What is a VCT?
Venture Capital Trusts explained
VCTs (Venture Capital Trusts) are investment companies that are listed on the London Stock Exchange and set up to invest in small UK businesses that meet certain criteria. To encourage support for these businesses the Government offers generous tax benefits for VCT investing. This also reflects the higher-risk nature of the companies they invest in.
What do VCTs invest in?
Venture Capital Trusts invest in small or early-phase businesses that are either unquoted or listed on AIM (the London Stock Exchange’s market for growth companies). These businesses need investment in order to develop. They can potentially give you a high return, but they can also be much riskier than larger, more established companies.
Small businesses need investment to grow – potentially giving investors a high return but with more risk.
There are strict rules on which companies are eligible for VCT investment – find out more in our VCT guide. Each VCT will typically hold 20-70 of these companies, depending on how long it has been running.
VCT tax rules and relief
VCTs offer several tax benefits to encourage investment into higher-risk companies. These tax benefits make VCTs popular among higher and additional-rate taxpayers.
- Income Tax credit
- 30% Income Tax credit on investments of up to £200,000 each year when you buy shares in a new VCT share offer – but you need to have paid at least as much tax as the rebate and must hold the shares for at least five years
- Tax-free dividends
- There is no Income Tax to pay on dividends from VCT shares
- No Capital Gains Tax
- You won’t be liable to Capital Gains Tax when you sell your VCT shares.
History of VCT tax relief
|Tax year(s)||Income Tax credit||Minimum holding period||Capital Gains Tax deferral?|
|1995/96 - 2000/01||20%||5 years||Yes|
|2001/02 - 2003/04||20%||3 years||Yes|
|2004/05 - 2005/06||40%||3 years||No|
|2006/07 - present||30%||5 years||No|
The different types of VCT
There are a variety of strategies to be found on the VCT market. They all invest in smaller companies and give you tax relief, but they are different in their approaches to managing risk and reward.
Most Venture Capital Trusts are Generalist VCTs. These typically invest in unquoted companies across a range of sectors, although some larger VCTs will also hold AIM-listed shares. Generalist VCTs use a range of different approaches. Some focus on young companies that aren’t yet profitable but have strong potential. Others look at more mature businesses and some take an asset-backed approach similar to Limited Life VCTs.
Investments are usually made through a combination of loan notes or preference shares alongside equity in the business. Loan notes and preference shares give the VCT a potential income source. They also have greater security than equity as they rank ahead of ordinary shareholders in the event of a potential wind-up.
VCT management teams often place directors on the boards of unquoted companies they invest in, especially when they are the main shareholder. They monitor the investment and guide the business to an eventual exit – usually a sale to another investor or trade buyer, but sometimes a stock market listing.
Limited Life or Planned Exit VCTs
Although all VCTs are higher risk investments, Limited Life VCTs sit at the more conservative end of the spectrum. They aim to reduce some of the uncertainty over how investors will eventually crystallise their investment. They do this by launching with the goal of winding up shortly after the end of the five-year holding period required for investors to keep the 30% Income Tax relief.
Limited Life VCT investment strategies normally focus on preserving capital rather than maximising returns, so most of the total return comes from the 30% Income Tax credit. They mainly invest in asset-backed deals, where the VCT can secure its financing with a first charge on an asset owned by the business – like freehold property. This means that if the business fails, they can take ownership of the asset to help reduce any loss.
AIM VCTs focus on companies that are listed on AIM – the London Stock Exchange’s market for smaller growth companies. Their management teams usually have a background in fund management rather than private equity investment. Unlike Generalist VCTs, investments are normally made through ordinary shares rather than loan notes or preference shares, and it is rare for the VCT to seek board representation.
As these shares will fluctuate in value, AIM VCTs can potentially be more volatile than Generalist VCTs, especially as unquoted companies are valued periodically rather than daily. However, they do have more flexibility since ordinary shares are more easily sold on the market – unlike a position in an unquoted company.
VCTs should be regarded as higher risk investments. VCTs are only suitable for UK resident taxpayers who can tolerate higher risk and have a time horizon of greater than five years. Historical or current yields should not be considered a reliable indicator of future returns, which cannot be guaranteed. Share values and income from them may go down as well as up and you may not get back the amount originally invested. Owing to the nature of their underlying assets, VCTs are highly illiquid. Investors should be aware that they may have difficulty, or be unable to realise their shares at levels close to that that reflect the value of the underlying assets. Tax levels and reliefs may change, and the availability of tax reliefs will depend on individual circumstances. You should only subscribe for new VCT shares on the basis of the relevant prospectus and must carefully consider the risk warnings contained in that prospectus.