The UK stands as the biggest venture capital market in Europe, a hub for creating more billion-pound companies than any other European country, writes Triple Point’s Diana French. At the end of 2022, the number of unicorns – privately held companies valued at over $1bn – in the UK rose to 144, up from 116 in the previous year.
This means investors seeking growth, innovation and entrepreneurship can find it right here in the UK. The extension of the VCT and EIS Sunset Clause to 2035 further positions the UK to continue this upward trend.
In line with this growth, venture capital trusts (VCTs) – which make it possible for UK investors to get access to a portfolio of early-stage businesses – are also experiencing a surge in strength.
This surge is demonstrated by the significant fundraising achievements reported by the Association of Investment Companies (AIC). VCT fundraising has topped the £1bn mark in consecutive tax years, with a record £1.13bn invested in the 2021/22 tax year and £1.08bn invested in the 2022/2023 tax year.
These figures reinforce the demand from investors keen to back early-stage UK companies, driven by both the potential for growth and the attractive tax incentives.
The importance of diversification
Aside from the growth potential that comes with owning a portfolio of ambitious early-stage companies, one of the most important aspects of owning a VCT is the diversification it offers to investors.
A VCT will invest in a carefully made selection of companies, many of which will be at different stages of their development. This helps to spread the risk associated with investing in young and growing start-ups. VCTs also have investment restrictions, such as limits on the maximum investment in a single company, which encourages further portfolio diversification.
Selecting the right VCT
Broadly speaking, there are three distinct types of VCT: generalist, specialist and VCTs that invest in companies listed on the Alternative Investment Market (AIM).
- Generalist VCTs: these invest in VCT-qualifying companies across a range of different industries and business sectors. The aim is to assemble a well-diversified portfolio of companies without being too heavily invested in one or two areas.
- Specialist VCTs: these VCTs are more closely focused on finding and investing in companies operating in a specific sector or industry.
- AIM VCTs: some VCTs invest in VCT-qualifying companies listed on AIM, which is the ‘junior’ market of the London Stock Exchange.
To ensure clients can truly capitalise on the benefits of a VCT investment, advisers should look to invest in VCTs which they think have the best strategy. With a significant number of start-ups not surviving the critical first years, the strategic approach of a VCT in identifying and managing risks is vital for nurturing young companies.
A successful VCT strategy follows investment criteria which ensures that each early-stage company has both an appetite for growth and a clear path to long-term profitability. Part of this process involves identifying companies that have already identified a gap in the market and established a demand for their products or services.
Strategic VCT investments enable innovation in young companies, helping create local and highly skilled jobs whilst allowing the investor to back high-quality and better capitalised companies with lower valuation.
Although investors should always consider the investment potential associated with owning shares in a VCT, investors can also claim the following valuable tax reliefs after they’ve made their investment:
- Up to 30% upfront income tax relief
- Tax-free dividends paid by the VCT over the lifetime of the investment
- Tax-free capital gains on the sale value of their VCT investment – so no Capital Gains Tax (CGT) to pay
An individual investor can invest up to £200,000 in VCTs per tax year and can therefore claim income tax relief of up to £60,000, depending on the value of their investment. But to benefit fully from the available relief, you must have paid or owe as much income tax during the tax year in which you bought the VCT shares.
To keep any income tax relief claimed from HMRC, you must hold your VCT shares for at least five years. Importantly, income tax relief can be claimed against both earned and unearned income (such as the annual income you get from a rental property).
Investing in VCTs carries risks and is not suitable for all investors. These investments, prone to value fluctuations and potential losses, demand a diversified approach and a minimum five-year commitment; selling VCT shares before this period ends necessitates repayment of claimed income tax relief to HMRC. VCTs invest in smaller, more volatile companies with a higher failure rate than larger firms, which can impact the overall performance of a portfolio.
To counterbalance these risks, the UK government offers tax incentives, encouraging investments in key innovative sectors crucial to the economy. While VCTs pose risks, they offer investors the chance to contribute to economic growth and innovation. However, owing to their high-risk nature, they are recommended only for those who can navigate and absorb potential financial fluctuations.
In conclusion, VCTs offer a unique blend of opportunities and challenges. They are not just financial instruments but are vehicles that drive forward the UK’s innovative capacity and support job creation.
The incentives and tax reliefs available present a compelling case for investors, but it is the judicious, informed approach to VCT investment that will determine the extent to which these benefits can be realised. This all means VCTs will continue to play a pivotal role in supporting the UK’s venture capital success story.
This article was written for International Adviser by Diana French, retail strategy director at Triple Point