Venture Capital Trusts – What Are They?
Venture capital trusts or VCTs are exceedingly tax-efficient closed-end composite investment schemes in the United Kingdom. Venture capital trusts were first introduced by the Finance Act of 1995 by the UK Conservative Government. Similar to investment trusts and registered with the London Stock Exchange (LSE), Venture capital trusts provide investments to companies which are not listed with the LSE.
Venture capital trusts are a type of public-traded private equity, providing finance capital to small, unquoted companies with expansion potential, and are designed for capital gains for investors. Venture capital trusts encourage investors to indirectly fund risky trading businesses that function without registration of their shares and securities with the LSE. Therefore, individuals who invest in venture capital trusts, cause other companies to fall under the purview of investment risks.
Having started on April 6, 1995, Venture capital trusts have proven less risky than were initially expected. VCTs can be compared to the United States’ business development companies.
How Do Venture Capital Trusts Work?
Usually, members of large investment companies take up responsibility for managing venture capital trusts. As fund or investment managers of the VCTs, they raise capital from private investors and administer equity for investment in start-up ventures. Individuals investing in venture capital trusts can buy or subscribe shares to invest in trade and help budding companies with capital for expansion. Venture capital trusts will make new investments from time to time following the realisation of gains from earlier investment. If an investor wants to exit, he/she may do so after selling his/her shares.
Venture capital trusts are of three types – alternative investment market (AIM), technology and general VCTs. Some investors invest in all three areas. Of late however, VCTs have become more focused and invest in specific industrial sectors, concentrating their majority assets (barring some asset-backed trades) in well established companies.
Venture capital trusts usually have 3 years to invest 70% of their funds, either as gilts, bonds or cash, in start-up businesses, which are ‘qualifying’ holdings, operating in the UK.
Ordinary shares must amount to 30% of these funds, with the balance in preference shares and loans. 30% of this balance can be in fixed interest low risk securities. Companies receiving investments, including AIM listed companies, cannot exceed £15 million worth assets from venture capital trusts. VCTs cannot invest more than £1 million a year in a holding exceeding 15% of the VCT’s total investment at cost. Also, venture capital trusts investments cannot be made in companies that have more than 50 employees.
Following fulfilment of the above criteria, investors will be eligible for 30% tax relief on maximum investment in every tax year. The whole investment amount can also be set against tax-free capital gain and without deduction of further income tax on dividends received by the investor. The VCT should be held by investors for at least 5 years if they want to take advantage of these tax relief benefits:
- 30% tax relief on income tax due on claim in the tax return
- No tax applicable on dividends received on ordinary shares in the venture capital trusts
- If VCT shares are disposed, investors will not be liable for any capital-gains tax
- Exemption from tax once investment gains have been realised – no tax relief is offered for losses incurred
Return on Venture Capital Trusts
A venture capital trust investment can be made towards both – income generation and capital growth. Return on investment will vary, depending on the performance of the company on which a VCT investment is made. This means incurring losses following failure of some start-up ventures, and also yielding substantial returns on VCT investments from successful start-ups. The outcome of VCT investments cannot be predicted, nor its share prices. Venture capital trusts are investments that involve high risk. Although, there are tax relief advantages, these should not make an investor take hasty, unconsidered decisions.
Buying Venture Capital Trust Shares on the Market
Investors who are not direct subscribers to the VCT shares, i.e., they have bought second-hand shares on the market; will not be eligible for the 30% tax relief on income tax. Second-hand shareholders will also not receive any tax relief for losses incurred. They will however, be eligible for exemption from capital-gains tax following the £200,000 per tax year investment limit. They will also be exempted from income tax on dividends from venture capital trusts.
Choosing a VCT to Invest In
If you are planning to invest in a venture capital trust, your investment considerations must include the following:
- The experience of fund managers employed at venture capital trusts – are they capable of putting the funds that have been raised to good use?
- Obtaining sound professional advice on your investment plans.
- The prices of shares of venture capital trusts are susceptible to discounting more than conventional investment trusts. This is because buyers of second-hand VCT shares are not entitled to tax relief advantages enjoyed by direct VCT share subscribers.
- Venture capital trusts involve risky investments. At no point should the tax benefits relieve you of the need to carefully consider any investment opportunity before investing capital.