Venture forth and take chance to be an investment 'dragon'

Providing venture capital for today's entrepreneurs is an exciting form of finance and individuals increasingly have the chance to take the place of banks. Stimulating enterprise and encouraging innovation whilst increasing tax revenue should be music to the Chancellor's ears.

The Government is placing much reliance on growth in the private sector and nurturing small businesses. For this reason, it has continued the tax incentives available to those who buy into a venture capital trust (VCT) when initially available.

In return for making an investment that carries a fair proportion of risk, there are three incentives, provided the money is held for at least five years:

n 30 per cent income tax relief on the sum invested up to 200,000;

n no capital gains tax liability on any eventual disposal of shares;

n dividends received tax-free.

This makes for "a remarkably attractive cocktail for those comfortable with investment in a broad portfolio of UK unquoted companies", says Patrick Reeve, managing partner at Albion Ventures.

You may back the next Apple or Google. Your enterprise may make you feel like a member of BBC's Dragons' Den.

To keep the emphasis on acorn-building, a VCT cannot put any more than 1m into a single firm annually and the total investment must not exceed 15 per cent of its money. A minimum 70 per cent must be invested in qualifying companies within three years of initial fundraising. The balance can be placed in the stock market.

A 'qualifying' company has to employ fewer than 50 staff and have assets that do not exceed 8m.

VCTS fall into several different types. Limited life VCTs are the lowest risk, going for asset-backed projects like pubs and restaurants. If there should be a failure, there are the buildings to sell. Usually they hold the maximum 30 per cent in secured loans and fixed interest.

Such a VCT model aims to repay shortly after five years. Peter Heckingbottom, Chartered Financial Planner at Leeds-based Pearson Jones, warns that illiquidity can be a problem and the sale prospects of a failed business could adversely affect returns.

Some prefer a specialist VCT in a field like entertainment or solar or wind power. This is the riskiest VCT to buy into but might appeal if you have knowledge of the sector or take a philanthropic view of finance.

A generalist fund may provide seed capital to launch a firm or developmental capital to grow it or finance for a management buyout.

This type of VCT is "more akin to more volatile equity funds", warns Richard Harwood, divisional director for financial planning at stockbrokers Brewin Dolphin.

Harwood adds that this could be appropriate for a client with an equity income portfolio who accepts some higher risk assets.

Such VCTs are usually open-ended and so there is no guarantee when savers can recoup their capital but the long-term returns with a stream of tax-free dividends certainly appeal to higher rate taxpayers.

A fourth type is based on companies quoted or expected shortly to be listed on AIM (Alternative Investment Market) which is the junior trading market to the London Stock Exchange.

Liquidity can be an issue here. Managers should not diversify too far so that they can keep a close watch on your investments.

Pearson Jones gives an example of a saver in Baronsmead VCT. In the mid 1990s they would have enjoyed initial tax relief (20 per cent then), all their original investment returned via tax-free dividends and an investment worth roughly their original stake. All recent Baronsmead offers have been fully subscribed and there are no current ones available but watch this space.

In the last 15 years, VCTs have grown to now hold 2.5bn under management. They provide a core, permanent and long-term infrastructure for capital investment into small and medium-sized enterprises.

Whilst VCTs have to be held for a minimum five years to qualify for the tax benefits, apart from the 'limited life' type, it is probably better to consider such an investment for at least double this time to let it show its true potential.

Before purchasing, ask your adviser about the alternative exit routes. Many VCT managers have active share buy-back schemes (usually at a 10 per cent discount) although you can always sell directly through the stock market.

When selling, use a full service stockbroker – rather than an internet broker – "as sales are by negotiation and not just published prices which are in nominal amounts", tips Robert Corden, VCT analyst at brokers Charles Stanley.

There is now a firm secondary market even though purchasers miss out on the tax relief given to those who support a venture at launch. This is because VCTs can both pay regular tax-free dividends and acquire a mature portfolio which immediately generates returns.

A third benefit is that savers can often purchase shares at a discount to net asset value, which increases the relative dividend yield.

Compare performance, not only for considering those VCT managers who have shown real success for their next launch but in advance of buying on the open market.

Research by Morningstar specially for the Yorkshire Post reveals the stars for growth over five years (excluding tax benefits):

n Northern Ventures up 74.81 per cent;

n Foresight 3 up 62.62 per cent;

n Elderstreet up 44.34 per cent;

n Hygea up 44.31 per cent;

n ProVen Growth & Income up 42.33 per cent.

Yet there are some notable laggards over the same period: Bluehorne AIM VCT2 – 64.61 per cent, Ortus – 72.41 per cent, Spark VCT2 Ord – 77.1 per cent and Bedford Row – 90.95 per cent.

Northern Ventures is currently invested in 58 unquoted and AIM-listed companies across its four VCTs.

This includes Cawood Scientific, a North Yorkshire independent provider of analytical testing services. It has sold three Yorkshire companies since 2007: Liquidlogic, Pivotal Laboratories and Stainton Metal.

Its oldest VCT, launched in November 1995, has provided 74.2 per cent growth, equivalent to five per cent annually.

There tends to be a concentration of VCT offers in the months before the end of the tax year and often for a short time after.

Look at the sectors managers plan to support, assuming they have already done thorough homework on strength of management, product and market potential.

Healthcare – from building hospitals to cutting edge medical technology – and environmental businesses were among those identified last year by Albion Ventures.

The VCT market has shown both good real returns to investors and the Government. It is likely to win plaudits as a vital cog in the recovery of the economy.