Small companies remain the lifeblood of the UK. They are creators of jobs. They are creators of growth. However, support for growing businesses isn’t always widely available.
With traditional lenders remaining parked on the sidelines, Venture Capital Trusts (VCTs) can be an important source of funding and guidance for business in early stage growth, and investing in them can provide the growth component to your investment portfolio.
The financial news is contains many stories relating that money is currently flooding into VCTs with savvy investors taking advantage of the excellent growth opportunities and the tax benefits associated with them. Many may well be using the investment to top up pension pots having already reached their annual allowances, but VCTs are more than just a tax efficient savings vehicle.
It is worth reminding ourselves what a VCT is.
A VCT is a form of investment company that invests in small, largely unquoted companies in the UK of up to £15m in size. The aim is to invest in these companies to support their growth over five or so years at which point the successful firms will be ready to fly the nest’, progressing to ownership under later stage investors, trade exits or in some cases via IPO. The initial funder will sell them and reinvest the proceeds in younger growing businesses, although special dividends to investors on investment exits are frequent.
HM Revenue & Customs (HMRC) grants investors 30 per cent tax relief on a VCT investment. So if you invest £10,000, you get £3,000 knocked off your tax bill. In addition, dividends and growth in the value of the investment is tax free. Most of the profits are paid out as dividends so you'll get a regular stream of tax free cashflows every six months. If you take into consideration that your net cost is only 70 per cent thanks to the tax relief, your net dividend is effectively magnified by the HMRC scheme.
The tax-efficient nature of a VCT is clearly an important aspect for investors and makes them suitable for longer term savings, alongside pensions and Enterprise Investment Schemes (EIS) funds, but, in the eyes of the government, a VCT’s primary purpose should be to seek "higher than average growth" from small, unlisted firms. Their tax-efficient nature should be the icing on the cake.
Indeed, 2015 rule changes by the Treasury and HMRC has meant that all VCTs now need to be focused on more typical venture capital investments, rather than buyout opportunities. In other words, what they were originally designed for – backing growth opportunities.
In simple terms, a VCT is much like any smaller cap UK growth fund.
Clearly earlier stage investments bring higher risks alongside larger rewards. However, a VCT will have upwards of 25 or 30 investments so that risk is diversified. It makes sense to me to invest in companies that have an already proven product and service that is generating revenue.
Fees are an important consideration. Remuneration, over and above the management fee, should come solely as a measure of the performance of the VCT. Some are charging upwards of 2.5 per cent and many over three per cent annually. We would think that unnecessary despite the level of management that goes into running a smaller companies’ portfolio.
The bottom line is, if you know what you’re doing and understand the companies you’re investing in, you shouldn’t need to charge an excessive management fee.
The whole reason the government allows for VCTs is to provide companies access to capital for growth, not to pay money managers through the back door. VCT managers should succeed only when its investors succeed. And it is about growth - at the point of investment our portfolio companies employed fewer than 200 people, today those same companies employ over 5,000.
While investing in VCTs has its risks, just as any investment has, there is a lot to be said for apportioning a small part of a portfolio in well-regulated venture capital trusts.
Many of the smaller companies VCTs invest in, might well be names that you’ve actually heard of.
In our case you could eat at Five Guys, be dressed in clothes by designer brand ME+EM, and ride home on a bike guided by a Blaze headlight, the bike light firm that has just been installed on every Santander bike (the one that beams a green outline of a bike in the road in front of it).
The UK is a nation of small businesses and there is a large pool of them that have promise and proven capability that just need access to capital. This is what VCTs can and should provide, and at the same give investors the tax breaks to invest in their growth.
VCTs should be seen a growth-oriented smaller companies fund investing in and run by entrepreneurs. They just happen to be tax-efficient.
The added benefit… you are funding the UK’s entrepreneurial spirit and helping to create jobs.