Everything you need to know about venture capital trusts

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Small businesses struggle to raise investment capital because they have little assets, brand image, or financial backing needed to grow and grow.

A Venture Capital Trust (VCT) is a fund created by the government in the 1990s to support investment directly in small private companies, with generous tax incentives for shareholders.

The downside is that the associated risk of business failure is quite high. However, global names such as Twitter, Microsoft and Amazon have become publicly traded companies with huge success thanks to VCT funding.

For investors, the big plus is tax relief, with an upfront 30% relief from income tax, tax-free dividend payments, and capital gains tax (CGT) exceptions. ).

Statistics from HMRC Venture Capital Trust show that in the 2019/20 tax year investors claimed £575m in income tax relief compared to £645m in income tax relief. shares issued.

How VCT Works

Although a VCT company must meet several conditions, the fund operates in much the same way as a conventional investment trust with additional tax relief for shareholders.

The concept is that the fund pools money from investors and uses this collective investment to provide funding to eligible companies, usually by buying shares.

Investors often choose a VCT over other incentive investments because the funds provide access to a broader equity portfolio.

Note that investors own shares in the VCT, not the companies in which the VCT buys a stake, and you need a formal tax certificate to claim tax relief.

VCTs are listed companies, listed on the London Stock Exchange and must:

  • Publish an annual set of financial accounts and reports.
  • Hold independent board meetings to protect shareholder interests.
  • Invite shareholders to meetings, including an annual general meeting (AGM).
  • Comply with corporate governance rules.

Trusts must adhere to HMRC rules to ensure that the VCT meets government objectives and directs capital to small businesses within targeted awards.

To be eligible for VCT investment, businesses must have permanently established premises in the UK and be undertaking qualifying trade, excluding a few specific sectors which the tax office says do not require funding in additional capital.

Trades excluded include financial activities, agriculture, hotel management, energy production and forestry.

Advantages of investing in a CDV

VCTs have considerable growth potential and allow investment in smaller unlisted companies.

Although risk analysis is essential, a micro-enterprise or a start-up has greater potential for rapid evolution than a less agile company.

The main benefit is the tax relief, which applies to investments up to £200,000 a year, including:

  • Up to 30% income tax relief, provided you hold VCT shares for five years. So an investment of £10,000 gives you an immediate £3,000 reduction in your income tax bill.
  • Non-taxable gains, whereby a sale of VCT shares with a resulting profit will not create a CGT liability.
  • Tax-Free Dividends – VCT dividend income does not need to be reported and is not taxable.

Investment cycles in small companies are somewhat different from those in more established companies, so many investors decide to buy VCT shares partly for tax relief and partly as an exercise in diversification.

The risk profile is inevitably higher, but stocks of VCT can offset retirement products or long-term investments as a valuable retirement planning strategy, particularly if you reach the annual pension contribution limit or lifetime allowance.

Understanding the risk of VCT investments

Every investment carries an element of risk, although the nature of an unlisted company makes it more of a guessing game than buying stocks with a long track record.

There is no guarantee that you will make a profit or that every investment company will be successful, so taking financial advice is highly recommended.

Potential pitfalls to VCT investing can be:

  • The long-term nature of the investment, with a minimum retention period of five years. If you sell the shares early, you must repay the income tax allowance.
  • Difficulties selling VCT shares without an active market. Finding a buyer or demonstrating the value of your shares can take time, which often means you get a price below NAV.
  • Changeable tax rules, with the ability for HMRC to change qualifying criteria.

VCT status is not granted indefinitely, and if your investment fund owns shares in a company that ceases to maintain VCT classification, all tax benefits are removed.

If this happens within the first five years, any relief you have claimed will need to be repaid.

Different Types of Venture Capital Trust

There are three types of VCT, although most fall into the first category.

General VCT investments

Around 75% of VCTs are generalist funds, which invest in a range of companies from different sectors, creating a highly diversified investment portfolio.

Each VCT will have an overriding objective, so it may focus on start-ups that have not yet made a profit or perhaps select organizations with a specific maturity.

Alternative Investment Market (AIM) VCT

AIM is the junior counterpart to the London Stock Exchange and was launched alongside VCTs to similarly support the growth of small businesses.

Companies listed on AIM must meet regulatory conditions with a daily stock price.

AIM is an exchange, so it is easier for investors to buy or sell stocks than through other VCT structures.

Specialized VCT funds

A specialized VCT is a fund with a more defined objective and generally invests in sectors such as biotechnology, infrastructure or energy.

Investment risk is higher because there is no diversification between different industries, but returns may be better if the specified sector performs well.

All you need to know about venture capital trusts FAQs

What are the qualification rules for companies seeking VCT investments?

Companies looking to raise capital must meet several conditions and must have been trading for at least seven years since the first sale.

There are caveats where more established companies might qualify if they want to raise a significant amount of money to develop a product or enter a new market.

Companies must have gross assets of no more than £15 million at the time of the VCT investment, or up to £16 million once the increase is complete, and have fewer than 250 full-time employees.

VCTs can choose to invest up to 15% of the total value of the trust in a single business. The recipient company can accept up to £5m of tax-advantaged funding (through VCT or schemes such as SEIS or EIS) per year, with an overall cap of £12m.

How to claim tax relief for a VCT investment

Once you have made your stock purchase, you will receive two different certificates:

  • A share certificate required if you decide to sell your shares
  • A tax certificate which you need to claim income tax relief on your next HMRC return.

PAYE taxpayers can contact HMRC and request an immediate adjustment to the tax code to reflect the lower liability in their monthly payroll deductions.

Alternatively, they can leave it until the end of the tax year and submit a self-assessment tax return to claim a refund for the 30% relief.

What is the easiest way to buy VCT shares?

Investors have two main options. One is to apply for shares in a VCT when it is open to new investment, called a new share offering.

After reading the stock offer, you will need to submit an application form and make payment, usually via online banking.

Another option is to invest through a financial advisor or an online investment platform. Most digital platforms will require you to sign a waiver confirming that you have sought independent advice before making your investment.

It is also possible to buy VCT shares on the open market since the VCT itself is a listed company. Most investors buy through a broker, although used stocks do not have the same level of tax relief.

Second purchases of VCT remain eligible for tax-free dividend payments and exemption from CGT and still count towards the maximum limit of £200,000 for each tax year.

What is the best way to balance an investment portfolio with VCT shares?

The balance of your portfolio will depend on your risk appetite, other assets, whether you have a concentrated investment in a specific sector or asset class, and what you want to achieve.

VCTs must invest at least 80% of their portfolio in eligible companies. They may hold the balance in cash or cash equivalents, so it’s important to understand the purpose of your selected VCT and what types of assets or businesses they prefer to invest in.

Can I sell VCT shares?

You can, but it can be tricky because a previously held VCT share will not provide tax relief.

Most investors sell their VCT shares when business owners decide to redeem the VCT shares, usually at a discount to the net asset value.

If you sell before the property is five years old, you must report this to HMRC and repay any tax relief you have claimed.

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