If you fancy the idea of Dragons’ Den, then putting your money into a venture capital trust may be just the answer. This means investing in a selection of enterprising, youthful companies to benefit from their growth in a tax-efficient way.
There is no need to do the initial homework in seeking such firms as an experienced manager will undertake this.
The birth of the venture capital trust (VCT) is credited to Kenneth Clarke, who sought to raise the flow of capital to the UK’s small but faster growing businesses whilst at the same time raising funds from private investors, giving them the chance to invest directly in quoted companies – all part of the share-owning democracy.
From an initial £100m raised just over 22 years ago, there is now over £4.1bn in VCTs. The number of funds has grown steadily. At one stage there were over 130 trusts but consolidations and mergers has cut the number to around 68, advised by 27 different managers.
Technically, a VCT is a ‘closed-end’ collective scheme which means that a given number of shares are issued, unlike a unit trust which can expand or contract depending on demand. As there are risks involved in lending to relatively new firms, the Government has given several tax carrots.
Dividends are paid without a tax liability and there is also a 30 per cent concession on income tax for purchases up to £200,000 in the current tax year provided the VCT investment is held for at least five years. Once ISA and pension allowances have been used, VCTs are the next popular choice.
According to the Association of Investment Companies, the average VCT total return over five years has been 48.6 per cent with dividends reinvested but not including income tax relief. The average targets a dividend of 4.9 per cent but actually achieves 6.7 per cent.
A VCT allows savers to have a more diversified portfolio but take advice as to the underlying assets, experience of the managers and their plans.
Paul Lumley, investment manager at Redmayne Bentley in York, stresses the high risk of VCTs. He selects three of the “better recent performers”:
Unicorn, which aims to provide an attractive return from a diversified portfolio, notably in Alternative Investment Market-traded companies
Octopus Investments, whose VCTs include AIM and Titan
Baronsmead, with two VCTs which target long-term returns in both unquoted and AIM-traded stocks
Demand for VCTs in the current tax year has been extremely strong. From April to the end of January, £483m was raised, more than double the £221m in the same 2016/17 period.
Yorkshire is seen as a good area to invest by several trusts. Artemis VCT invested £850,000 in December 2016 to support the growth of ECSC, a cyber security provider based in Bradford. Launched in 2000, the firm has grown rapidly and now has 10 per cent of the FTSE 100 as clients.
The Northern VCTs, managed by NVM, invested £2.5m to help Rockar of North Newbald to roll out digital stores and an online platform. Rockar is a car retailer which has changed the traditional experience of buying a car by opening shops in retail centres. It recently announced a partnership with clothing retailer, Next.
YFM Equity Partners, led by the energetic David Hall, manages the British Smaller Companies VCT. They spotted Selima, a Sheffield software firm which provides HR management services for such clients as Volkswagen Financial Services and the Hawksmoor restaurant chain. In 2012, the VCT invested £900,000 to help Selima develop their product and grow its team, allowing a successful exit to be made in May last year. In total, VCTs created an impressive 27,000 jobs in the last tax year.
Darius McDermott, of Chelsea Financial Services, ascribes the popularity of VCTs in the current tax year to a fear that income tax relief would be cut in the Budget, which proved to be unfounded. This spurred a larger number of VCTs to raise money.
He tips both the relatively little known Marven, which diversifies through its large, profitable book of management buyout investments, and Hargreave Hale AIM, which McDermott says has a “very good, consistent long-term record with one of the lowest expenses, only undercut by Pembroke”.
VCT managers affirm that they have many investment opportunities and that the entrepreneurial spirit is very evident. They are fulfilling the place of banks who are currently reluctant to lend capital to small firms.
However, so much fundraising puts pressure on managers. “The risk is they may rush into companies that turn out to be weak or that valuations get pushed up, which affects long-term returns,” warns Richard Troue, head of investment analysis at private client broker Hargreaves Lansdown.
Troue adds that in the event of an economic downturn, smaller, less established, higher-risk companies will face significant headwinds. He recommends that no more than five to 10 per cent of an equity portfolio is held in VCTs.
He favours Pembroke, which was launched five years ago by Oakley Capital. It primarily invests in leisure and luxury brands with firms at all stages of development considered.
Troue says there is “the potential to deliver good returns”, whilst noting that consumer-facing businesses tend to rely on discretionary spending which can struggle during a recession or tougher spending times.
Marven is also tipped where the managers work with the constituent firms to help them make operational improvements or grow sales.
The product spheres include energy services, finance, healthcare, industrial and telecommunications.
Stuart Veale, managing partner of Beringea which manage the ProVen VCTs, says that two areas are proving particularly fruitful: software as a service, known as SaaS, and e-commerce with mobile commerce.
They have recently invested in SmartAssistant whose technology allows customers to create intelligent, digital advisers. Mobeus manages four VCTs with over £250m. It has also seen software-related business opportunities but also engineering and advanced manufacturing openings.
Biosite Systems with a fingerprint algorithm providing access control for workers on building sites, is one example where Mobeus has invested £4m.
Trevor Hope from Mobeus Equity Partners welcomes recent VCT rule changes which favour knowledge-intensive companies, notably intellectual property.
Yet he sounds an overall caution that as investment strategies focus on earlier stage firms, “VCT funds and their shareholders must expect a greater volatility in returns”.
Finally, savers might like to combine their money with a hobby or sports interest. Puma VCTs are backing the personal fitness area by investing £3.75m in Sweat! This is an innovative business set up by Virgin Active founder, Frank Reed.
The money will support the planned roll-out of five gyms in the next 12 months with the option to make a further investment up to £2.5m.
The top performers
Top trusts over 5 years - Sector - per cent
Artemis VCT AIM quoted 278.8
Oxford Technology VCT 2 Technology 170.6
Mobeus Income & Growth 2 VCT Generalist 134.9
Chrysalis VCT Generalist 130.7
New Century AIM 2 VCT AIM quoted 116.7
Top trusts over 10 years
Artemis VCT AIM quoted 288.2
Northern Venture Trust Generalist 271.0
Oxford Technology VCT Technology 211.8
British Smaller Companies VCT 2 Generalist 183.6
Maven Income & Growth VCT Generalist 182.9