About Venture Capital Trusts What are VCTs?

A Venture Capital Trust is a quoted collective investment vehicle similar to an Investment Trust. General features include:

Other rules for VCT managers to follow are that at least 10% of any one qualifying investment must be in ordinary shares of the investee company and that across the portfolio at least 30% of holdings must be in ordinary shares. The maximum investment in any one company must not exceed 1 million in a single tax-year; two investments must be separated by at least six months. Investments in any one company must be less than 15% of total investments and the VCT may not retain more than 15% of the income it receives from shares and securities.

A VCT is like a large portfolio of EIS qualifying companies, but with different tax breaks. For an investment of up to 200,000 in any one tax-year, investors receive:

In addition to the tax rebate, the key benefits of a VCT are its investment in a portfolio of companies, which reduces risk and the income stream from tax-free dividends that also include realised capital gains.

Unlike EIS, VCT shareholdings will form part of an investors estate and will therefore be subject to IHT on death. The industry is lobbying for a further concession here so we await possible news in later budgets.

Although they are quoted on the main exchange, VCT shares may be difficult to sell. This is mainly because the largest tax advantage (the 30% income tax relief) only applies to the purchase of new shares, so that no active secondary market has developed. In addition, investment trust shares usually trade at a discount to the net asset value (NAV). The average stockbroker is therefore unwilling to take VCT shares and the price will be unattractive. However, many VCTs now offer a buy-back policy, which should mean you should receive a price at about a 10% discount to the NAV. This can never be guaranteed. If you are buying VCT shares it is worth checking whether the trust has a buy-back policy. If you are selling VCT shares, always check with the fund manager to find out your best course of action.

For further details on VCT benefits there are a number of booklets published by the providers. You can also see details on the Inland Revenue website at http://www.hmrc.gov.uk/guidance/vct.htm

There are two main types of VCT: Generalist and AIM. The terms are a little misleading. Generalist strictly refers to the sectors in which the VCT invests, but has come to mean VCTs in which the majority of investments are in unquoted companies - i.e. the shares of the company are not quoted on any market such as AIM or OFEX. AIM VCTs, as the name implies invest almost exclusively in shares quoted on the Alternative Investment Market (AIM) of the London Stock Exchange. They may also invest in some OFEX (the Off Exchange market run by PLUS Markets Group plc) quoted shares or unquoted companies approaching an IPO (initial public offering) on AIM.

AIM VCTs are more like traditional investment trust or unit trust/OEIC funds in that the manager selects target companies in which to buy and sell shares. However, the big difference is that VCTs can only invest in new shares, so the fund manager must ensure that offers are received from as many brokers as possible. Normally his investment is limited to ordinary shares so that there will be no certainty of income in the short term. However, when the quoted prices of shares in investee companies rise the manager can take capital profits and distribute these to the shareholders.

The net asset value (NAV) of AIM VCTs is simply the market valuation (usually bid or indicative selling price) of all the underlying stock holdings. AIM VCTs can therefore theoretically arrive at an up to date NAV with little difficulty. Some publish more than once a week - others still only six-monthly with the interim and final accounts. We are obviously keen to see NAVs published frequently.

In contrast to AIM managers, generalist VCT managers reflect the world of the true venture capitalists who invest in unquoted businesses in the hope of making profits when these companies are floated or sold to an acquiring company. The fund manager obtains opportunities to invest (deal flow) from a network of contacts - corporate financiers, accountants, lawyers and other advisers who are in contact with their local business communities.

The VCT investment team will take considerable care in the selection process. Due diligence will include analysis of the accounts and key contracts, understanding the business and its market, evaluating competition, checking with customers and suppliers and of course assessing the management team and key employees. The VCT may also have to sell itself as financier to good investment prospects who may have other options. Finally, a deal is put together in which the VCT can split its investment between ordinary shares and a range of interest bearing loans or other instruments.

Some generalists favour repeat investments in companies. Their knowledge of the companies is greater having worked with them and the company may benefit from further funds at critical times in its development. Other managers will move in the direction of increasing the size of the portfolio to reduce risk.

Few VCTs invest in start up companies these days - too many have failed in the past and investors are shy of taking such risks again. But there are one or two specialists who perhaps have the knack of picking the one or two exceptional investments whose growth potential is mathematically far higher than that of any established business. Most VCTs will favour either an investment where the company needs development capital for the next stage of growth or for a management buy-out where the managers of an existing business can thrive outside the constraints of the previous parent.

Some VCTs invest in specific market sectors e.g. biotechnology, healthcare, media or renewable energy. In turn these may be AIM based, generalist or a mixture of the two. The best performing VCT of all time is a technology specialist and has proved its competence by investing in more than just one stellar performer.

To reduce risk, sector specialist VCTs aim to substitute spreading investments with an in-depth knowledge of a sector in which high growth potential exists.

Strategies can differ in other respects also. Many VCTs place the un-invested funds into safe interest bearing securities such as gilts or other cash investments. The performance of this part of the fund will not be exciting, but where some VCTs put this money into equity investments, their managers run the risk of market downturns depleting the fund before qualifying investments are made.

It is easy to see that fund managers of generalist VCTs have a different role from their counterparts in at the helm of AIM VCTs. Likewise the investor may see differences in performance. A generalist VCT will take time to invest, will not realise investments early, but may produce income from part of the qualifying investments as well as from non-qualifying cash or other short-term securities. We have discovered there are no rules. AIM companies may be larger and better established than the majority of unquoteds, but their valuations fluctuate with the volatile AIM market and have as often disappointed as delighted. An investor should probably try to construct a portfolio of both types - with some specialist VCTs as well

more information on VCTs