A Guide to VCTs Venture Capital Trusts
IMPORTANT INFORMATION This guide is for information purposes only and is designed to provide an introduction to Venture Capital Trusts (VCTs), as well as an understanding of the investment opportunities and the range of tax reliefs available to VCT investors. It also contains details of the different types of VCT and the risks of investing. This guide contains opinions which would be regarded as subjective, and is intended only as a high level summary of VCTs. Investors and advisers should note that it is not an exhaustive description of any aspect of VCTs. Maven Capital Partners cannot give any investment, taxation or legal advice. This guide is neither a recommendation nor a solicitation to subscribe, and does not in any way provide advice on the merits or otherwise of VCT investment. The content of this guide should not be regarded as providing financial advice, and if a prospective investor has any doubt about the suitability or affordability of private equity investment, they should consult an authorised financial adviser. Investors should pay particular attention to the risk factors set out in each VCT prospectus or offer document. Please note that this guide is based on VCT legislation currently in force and tax reliefs as Maven understands them in respect of the 2014/15 and 2015/16 tax years. Taxation rules can change and the levels and the availability of tax reliefs will depend upon individual circumstances. Investment in VCTs carries a higher risk than many other forms of investment. VCT shares, though listed, are likely to be difficult to realise because the underlying assets are predominantly unlisted companies which are not publicly traded. The value of shares in a private company, and the level of income derived from them, may fall as well as rise and investors may not get back the money originally invested. Past performance is not a guide to future performance. Issued by Maven Capital Partners UK LLP which is authorised and regulated by the Financial Conduct Authority.
USEFUL CONTACTS AND SOURCES Useful websites for VCT information AIC BVCA Trustnet HMRC www.theaic.co.uk www.bvca.co.uk www.trustnet.com/vct www.hmrc.gov.uk Maven contacts Please note that Maven Capital Partners cannot provide investment, taxation or legal advice. However if you have any questions about the Maven VCTs or Maven s later-stage investment strategy, please contact us using the details below. Maven Capital Partners UK LLP Kintyre House 205 West George Street Glasgow G2 2LW t: 0141 306 7585 e: enquiries@mavencp.com
CONTENTS 6 8 10 12 14 16 What are VCTs? How do VCTs work? Why invest in VCTs? How a VCT provides returns Factors in choosing a VCT What are the risks with VCTs?
18 20 22 24 26 What are the tax incentives for VCTs? Costs and charges with VCTs Types of VCT Claiming VCT tax reliefs Selling VCT shares
WHAT ARE VCTs? Venture Capital Trusts (VCTs) offer some of the most attractive tax incentives available to UK investors, in return for investing in the UK smaller business sector. VCTs are investment companies, similar to Investment Trusts, whose share are listed and traded on the London Stock Exchange and can be listed on any European stock exchange. VCTs primarily invest in unquoted companies (i.e. private companies, not listed on a stock exchange) or in companies quoted on AIM or ISDX. VCTs invest in some of the most dynamic UK companies, and therefore participate at a relatively early stage in the growth potential of smaller businesses. Private individuals generally do not have low-cost access to these types of investment opportunities, which require extensive and specialist investment management expertise. Money raised from individual investors is aggregated to invest in a portfolio of businesses, as illustrated in the example VCT structure opposite. A VCT offers investors the usual benefits of pooled investment (spreading the cost and risk), whilst allowing them to consider alternative asset classes and a wider investment landscape. A VCT portfolio should be widely diversified in order to materially mitigate risk and, although some VCTs have been invested in as few as 10 companies, a well-managed established VCT will typically be invested in between 25 and 40 companies. Investment in VCTs, and their underlying smaller company assets, is however long term and speculative by nature, so significant tax incentives are in place to encourage private investment in this entrepreneurial sector of the UK economy, making VCTs one of the most tax efficient investments available. By way of illustration a 10,000 investment would have a net investment cost of only 7,000 due to the 30% tax relief currently available (assuming that a qualifying investor has sufficient income tax liability for that tax year, and holds the shares for five years), as well as offering a tax-free dividend stream and tax free growth. See page 19 for examples of the tax relief applying to VCT investment for various types of tax payer. 06 A Guide to VCTs
