Back in 1998, Norman Cook – better known to some as Fat Boy Slim – launched his most successful album, You’ve Come A Long Way, Baby. And without wishing to upset any readers – yes, it was 20 years ago this year. Feeling old? Don’t worry, you are not alone.
If back then you were busy dancing to The Rockafeller Skank, you could be forgiven for not noticing venture capital trusts (VCTs) were starting to gain in popularity, as those who had made gains in the tech boom of the late 1990s sought to shelter their gain.
Many investors and their advisers might not remember VCTs were once a capital gains shelter vehicle but this illustrates two points – first, how long VCTs have been around as an established part of the investment landscape and, second, how much they have evolved over that time.
Over the past 20 years, VCTs have raised over £6.5bn for investment into smaller companies. Please note, the word ‘smaller’ is key here as it is a common myth surrounding VCTs that they target start-up or seed companies only. VCTs can invest into companies that have experienced management, established track records of revenue generation and significant assets within the company.
The VCT market has evolved over this time into three types. First, the generalist VCTs are the longest established and look to invest into the equity of predominantly unquoted companies and, hopefully, grow those companies over time. When the generalist VCT manager gets it right, there is potential for them to make significant gains on their investments. Companies such as FatFace and Zoopla are examples of household names that have benefitted from VCT investments.
AIM VCTs, the second type, look to invest into the new issue of VCT-qualifying companies listing on the Alternative Investment Market (AIM). The benefit here is the companies they invest into are listed, which should increase the underlying liquidity of the investments in an AIM VCT. They are, however, restricted to investing towards the lower end of the capitalisation scale of the AIM market due to the VCT-qualifying rules.
The third type is the ‘limited life’ or ‘planned exit’ VCTs. These managers look to invest as a combination of debt and equity in the underlying companies, and target businesses that typically own an asset associated with their trade, such as garden centres, nurseries and pub chains.
It is important to understand that, while these VCTs probably cannot generate the same level of returns on an individual investment as the generalist or AIM VCTs, they often have less downside risk due to the asset within the company providing a fall-back position if the business does not perform as expected.
They can also offer investors a more predictable dividend stream from the debt element, as well as a defined end date of the VCT. Investors in generalist and AIM VCTs have to sell their shares in the relatively illiquid secondary market to achieve an exit or ask the VCT manager to ‘buy’ their shares back at a discount to the prevailing net asset value.
Right Here, Right Now
Now is the time of year when VCT investments come to the fore. Investors who have maximised their pension contributions, or in some cases are unable to make any pension contributions due to the lifetime allowance, are looking to VCTs to help maximise their tax-efficient investments.
The deadline to invest is tax-year sensitive and, at this time, many VCTs are starting to close, having reached their required fund-raising level. Advisers need to act now if they are to ensure their clients get into the most suitable VCTs and to avoid a last-minute rush at the end of the tax year.
As with all venture capital investing, it is important to ensure clients look at any VCT investment with a six to eight-year time horizon and that any investment fits the investment objective and risk profile of the client. Diversification is, as always, the key to risk mitigation and, if they can, advisers should seek to split a client’s VCT investments across all three of the different types of VCT mentioned above.
VCTs have shown remarkable resilience over the past 20 years and have undoubtedly helped smaller UK companies to grow; which in turn has created jobs and capital expenditure that has benefitted all of the UK economy.
The last Budget, at the end of November 2017, introduced a few well thought out changes to the investments VCTs can make, without materially affecting the investment strategy of the aforementioned three VCT sectors. Hopefully in another 20 years, we can write another article to scare the Millennials on how time has passed.
Hugh Rogers is business development director at Puma Investments