John Davies: Will Covid-19 create a dividend dilemma for VCTs?

No part of the economy has been left untouched by the coronavirus pandemic and VCT dividend payments are not immune, writes John Davies. However, he believes tax-advantaged capital has a role to play in the economic bounceback

Tax-free dividends have been a long-standing and fundamental attraction for VCT investors and generally have been well rewarded in recent years. However, with the economy in the grip of coronavirus, the full economic impact is yet to be revealed.

In a year of mind-blowing but vital levels of financial support from the UK government, businesses have at least been able to access short term funding. As we head into Autumn, the job retention scheme appears set to end and businesses will need to work out how to deal with their government-funded loans that will eventually need to be repaid.

Of course, there are some businesses emerging strongly from the Covid-19 pandemic, but a large number will inevitably see supply chains stretched and cash runways considerably narrow in the months to come.

Investing for growth has an inherent time horizon attached and investors will make their judgements on which VCT managers offer the best growth prospects and will likely diversify their subscriptions across multiple providers. But when investors come to consider historic dividend track records, just how relevant will they prove in the current economic climate?

The ongoing ability to be able to make dividend distributions will depend on having distributable reserves available but more crucially, cash on account from which to be able to pay them. With many businesses needing financial help through the pandemic, it could well be that cash which would ordinarily be used in the payment of dividends will be otherwise required to keep the wheels turning within current portfolios.

Existing investors are more likely to see the merit in doing that and such support for their existing investment could be seen as a defensive strategy, but that is far less likely to be an attractive prospect for new or incoming investors.

Big picture

There is also a bigger picture to consider here too. The level of distributable reserves is directly influenced by profits and losses. While profits should increase these reserves, conversely any losses will reduce them. Depending on the composition of VCT portfolios, the trading performance of some of those businesses is likely to have been impacted. On that basis, whether the larger VCTs are able to generate the scale of profits necessary to be able to maintain dividends at previous distributable levels may be highly debatable.

Equally, with some of the larger VCTs, the dilemma may be whether to make dividend distributions of x pence per share, at a cumulative cost to the VCT of several million pounds, or to use those funds instead to support their investee companies through this most difficult of trading periods.

Investors will have a keen eye on this year’s open offers and the objectives behind their fundraising. The expectation will be that new investors will want a clear view to growth opportunities in sectors that have emerged from the enforced lockdown in good shape, and not to necessarily see their subscriptions used to support an existing business which has encountered problems.

VCTs which hold cash or are raising cash to invest in the post-lockdown world, without having to factor in legacy issues resulting from the impact of Covid-19, may prove to be more agile and attractive this year than their longer standing counterparts.

The remaining months in this tax year are likely to continue to be challenging as government support measures become more focussed or are eased significantly.

Brexit almost seems to have slipped off many radars but still looms large, and all eyes will soon be on the Chancellor’s November budget.

Recent market commentary has centred on possible changes to taxation levels which may or may not come to pass. What shouldn’t be in question is the power of tax-advantaged capital in supporting the economy and the part it should play in its recovery.

Tax-free growth and dividends will continue to be much sought after and so homework done in readiness is likely to serve investors well.

John Davies is investment director at Seneca Partners and manager of the Seneca Growth Capital VCT, Seneca EIS Portfolio Service and Seneca IHT Service