Investing in UK Smaller Companies VCTs were introduced in 1995 as a Government measure aimed at encouraging private investors to invest in small UK trading companies, whilst benefitting from substantial tax benefits. Over 4 billion has been raised to date in VCT investment, and VCTs are an increasingly common component of income focused investment portfolios. SMEs (small and medium-sized enterprises) employ an increasing proportion of the UK workforce, and development/growth capital is critical in supporting their ability to innovate, modernise their businesses, diversify their product ranges and expand internationally. Successive UK Governments have acknowledged that SMEs face significant constraints on their ability to expand due to the shortage of growth funding available to support their development, but have clearly recognised the significant economic potential of that sector in terms of increased job creation, competitiveness and productivity. This inability to access finance presents a substantial barrier for ambitious businesses seeking additional investment in the range up to 5m, and the problem has been made considerably more acute in the aftermath of the global banking crisis since 2008, with many SMEs looking for alternative sources of funding. Pool of investors invests 10m in a new VCT Investor A Investor B Investor C 20,000 + 100,000 + 10,000... And so on VCT manager invests 70% in qualifying investments within 3 years of launch Portfolio Company 1 Portfolio Company 2... Portfolio Company 25 Structure and operation Board of Directors Each VCT has a Board of Directors, where a majority of the Directors is required to be independent of the VCT manager. The Board s objective is to protect the interests of shareholders, and it is ultimately responsible for the decisions taken about investment strategy, the use of shareholder funds, dividend payments, share buy-back policies and the appointment of the VCT manager. VCT Manager The VCT manager reports to the Board and is responsible for sourcing and completing investments, monitoring the performance of all portfolio companies and advising on the sale of those investments. The better managers will be extremely active in supporting each portfolio business, often involved in major strategy and adding value to that business in a variety of ways in order to maximise the value for shareholders.
HOW DO VCTs WORK? What does a VCT invest in? Each VCT will invest in a range of smaller unquoted companies or AIM/ISDX quoted businesses, which the manager believes have strong growth prospects and exit potential. Most VCTs will then aim to provide shareholders with attractive medium to long term returns through growth in the NAV (net asset value) Total Return, a combination of dividends paid since inception and NAV at any given time. Some VCTs and their managers specifically pursue a conservative investment approach as a means of mitigating the risk inherent in private equity investment. In the case of a manager which is equipped to source a wide range of good quality assets and add value to those businesses, effective risk management does not have to be at the expense of a significant impact on the potential returns. To maintain its HMRC qualifying status, and the entitlement to VCT tax reliefs on behalf of its shareholders, a VCT must have at least 70% (by value) of its total assets in qualifying investments. In addition 70% of those qualifying investments must be in ordinary shares carrying no preferential rights to dividends or return of capital (though this is only 30% for VCT funds raised before 6 April 2011). For more detail about the conditions a VCT must satisfy for HMRC approval, visit www.hmrc.gov.uk/guidance/vct. A generalist (see page 23) VCT manager, which invests predominantly in private companies, will typically structure each VCT qualifying investment to generate a paid yield, in order to provide an income to the VCT and allow it to pay a sustainable dividend stream. For VCT funds raised before 6 April 2011, the manager will typically invest around 70% in loan stock, structured to make regular yield payments to the VCT and often with a substantial redemption premium attaching, with the remainder invested in equity. The loan stock element will also rank ahead of the equity element, which provides some downside protection if an investment should fail. 08 A Guide to VCTs
Qualifying VCT investments In line with the Government intention that VCT investment is intended to provide growth or risk finance to SMEs, VCTs are restricted in terms of both the nature of the companies and the sectors in which they can invest, and are subject to a number of specific criteria over the size of the companies. Due to a number of rule changes since VCTs were introduced, the specific rules applying to a VCT will be determined by the regime applying when the funds were raised. Generally speaking older funds have more flexibility in their choice of investments, but rule changes since April 2012 have introduced increases in the size of companies able to qualify for investment, and the amount a VCT can invest. a A VCT can now invest in companies with up to 15 million of gross assets (before investment), up from 7 million, and with a maximum of 250 employees, up from 50. At the same time, the limit on annual investment per qualifying company has increased from 2 million to 5 million. A company must also carry out a qualifying trade in order to qualify for VCT investment. Most trades qualify, but there are a number of excluded activities including dealing in land, financial activities, property development, farming, forestry, operating or managing hotels or nursing/residential care homes, and generating or exporting electricity which will attract a Feed-in Tariff. This is not an exhaustive list, and further detail can be obtained on the HMRC website at www.hmrc.gov.uk/guidance/vct.htm. VCT launch and