Patient Capital Review brings new opportunities for VCT investors

The world of Venture Capital Trusts (VCTs) rarely stands still and the landscape has experienced a significant shift since the Patient Capital Review (PCR).

 Venture capital and growth equity

Alternative investments such as venture capital trusts could be used more by pension schemes

A quick recap of the PCR highlights some of the benefits it is bringing to entrepreneurial businesses and, in turn, new opportunities for VCT investors.

The PCR’s aim was to boost the availability of long-term finance for growing, innovative, UK businesses. As part of this, one of the measures was the requirement for VCTs to invest at least 30% of funds raised in qualifying holdings within 12 months after the end of the accounting period, from April 2018. This should help to ensure investors’ funds are put to work quickly.

Related: VCTs in light of the Patient Capital Review – A guide

In addition, the PCR has also doubled the annual investment limit for knowledge-intensive firms to £10m.

The changes do not stop there. From April 2019, the percentage of funds VCTs must have in qualifying holdings increased from 70% to 80% and the period in which VCTs must reinvest gains will double to 12 months.

This extended 12-month window should help VCTs manage realisations and not be pushed into paying special dividends because of pressure to meet the previously shorter reinvestment period – good news for those investors who want to keep their money in VCTs and see smoother potential dividends.

Further rules have been introduced that point VCTs towards earlier stage companies, although this does not apply to the existing VCT portfolio companies. So, funds with an established, more mature, existing portfolio may help balance overall risk and support returns across the VCT, while allowing younger investments added to the portfolio under the new rules, to grow.

The demand for VCTs has risen steadily in recent years, with £745m raised in the 2017/18 tax year, the second highest since VCTs were launched in 1995 and the highest in more than a decade.

Tax incentives

Chancellor Philip Hammond’s Autumn Budget in 2018 did not see any changes to VCT tax advantages, and these remain attractive as they
currently stand.

For anyone needing a reminder of the incentives, investors have access to income tax relief of 30% on VCT investments of up to £200,000 each year when they buy into a new offer, provided they hold them for at least five years and the shares remain qualifying in this time.

Investors can also receive tax-free dividends from VCT shares and an exemption from capital gains tax when they sell them, both of which are very attractive to those paying higher rates of tax. Tax reliefs are of course subject to personal circumstances and may change.

As the PCR served to remind, these tax incentives are designed to encourage investment in the small companies held by VCTs.

Those companies are often early stage businesses and are either unquoted or listed on the Alternative Investment Market or NEX Exchange (while the actual VCTs are investment companies listed on the stock exchange).

Abundant opportunities

The UK’s entrepreneurial environment is currently very healthy, with no shortage of opportunities for VCT investors to support innovative and ground- breaking small businesses. The emergence of specialist VCTs such as Downing’s Healthcare Share Class is also an interesting development and allows investors to focus their investment in an impactful manner should they chose to do so.

Open Bionics, for example, is an award-winning designer, manufacturer and supplier of custom-made bionic limbs using 3D scanning and printing to produce custom-made prosthetics at a lower manufacturing cost than what is traditionally considered an expensive product.

Its first commercial product, the Hero Arm, secured commercial licenses from Disney, Marvel and Pixar to design arms for children with themes from Star Wars, Frozen and the Marvel Universe.

A strong case

The pension allowance cap, restrictions on buy-to-let tax reliefs and the growing interest in supporting small UK businesses should combine to mean that demand for VCTs will remain strong.

We believe that the investment case for VCTs is a strong one, with potential for high returns from firms needing a helping hand to raise them to greater heights. However, it needs to be understood that these businesses are high risk and typically have limited track record and no established market value.

The VCT shares themselves can sometimes prove to be illiquid if buying or selling on the secondary market, so it may be important to consider a manager with a strong share buy-back policy. But for those who do their research and understand the risks involved, VCTs can have an important role to play in long-term investment portfolios.

Laurence Callcut is a partner at Downing LLP.

Related: Investment watch – Ten of the best VCTs to invest in for 2019

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