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VENTURE CAPITAL trusts are rightly celebrating a quarter century since their birth. This is the most tax- efficient way to back small businesses and to share in their success.
The initial venture capital trust ( or VCT) launched in 1995, the same year as Jupiter was orbited for the first time, Starbucks introduced the Frappuccino, Disney played Toy Story to packed cinemas and the World Trade Organization was formed.
A VCT is a stock exchange quoted fund which invests at least 80 per cent in small enterprises with a high potential for growth. The capital raised must be invested within three years and the balance held either in cash or used to finance other deals.
To be eligible for VCT backing, firms can have up to 250 staff and no more than £ 15m assets. Unless they are ‘ knowledge intensive’ companies, they cannot have traded for more than seven years. VCT managers, most of whom charge performance fees, look for proven concepts which are already generating revenues. “They are not playing Dragons’ Den,” quips Jason Hollands from Tilney.
Although the 61 VCTs are stringent in their selections and £ 619m was raised in the last tax year, this is a relatively high risk area and should be regarded as a long- term saving.
The Government wishes to back small enterprises and gives several tax carrots to investors: no capital gains tax, no income tax on dividends, if invested at launch and held for five years, 30 per cent tax- relief.
Unlike ISAs, investors are not restricted to one provider but each year can choose as many VCTs and different management groups as they like with a total overall limit of £ 200,000.
The dividend advantages apply to purchases with new VCTs and on the secondary market. Whilst VCTs are listed on the London Stock Exchange, there is little trading. “No- one wants to be selling within the first five years if at all possible as this would trigger a claw- back of the income tax credit,” warns Hollands.
When selling, he urges not to use online trading accounts as “a sensible price is unlikely.”
Nearly all VCTs now have regular share buy- back mechanisms in place and therefore it is wise to deal through a broker to can speak to the market maker and ensure your shares are purchased through the next buy- back.
A monumental £ 8.7bn has been raised since 1995. The UK is third in venture capital funding behind the US and China. Three categories are offered: general ( 41), specialist ( 12) and quoted on the Alternative Investment Market or AIM
( 8). The specialists range from environmental, healthcare and biotechnology to media, leisure, events and technology.
Over five years, Albion Capital’s Crown Place has been the most successful with a 51.3 per cent share price total return, followed by Downing Four D with 50.2 per cent. Crown Place actually merged with the oldest VCT, Murray. With results specially secured from AIC/ Morningstar for The Yorkshire Post, the top duo over a decade are Mobeus Income & Growth 2 and Albion Capital’s Kings Arms Yard. They achieved 422.6 and 361.7 per cent share price total return.
Northern is the longest running VCT with a listing since November 1995, followed by Baronsmead. The former has returned 418.7 per cent whilst the FTSE 100 is up 304 per cent and inflation ( CPI) by 61.1 per cent over the same period.
Share performance for VCTs should be treated with caution as many of the early ones did not try to maximise returns but were run essentially to extract the tax breaks. Others focused on management buy- outs. Today deals must be growth capital investing.
Often early stage companies are illiquid. The scandal of having to sell unlisted catatonic equity held by Neil Woodford’s funds at discount prices has made some investors more cautious.
Pembroke VCT B focuses on unlisted companies but the serial entrepreneur behind it, Peter Dubens, has a record of success. He has backed such businesses as Boom Cycle, which operates high intensity work- out classes, the UK franchise of Five Guys burger chain, and nutmilk drink Plenish.
Darius McDermott, from Chelsea Financial Services, says the five- year holding rule does not apply when buying through the stock market. His research shows VCTs that have invested in fledging firms with better trading through coronavirus. They include Mobeus with Virgin Wines, Parsley Box ( a meal delivery service) and My Tutor ( online tutoring).
Richard Harwood, from wealth manager Brewin Dolphin, in Leeds, says that the approach to VCTs has changed over the years: “From a relatively niche vehicle used by experienced investors, they became seen as more mainstream along with the mass marketing of EIS ( Enterprise Investment Scheme) in the last decade.” He has heard of investors using them as an alternative to pension contributions.
If investing in Yorkshire firms appeals, look at two funds managed by Dave Hall and his experienced team at YFM – British Smaller Companies VCT and VCT 2 – which launched in 1996 and 2001. Their top 10 choices received around £ 9m and have returned approximately £ 80m. They include David Brown of Huddersfield ( automobile parts), Hunters of Leeds ( printers), Sarian Systems of Ilkley ( design, manufacture and sales of IP routers) and President Engineering, Sheffield. Whilst most VCTs invest in unquoted firms, a fund using those listed on AIM can appeal. Amati AIM VCT is raising £ 25m by the end of October. McDermott says its lead holding, the gaming company Frontier Developments, has seen its stock price double since March. Amati AIM has been “the strongest performing AIM VCT in recent years and provides exposure to a diversified existing portfolio of both mature holdings backed in the past and newer early- stage investments,” says Hollands. Another AIM one is Hargreave Hale which is seeking £ 20m. Its holdings include defence technology and the Everyman cinema chain.
James Rowbury, at Redmayne Bentley, says VCTs are “a gateway to access some of the most exciting, high growth companies”. However, he warns that firms are often highly indebted and require consistent rounds of funding to achieve growth. Rowbury likes Downing Four which has around 30 investments. He looks for financially viable firms and ones which make an impact on society and the wider economy. Dividends can be paid from two sources, says Hollands: profits made on disposals within a VCT and natural income created.