fundraising VCTs are launched by raising funds from private individual investors. The VCT issues a prospectus, approved by the UK Listing Authority (UKLA), which will set out the proposed investment strategy, Board members, and extensive detail of the VCT manager and its track record. Investors would subscribe for shares in the new VCT, normally at a subscription price of 1. It is also common for mature VCTs to seek further investor funds through top-up fundraisings, usually aimed at providing additional investment capacity for the manager in order to expand the portfolio and spread costs over a wider shareholder base. Such top-up issues are either specific to a VCT or provide linked access to a number of similar VCTs offered by the same manager, where the investor acquires shares in one or more of the VCTs via one application. An investment via a top-up offer provides the opportunity for investors to gain immediate access to mature VCTs that have already been through the initial three year investment phase and should have an established pattern of dividends. Investors subscribe for additional shares in the VCT, where the subscription price will usually be based on the current NAV. Shares issued under a top-up offer attract the same tax benefits as with a newly launched VCT, including the initial tax relief. Key points VCTs invest in a range of smaller unquoted companies with growth prospects and exit potential VCTs aim to provide shareholder returns through growth in the NAV and tax-free dividends VCTs are restricted in terms of both the nature and size of the companies in which they can invest A VCT can invest in companies with up to 15 million of gross assets, a maximum of 250 employees, and can invest up to 5 million per qualifying company in any one year Shares issued under a top-up offer attract the same tax benefits as a newly launched VCT
WHY INVEST IN VCTs? Investment in VCTs offers a number of notable attractions for investors, whether as part of wider portfolio and tax planning, or a specific focus on tax-efficient investment and income generation. Attractive potential returns VCTs offer the potential for very attractive and tax-free medium to long term returns from dynamic smaller companies. These companies are not ordinarily accessible by retail investors and require specialist investment research and management. Significant tax benefits Investment in a VCT offers initial tax relief of up to 30% (provided that the shares are held for at least five years), with the ability to shelter up to 200,000 in each tax year, and tax-free dividends. There is also no capital gains tax liability on the proceeds of sale of VCT shares (see page 18 for more details). Tax efficient retirement or investment income VCTs allow an investor to derive a regular and highly tax efficient income stream, as they can pay dividends from both income and capital. VCT income can supplement investment and retirement income, particularly in view of the significantly tighter restrictions on pension contribution tax relief and the relative flexibility of accessing the funds in comparison with annuities. The benefits of pooled investments VCT investment allows investors to spreads the cost and risk, whilst allowing them to consider alternative asset classes and a wider investment landscape. 10 A Guide to VCTs
Access to specialist fund managers A well managed VCT, run by a proven investment management team, provides access to a wide range of good quality smaller companies. A well resourced VCT manager will be able to generate a consistent flow of good quality investment opportunities, and each asset will be subjected to extensive due diligence by specialist teams capable of carefully managing the risks inherent in smaller company investment. Diversification A large and mature VCT will use asset and sector diversification to significantly dilute the risk for investors, typically investing in up to 40 holdings and, with some managers, across a wide range of industry sectors and UK geographic regions. Alternative assets VCTs invest predominantly in private equity, an asset class whose historic returns have often outperformed mainstream equity markets and assets classes, and the better performing VCTs have been able to achieve consistently good returns. This offers private investors the chance to invest at low cost for a financial stake in flourishing UK businesses and to share in the early growth potential. Key points Access to investment opportunities in well-researched fast growing companies Up to 30% income tax relief on subscriptions up to 200,000 in each tax year Tax-free dividends, providing a highly tax efficient income stream for the medium to long term No Capital Gains Tax payable on disposal of VCT shares 5 year minimum holding period to retain the tax benefits listed above Opportunity to invest in widely diversified and income-producing portfolios of established private companies A complementary source of retirement planning, in the face of increased pension funding restrictions
