM) are forecast to hit $23.21 trillion by 2026, nearly double the $13.32 trillion at the end of 2021.[1] Popular alternative assets, such as real estate, infrastructure and natural resources, have offered investors income, diversification and the prospect of enhanced returns. But it’s the tax incentives and impressive returns that have seen VCTs attract investment in the UK exceeding £6.3 billion.[2]
VCTs are UK listed investment funds which raise money only from private investors. They focus on investing in and providing support for young UK-based companies that are generally less than seven years old. These companies are among the fastest growing in the country, innovative, and an attractive proposition for potential investors.
VCT tax efficiency gets mini-Budget boost
During 2020-2021, £688m was invested in VCTs, strongly suggesting that the benefits of this investment vehicle are becoming increasingly obvious to investors. That appeal will likely grow further following the UK Government’s confirmation of an extension to the VCT tax relief scheme beyond 2025.[3] VCTs have invested almost £1bn during the same period which has seen them raise funds in the current tax year.
The scheme enables VCTs to invest in earlier stage private and AIM listed companies, and benefit from 30% tax relief in advance if the investments are held for five years, with both dividends earned and capital gains also tax-free.
For investors, the alternatives hardly excite. Double-digit inflation and sterling at its lowest level since the mid-1980s – down 20% against the US dollar this year – means holding excess cash is not recommended. Gilts aren’t any better, with borrowing needs set to soar alongside rapidly rising borrowing costs. The Bank of England’s 50 basis-point rise in the base rate to 2.25% on 22 September is not even half-way to the forecast peak of 5% in 2023.[4]
Elsewhere, investors will likely sit on their hands when viewing the prospects of the FTSE 250 index – comprising mid-sized companies closer in size to those in which a VCT would invest – which has fallen 25% this year. During the past decade, the FTSE 250 averaged just 5% growth annually[5], in contrast to an annual return of 15% by European buyout funds during the same period, according to the European Private Equity and Venture Capital Association.
VCT-invested companies see very strong revenue growth
Noteworthy too is that almost half of venture capital trust (VCT) investments are in companies seeing revenue growth of more than 25% year-on-year, compared to 5.9% for London Stock Exchange-listed companies.
Maven has more than £660m of assets under management including four VCTs. It is helping its investors benefit from supporting some of the UK’s most dynamic growth businesses to weather the economic downturn, while also enjoying the tax advantages. Since 2016, Maven VCTs have invested in more than 40 companies.
With investors allowed to invest up to £200,000 a year in a VCT and receive up 30% income tax relief – or £60,000, any growth thereafter is tax free and normally paid through tax-free dividends. This automatically builds in an advantage compared to taxable dividends. For example, a tax-free dividend of 5% would be the equivalent to a taxable dividend of 7.41% (higher-rate taxpayers) or 8.1% (additional-rate taxpayers).[6] There is also currently no capital gains tax on VCTs.[7]
The merits of having VCTs as part of a balanced growth portfolio are clear. But what also attracts investors is being able to help innovative up-and-coming British businesses. VCTs currently support over 1,000 young UK businesses, employing more than 70,000 people[8], and by extension supporting the broader economy. Several UK unicorns, including Depop and Zoopla, were backed by VCTs in their early days.
Economic crises can spur change and the creation of new disruptive, high-growth companies. VCTs present an alternative investment that offers a way tap into those young dynamic high-growth businesses, while also enabling investors to diversify so as to drive innovation, economic growth and UK business. It’s just possible too that they will find the next new, new thing.
[1] https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/global-alternatives-aum-forecast-to-double-by-2026-topping-23-trillion-68404362
[2] https://vcta.org.uk/news/2022/6/9/vcta-responds-to-treasury-select-committee-inquiry-into-venture-capital
[3] https://vcta.org.uk/news/2022/9/23/vcta-welcomes-extension-of-vct-scheme
[4] https://www.reuters.com/markets/europe/new-uk-finance-minister-kwarteng-seeks-end-cycle-stagnation-2022-09-23/
[5] https://www.google.com/search?client=firefox-b-d&q=ft+250+chart
[6] https://www.wealthclub.co.uk/vct-tax-relief/
[7] https://www.gov.uk/guidance/venture-capital-schemes-tax-relief-for-investors
[8] https://vcta.org.uk/news/2022/7/5/vcta-appoints-will-fraser-allen-as-new-chair
