How to capitalise on venture capital

V enture capital trusts (VCTs) are on track for a bumper year, as high earners rush to put money into them and use the tax breaks they still offer. But analysts warn that VCTs, which invest in both quoted and unquoted companies, vary widely in how much risk they take on.

The vehicles, which are listed companies and offer different share classes to investors, offer tax relief of 30 per cent on contributions up to £200,000 a year, once the shares have been held for five years. Shares can also be sold on free of capital gains tax.

VCT dividends are exempt from income tax, making them attractive to investors at a time when income payments from other investments are at historic lows.

Restrictions on how much can be paid into a pension by higher earners this year have been a major driver behind interest in VCTs, advisers say.

Martin Churchill, editor of the Tax Efficient Review, which analyses VCTs, forecasts that fundraisings in this tax year will be double the amount in the previous year, as a result. Both Baronsmead and Downing Planned Exit have already met their fundraising targets before the end of the tax year, which is rare.

However, while all VCTs involve some risk to capital, schemes aim to minimise their exposure in various ways.

Limited life, or “planned exit”, VCTs tend to be lower risk. These companies are set up with a limited life of, say, five years with the aim of winding the company up and returning capital to shareholders at that date. Their investment approach tends to be more cautious than at other companies, although this also means the trusts are unlikely to perform as well.

Generalist VCTs, by contrast, have no set wind-up date, and can invest in any kind of start-up companies.

Lee Smythe at Killik & Co recommends Elderstreet VCT, a generalist trust that has had strong returns in previous years. However, investors can run into problems with generalist VCTs when they come to sell their shares. Most VCT investors sell out after the five-year time period, at which point they can claim their tax relief. With a generalist trust, which has no fixed life span, this means they will have to sell their shares on the secondary market, so they could be forced to sell shares at a discount.

“You can sell them but often the sale price is considerably below net asset value,” warns Smythe.

Matthew Woodbridge at Chelsea Financial Services recommends Northern 3 and ProVen as good generalist picks. He says his clients still prefer generalist VCTs.

“People still want to buy into VCTs with a collection of small British companies that will do very well indeed,” he says. “That’s why Baronsmead has sold out.”

There are also specialist VCTs, which tend to be at the higher end of the risk scale as they focus on just one area of the market, such as clean energy. Foresight and Ventus are two specialist providers in this area. The Ventus fund targets an 8 per cent dividend yield.

“I would say for a long- term, tax-efficient income stream, Ventus is potentially very exciting,” says Woodbridge.

John Davey at Bestinvest recommends investing in asset-backed VCTs, which back companies with tangible assets such as property. Puma, for example, invests in freehold pubs and conference centres. He says these VCTs can invest on more attractive terms for their investors as banks are lending less to small businesses. The lack of competition makes the VCTs better able to pick and choose the companies they invest in, making the quality of the underlying businesses more robust, says Davey.

“Asset-backed looks like a great strategy this year – the unwillingness of banks to lend means the deal flow is much better than it has been,” he argues.

But investors should be aware that venture capital can flow into untested areas of the market, so good returns are never a sure thing.

“If you’re looking for VCTs that have done poorly, there’s a graveyard out there,” warns Woodbridge.