HOW A VCT PROVIDES RETURNS The commonly accepted measure of VCT performance is NAV Total Return, which measures the NAV (net asset value) per share at a given date plus dividends paid since inception, to give the overall return achieved for shareholders. VCTs aim to provide investors with a regular tax-free income alongside capital appreciation reflected in an improving NAV per share. A VCT can uniquely pay dividends from both income and capital distributions, and the payment of a sustained dividend flow will normally be a major objective for a VCT. Typically therefore a substantial proportion of overall VCT returns is received in the form of dividends in order to provide an attractive tax-free income. The VCT will generally look to achieve a regular turnover of assets, where the proceeds of portfolio realisations provide funds for both dividend distribution and investment in new assets. Improving NAV A VCT will generally achieve increases in NAV through a combination of (i) creating additional value in existing assets (by working closely with the executive team in each business to achieve growth through e.g. increasing earnings, developing new products and sales channels, and acquisitions) which will be reflected in increasing valuations over the time of investment, and (ii) profitable exits from portfolio businesses which crystalise the value created for shareholders and release additional funds for adding new assets to the portfolio and sustaining a regular flow of capital distributions. Dividend income A generalist VCT will typically structure each private company investment with a significant element of loan stock, in order to provide an immediate and regular income to the VCT in the form of interest and dividends. The aggregate income received across the portfolio in excess of running costs will typically be distributed in the form of dividends, which for VCTs are tax-free. HMRC rules require that no more than 15% of gross investment income, after deduction of expenses, including dividends, is retained by the VCT, which in effect means that the VCT must distribute 85% of its investment income. 12 A Guide to VCTs
MATURE VCT INVESTMENT, REALISATION, DIVIDENDS AND REINVESTMENT Portfolio of VCT qualifying and non-qualifying assets * Existing Portfolio of Private Companies New Private Company Investment Structured to make regular yield payments Income accruing to VCT Regular yield payments Realisation of Private Company Asset Sale proceeds to VCT VENTURE CAPITAL TRUST Funds for further investment and for income and capital distributions to shareholders Dividends to shareholders *Assumes a generalist VCT, making multi-sector private company investments using a loan stock and equity structure (where the loan stock element has a paid yield) to maximise the potential for income and capital gains
Factors IN CHOOSING A VCT When selecting a VCT an investor should consider a number of important factors, and should always take professional financial advice if in any doubt about the suitability of VCT investment. In particular the following areas should be considered, though this list is by no means exhaustive. Investment strategy VCTs employ a wider variety of investment strategies, and consequently will suit a range of investor risk profiles. Although VCTs would generally be regarded as higher risk investments, as described earlier some managers have the resource and expertise to use more conservative strategies whilst still accessing the potential for income and growth that can be achieved through investment in carefully selected private companies. Asset type VCT s are able to invest in a wide range of qualifying assets, across a variety of industry sectors and at considerably different stages in their development, including start-up, early-stage, later-stage, technology and AIM listed businesses. The nature of the underlying assets will have a significant bearing on the risk profile of the VCT. It should also be noted that a VCT will usually have an element of up to 30% non-qualifying assets, which can be invested in some or all of cash, gilts, other cash equivalents, unquoted companies, quoted equities or investment bonds, and can make a valuable additional contribution to the overall returns and risk profile of the VCT. Investors will therefore be keen to ensure that this non-qualifying portfolio is being managed as effectively as the other assets, and in line with the VCT s overall investment strategy and risk profile, as the poor selection and performance of nonqualifying assets could have a significant impact on investment performance. 14 A Guide to VCTs
Diversification VCT s are also able to achieve a significant level of diversification, both in terms of geographic spread and industry sectors, which will be an important factor in assessing the overall risk profile of the VCT and the potential impact of investment failures within the portfolio. Manager s expertise and track record The ability to source and invest in good quality private company and AIM assets requires specific areas of expertise and the VCT management team should be able to demonstrate considerable experience in that area. Equally investors will look for evidence of the manager s past performance in achieving good dividend flows and total returns from VCTs, with the ability to make regular private company investments and profitable realisations. This is usually easily ascertained from a VCT s website and annual accounts. Deal flow and investment capacity The success of a VCT and its ability to achieve its investment objective will be influenced by the manager s ability to generate high levels of good quality deal flow. The size and diversification of the VCT manager s existing VCT portfolios, along with a regular pattern of new investments, will usually be good indicators of strength in this area. The more established VCT managers will also tend to manage a