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Money invested in venture capital trusts surged following the announcement that the government will slash the tax-free allowance for dividends. It will halve to £1,000 this year, and again to £500 from 2024.
Figures from Wealth Club show £9.8 million was invested in venture capital trusts (VCTs) through its investment platform in the two weeks following the autumn statement, up from £4.1 million in the same two-week period last year.
“The chancellor’s announcement was brutal for higher earners and investors. Many allowances will be frozen until 2028 and the dividend and capital gains tax allowances are being slashed. It’s no wonder more people are considering alternative investments,” said Alex Davies, founder of Wealth Club.
Below, we explain how VCTs work and the risks involved. We will cover:
- What is a venture capital trust?
- VCT tax rules and relief
- The risks of VCT investing
- ‘I’ve invested £150,000′. VCTs will be my pension’
- What VCTs can I invest in right now?
What is a VCT?
Venture capital trusts were established almost 30 years ago to encourage investment into new companies.
VCTs are public companies listed on the stock market. They invest in smaller, innovative firms that may struggle to raise funding from banks and other mainstream sources.
VCTs are considered high-risk because they invest in companies that are not well established. They are considered long-term holdings, and you should be prepared to stay invested in the shares for at least five years.
Investors can buy shares in VCTs through a stockbroker or specialist investment platforms.
VCT tax rules and relief
VCTs are typically favoured by high earners looking for ways to reduce their tax liability.
Investors can invest a maximum of £200,000 in VCTs each year and benefit from 30% income tax relief on a new investment. VCTs are also not subject to capital gains tax when investors come to sell.
Crucially, the main benefit for many people is that dividends are tax free; many VCTs aim to pay annual dividends of about 5%. This benefit will become even more attractive when the general tax-free dividend allowance is halved in April 2023.
To benefit from the 30% income tax relief, investors must put their money into new shares that are issued during a VCT’s fundraising offer. They must hold that investment for five years to keep the relief.
VCTs typically fundraise once or twice a year. Once the fundraising target has been met or the deadline has been reached, investors cannot buy new shares. They can still do so on the secondary market at any time, but they will not benefit from the initial tax relief.
Find out more about VCT tax relief on the Government’s website.
What do VCTs invest in?
The government offers tax relief incentives because VCTs fund small businesses and therefore support jobs and economic growth.
A company must have gross assets of £15 million or less and fewer than full-time 250 employees to qualify for VCT investment.
There are three types of VCTs:
- Generalist VCTs: invest in a wide range of private firms
- Aim VCTs: target new shares issued by companies listed on the junior market of the London Stock Exchange
- Specialist VCTs: focus on one sector and will have a narrower investment objective
High-profile companies that are currently backed by VCTs include jewellery brand Monica Vinader and food subscription service Oddbox.
The risks and downsides of VCT investing
Investing in VCTs comes with a high level of risk. It could be many years before a start-up is profitable. Start-ups often go out of business and shareholders could lose all of their investment.
VCTs try to avoid this by investing in a range of companies, with the aim of backing more successes than failures.
Investors should also be aware that VCTs typically charge higher fees than mainstream investment funds or trusts. The annual management fee is usually about 2% and initial charges are likely to be higher.
It can also be difficult for investors to sell a VCT holding, as “second hand” shares do not offer the upfront tax relief for investors. The trusts do offer the option for investors to sell back their shares, but at a discounted rate.
‘VCT dividend income will be my pension’
Mark Cortacans, 60, a tutor based in London, has been investing in VCTs since 2016.
He has a total of around £150,000 invested in VCTs, and receives dividend income of £8,000 a year. The plan is for this dividend income to top up his state pension when he retires in a few years’ time.
One ought to be mindful though, that past performance is not an indicator of future results, and dividend distributions are never guaranteed.
“I’d never considered VCTs before, but when the government started taxing dividends more heavily in 2016 I saw the benefit of an investment that could produce tax-free dividend income.
“I think it’s a disgrace that the dividend tax-free allowance is about to be reduced. With the rise in the state pension age to 67 by 2028, and limited employment opportunities for people in their late 50s and 60s, dividends are an alternative retirement income strategy.
“VCT finance helps support British innovation and the economy – VCTs invest in innovative smaller companies and therefore create local and highly skilled jobs, as well as regional prosperity and economic growth,” he says.
Mark owns shares in 20 VCTs including those operated by Albion, ProVen, British Smaller Companies and Pembroke.
He does not use a financial adviser, and does his own research to decide which VCTs to invest in. He reads the key information documents (KID), attends webinars held by the fund managers and reads relevant news online.
But watch out for fees
“I don’t earn big money, so for me the draw is not the upfront income tax relief – just the tax-free dividends,” Mark says.
He doesn’t plan to sell and sees his VCTs as a long-term investment. “I also like the fact I’m helping UK businesses to grow and it’s a good way to help the wider economy.
“The big downside of VCTs are the fees. VCT managers will determine the net asset value (NAV) when you buy new shares and you will likely end up paying more than you think. Then there’s annual charges. When you come to sell, the VCT buys back the shares at a discount.
“For me, this shouldn’t be an issue because I hold my VCTs for income. But others should be aware that VCTs are not always easy to sell.”
What VCTs can I invest in right now?
These are some of the venture capital trusts that investors can currently invest in:
- Albion
- Baronsmead
- Blackfinch Spring
- British Smaller Companies
- Calculus
- Edition
- Foresight Enterprise
- Foresight Williams Technology
- Guinness
- Hargreave Hale AIM
- Maven Income and Growth
- Mobeus
- Molten Ventures
- Northern
- Octopus Apollo
- Octopus Titan
- Pembroke
- ProVen
- Puma
- Seneca Growth Capital
- Thames Ventures
- Triple Point
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