The number of people investing in venture capital trusts (VCTs) has hit the highest level in over a decade as the asset class firmly enters the mainstream of financial advice. As this happens, it is essential that investors refrain from relying exclusively on tax benefits and past performance and select experienced managers that seek to actively address the main impediments to early stage investing, as well as adjusting fully to the new rules.
Despite the cautionary note above, the future looks to be set fair at least in the medium term, with a much clearer political picture post election. In their 2019 Manifesto, the Conservatives acknowledged the fundamental role of enterprise investment schemes in supporting UK entrepreneurship and innovation. After securing a majority in the December 2019 election it seems likely that tax advantaged legislation such as EIS and VCT will continue to play an important role in fueling growth for the SME and investor community into the 2020s.
Last month, figures published from HM Revenue & Customs showed 18,890 VCT investors claimed income tax relief in 2017-18 – an increase of 24 per cent on the previous year. What’s more, some £731m was invested in Venture Capital Trusts in the financial year 2018-19 – the second highest amount on record. Advisers have reported that VCTs have become especially popular with high earners such as lawyers and doctors.
There are a range of factors contributing to the surge in popularity of VCTs, including the reduction on tax relief available on other investments and the growth potential of investing in innovative UK companies.
Over the last three years, higher earners have faced restrictions on how much money they can save into a pension and still receive tax relief. What’s been referred to as the ‘taper allowance’, introduced in 2016, affects those earning £110,000 a year or more and can gradually reduce a person’s annual allowance from the standard £40,000 to as low as £4,000. There is also a lifetime allowance on pension contributions, which currently stands at £1,055,000. In addition unlike a pension, where you are barred from accessing funds until you turn 55, if an investor holds shares in a VCT for longer than 5 years they have the flexibility and freedom to extract funds having qualified for income tax relief.
VCTs offer generous tax breaks in return for investors backing early stage, high-risk companies. Investing in a VCT enables individuals to claim upfront income tax relief of 30 per cent, providing they hold the shares for at least five years. Investors also gain from tax-free capital growth and dividends, with no capital gains tax to pay if the shares are sold after five years. Given restrictions to other tax efficient wrappers such as pensions, VCTs are attractive as the annual investment limit is £200,000, rather than between £10,000 and £40,000. There is also no lifetime limit on how much you can invest in VCTs.
VCTs typically invest in unlisted companies that offer both potentially high growth and diversification from other assets in a portfolio. However, there are core challenges that need to be addressed when it comes to investment approach. Any tax reliefs referred to may be subject to change and tax treatment will depend on the individual circumstances of the investor.
The changing backdrop to VCTs, driven by the adoption of EU state aid rules in 2015, the 2017 Budget and the Patient Capital Review has meant that VCT managers are now required to invest in early-stage companies that have been trading for less than seven years. While this could provide higher returns to investors, there is also a greater degree of risk that needs to be considered.
There are significant challenges in the early years of a business’ life and a huge number fail as a result. According to the Financial Times, only half of companies formed in London in 2013 succeeded after three years.
There are many reasons why start-ups fail, including intense competition, geopolitical factors and issues with workforce. However, there is one factor that surpasses the rest in causing the most problems for young companies. Research has shown that 40% of start-up failures are due to issues in the initial stage of testing market demand as the companies encounter problems relating to their market fit and business model.
Traditional venture investing has tended to focus on researching a broad cohort of companies with the aim of identifying those businesses that are likely to be successful. The central problem is that this analysis cannot always predict whether there is a genuine market demand for a product or service offered by the investment company
What we have started to see in the VCT landscape is a movement towards a new, distinct approach to venture capital investing based upon the need to address certain risks associated with nascent companies – establishing market fit.
The basic premise of a challenge led approach is to work alongside large corporates to identify the problems they face and then identify the early stage business with the innovative new product or service that can provide the solution to these real challenges. This ensures that a market fit has already been established, before investment, which results in the same potential early stage financial benefits, whilst reducing the risk of the business not achieving a market fit.
By investing at this stage, the challenge led approach aims to mitigate some of the risks of early stage investment, whilst continuing to maximise potential returns for investors. As with any investment there is no guarantee that the target returns will be achieved and investors’ capital is at risk.
Triple Point’s Venture Fund VCT targets significant capital growth by investing in early stage innovative companies typically at the point at which they obtain market validation. This strategy aims to mitigates some of the risks of early stage investing whilst helping early stage businesses increase their chances of success.
With close ties to over 100 large corporates through their wider venture network, the Fund starts with the issue facing established businesses, and then invests in the innovative young company with the scalable solution.
By focusing on early-stage businesses which have established a market fit for their products and services with established corporates, Triple Point aims to address some of the risks of early stage venture capital and can enhance investors chances of securing a robust return on their investments.
Triple Point has a 15 year track record as an established VCT manager, with £260m of VCT and EIS exits to date. As Triple Point’s 20th VCT fundraise to date, this share class looks to targets income and capital growth by drawing on a distinctive ‘Challenge Led’ investment approach. If you want to find out more about Triple Point Venture Fund VCT click here
Risk Warning: The Triple Point Venture Fund carries all the risks of investment in smaller companies and places investor’s capital at risk. There is no guarantee that target returns will be achieved and investors may get back less than they invested. Past performance is not an indication of future performance. Tax rules and reliefs are subject to change.
Triple Point does not provide investment or tax advice, and information in this promotion should not be construed as such. Triple Point Investment Management LLP is authorised and regulated by the Financial Conduct Authority, firm reference number 456597. This promotion has been issued by Triple Point Administration LLP is authorised and regulated by the Financial Conduct Authority, firm reference number 618187.
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