stable of VCT funds and allow those VCTs to co-invest with each other in potential new assets. In this way a target portfolio company can benefit from a larger amount of funding than one VCT might be able to support, while the VCTs gain access to a wider range and larger businesses than might be the case for a single VCT, and each can avoid having too big an exposure to a single asset. This introduces an extra level of diversification for investors. Investment selection process The manager s ability to select and effectively research every potential transaction, is crucial in ensuring that investments are secured on the best terms for the VCTs and maximise the chances of higher returns on disposal. This will depend on the size and experience of the VCT management team, as well as the extensive use of third-party due diligence providers in carrying out a wide-ranging analysis of the trading, market and financial status of a business. Quality of portfolio management The ongoing performance of existing portfolio companies is just as important as the sourcing of assets, as there is a higher risk with smaller businesses of intervention and support being needed to achieve their business goals. A well resourced VCT manager can add considerable value to a business in order to help it meet its objectives, which will directly impact on the value of VCT assets and therefore shareholder returns and dividends. A VCT manager will often take a seat on the board of each private company, and be involved in shaping both the strategic direction and eventual exit strategy. Exit mechanism Shares can be traded on the open market (often referred to as the secondary market) using brokers, as VCTs are listed companies. However as the underlying smaller company assets are illiquid by nature, there is generally a fairly illiquid market in the shares of VCTs, such that the shares may be trading at a discount to net asset value (NAV) and it may not be possible to dispose of shares in the short term at a price acceptable to the investor. Investors and advisers will nevertheless want some reassurance that it is possible to sell shares, even when other buyers for the shares do not emerge in the open market, and preserve a reasonable element of any gain made over and above the net cost (after initial tax relief) of investment. A VCT can buy back its own shares where that is in the interests of its shareholders as a whole. A mature VCT will generally buy back shares at a discount to NAV in the market, but only where the Board is satisfied that the VCT will retain sufficient liquid assets to maintain its VCT qualifying status, make investments and continue to pay dividends. It is therefore important that a VCT s buyback policy is clearly stated, in order that investors can understand what exit options are likely to be available when they wish to sell their shares and there are no other buyers in the open market.
WHAT ARE THE RISKS WITH VCTs? VCTs primarily invest in smaller, usually unquoted, companies. There are significant risks associated with investing in businesses which are at an earlier stage in their development than larger quoted companies and therefore carry an increased risk of failing. Prospective investors should read the relevant Prospectus or Offer Document in full, before considering investment in new VCT shares, and should seek professional financial advice if they have any doubt over whether a VCT is a suitable investment. Investment risk There are a number of ways in which VCTs can effectively mitigate the investment risk, and the extent of this risk management is usually determined by a combination of the VCT s chosen investment strategy and the resource, infrastructure and experience of the VCT management team: Lower risk investment strategy some VCT managers have the expertise, deal flow and resource to focus their investment selection on businesses which by their nature involve less risk e.g. choosing only to invest in profitable later-stage companies, which offer significantly less risk than investment in early-stage or start-up businesses. The manager would normally also apply a range of specific investment criteria in evaluating each business, such as profitability, cash generation, the track record and balance of the management team, the range of products, market share and the ability to expand into additional markets. Diversified portfolio it is possible for a well resourced VCT manager, with widespread access to VCT qualifying deal flow, to significantly spread the risk by constructing a broadly based portfolio of qualifying investments, with the leading VCTs typically invested in more than 30. Managers with a genuinely nationwide office infrastructure should also be able to achieve a good geographic spread of businesses throughout the main UK regions. Management expertise and asset selection the better VCT managers will subject each potential investment to significant scrutiny by the investment executives, together with a rigorous process of third-party due diligence on critical aspects of a business including financial, management, market, commercial, insurance and pensions. An established VCT manager should also be able to call on a network of professional and industry experts who can input valuable experience both before and after investment. VCTs are generally regarded as high risk investments and are primarily targeted at investors who are in a position to take a long-term view and understand the risk of capital loss and falls in value. VCTs are most suitable for investors who have at least a 5 to 10 year investment horizon and are not likely to need the funds in the short term. 16 A Guide to VCTs
