Jack Rose: An Outlook on the VCT Landscape

  • On April 4, 2018
  • By Ajency Admin

As one tax year ends and another begins, Jack Rose reminds investors and their advisers they need to adapt to the fact the best VCT offers will continue closing earlier and being available for shorter periods of time.

Venture capital trusts (VCTs) raised a record £542m in the last tax year (2016/17) – the highest amount since the initial tax relief was lowered from 40% to 30%. As anticipated by many industry commentators, this year’s results look set to eclipse that total, with estimates ranging from £600m to £800m, depending on whether some VCTs use their over-allotment facilities.

Already this year the Octopus Titan VCT has beaten records for the largest ever single VCT fundraise. At this point, with well over £600m already raised across the market, the growth in the sector is continuing at a canter and shows no signs of slowing down.

It is a trend that looks set to continue for the next couple of years as investors use up their last remaining carry-forward allowances on their pensions. This, combined with the broader investor landscape – with its changes to dividend taxation, buy-to-let and pensions – is making it harder to save tax-efficiently, which will mean VCTs and the Enterprise Investment Scheme (EIS) will become increasingly relevant to a greater number of people.

Increasing interest from investors mirrors a growing maturity in the products themselves. Since 2008/09, the VCT market has consolidated down to a dozen or so managers, which will raise on a regular basis.

Due to the VCT rules, it is challenging to launch a new VCT, which explains why the market has not seen many new launches, despite the increasing interest in the space. The aforementioned managers have shown the ability to deliver, for the most part, consistent value for shareholders by way of dividends and capital uplift over multiple market cycles.

Additionally, VCTs themselves are now considerably more diverse and mature. On the whole there is less reliance on performance being driven by one or two investee businesses and instead it is coming from a wider base of investee companies.

Crucially, many of these VCTs will have substantial dividend reserves to meet future requirements, which provides investors with the knowledge and comfort of consistent dividend returns. Nevertheless, potential investors need to be aware of and ask prospective managers how the increased interest and investment will affect the performance of VCTs across the sector.

Although the most recently announced rule changes potentially have more of an implication for the EIS space, there are still some key adjustments to VCT legislation that will impact the sector. Put simply, the changes announced in the latest Autumn Statement have more of a focus on the managers’ ability to deploy funds raised in a timely manner and also ensure more of the VCT’s assets are within qualifying investments.

Potential investors need to understand the capability of each manager’s deal flow. This includes an understanding of why many VCT offers have increased in size in recent years and what impact this is having on the portfolio.

Investors and their advisers want to avoid falling into a trap where a VCT has increased its offer size without having expanded its deal flow capacity – and, as a result, is potentially under pressure to find qualifying investments to keep the portfolio compliant. This could lead to an erosion in the investment selectivity process, which could obviously undermine future performance of the VCT.

Investors and advisers also need to consider how, unlike before the 2015 rule changes (when MBOs were removed), many companies – due to their size and age – are now unlikely to warrant a cheque for the full annual state aid limit of £5m.

In years gone by, it was easier to make larger investments into single businesses, meaning you needed fewer companies in the portfolio. Under today’s rules, it is much more likely that companies will receive investment in smaller amounts over several tranches, as those businesses grow and mature over time. Companies now have to be younger than seven years old, which means they are less mature and unlikely to warrant such large initial investments. This can obviously add to the pressure on a manager’s deal flow.

This tax year, another potential issue for investors has been that – due to earlier speculation surrounding the Patient Capital Review and the Autumn Statement and whether there would be significant changes to legislation – a number of the most sought after VCTs closed before Christmas. Northern, Baronsmead and Unicorn all closed before the end of 2017.

Look Beyond Q1

Heading into the new tax year and looking further forward, investors need to stop merely researching and considering VCTs in the first quarter. I appreciate is difficult for many investors, as often they will not be in a position to know their tax situation before that point – but competition for products and capacity within them is only going to increase for the foreseeable future.

The best VCT offers will continue closing earlier and being available for shorter periods of time meaning, unless they are willing and able to move earlier and quicker in the year, investors will potentially miss out on some of the best offers.

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Source: Professional Adviser

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