Multi-sector approach the larger VCTs will also be able to target multi-sector investments, where the size and expertise of the VCT manager allows a wide range of industry sectors to be considered and carefully analysed. Deal Structure - within the constraints of ensuring that sufficient assets are invested in the ordinary shares of qualifying companies, a VCT manager is able to structure an investment in such as way as to provide greater security for the VCT. For example many private company investments will be structured with more than 70% secured loan stock which also pays an immediate yield to the VCT. Portfolio Management given the potential risks of investing in smaller companies, the VCT manager can have a significant influence of ensuring the success of a business by taking a proactive approach to managing the asset. A good manager will remain closely involved in the strategic direction of each business throughout the period of investment, often taking a seat on the board, and is therefore able to closely monitor performance and bring to bear a broad range of commercial and industry expertise in helping the business progress. It s also worth noting that the significant tax reliefs available on investment (currently 30% for 2014/15 and 2015/16) mean that the net cost of investment is considerably lower (70%) than the subscription amount and in the event of falls in the value of the VCT shares provides a measure of protection against a loss of the investor s net capital outlay. Liquidity risk The market for VCT shares is generally illiquid, with low levels of trading compared to trading in the shares of listed companies. As a result VCT shares may not be easy to sell at full value, and the share price may be significantly lower than the net asset value (NAV) at the time of sale i.e. trading at a discount to NAV. Investors in new issue VCT shares must hold them for a minimum of five years in order to retain the initial income tax relief. Although shares can be sold in the secondary market, where buyers are likely to be attracted by the ability to receive tax-free dividends and benefit from CGT exemption on disposal, secondary purchases do not benefit from initial income tax relief as they are not new issues shares, and there is therefore a limited group of potential buyers. When shares can only be sold at a discount to NAV, it can have a significant impact on the potential for capital gain, though VCT investors will typically have understood from the outset that they would receive a large part of their overall returns in the form of tax-free distributions see How a VCT Provides Returns on page 12. Most VCTs have the authority to buy back their own shares in situations when purchasers are not emerging in the market, and the intention will typically be to buy shares when discounts are within a range of between 5% and 20% to NAV. However the specific buy-back policy will be determined by the Board and will dictate how often buy-backs are conducted and the amount of the VCT s assets that may be committed to buy-backs. A VCT is restricted under Stock Exchange rules from buying back more than 15% of its issued shares in a year. Other risks It is important that an investor seeks suitable advice regarding their personal circumstances before investing in VCTs, as there is the additional risk that if they sell within five years they will have to repay the amount of tax relief claimed. It is also possible that HMRC could withdraw the tax exempt status of a VCT if it fails to meet the qualifying investment requirements, so it is essential that an investor understands and considers the need for a manager which is fully and effectively managing the qualifying position of the VCT. There is also the risk that a VCT fails to sufficiently diversify its portfolio, resulting in a concentration of assets in a small number of companies and/or sectors.
What are the tax INCENTIVES for VCTs? The changing tax rules Since VCTs were introduced in 1995 the regulations have been through a series of changes, affecting both the individual tax benefits and the restrictions on eligible investments. This has generally reflected the efforts of Governments to focus VCT funding on the appropriate types of small businesses whilst ensuring sufficient incentive remains for private investors to invest. Investors will therefore often have VCT holdings acquired under different tax regimes, according to when the VCT funds were raised, and if necessary should seek professional advice on which specific tax benefits apply to their holdings. For further information on the latest rules, please visit the useful sites listed at the front of this guide, such as the AIC and HMRC websites. There are a number of tax reliefs available on investment in new VCT shares, up to a maximum investment of 200,000 per individual per tax year: Income tax relief at 30% (1) of the amount subscribed, provided that the shares are held for at least five years Tax-free dividends and capital distributions from a VCT (2) No capital gains tax (CGT) payable on the disposal of ordinary shares in a VCT (2) (1) The investor will obtain income tax relief at the rate of 30%, regardless of their marginal tax rate. However the amount of relief will be limited to that amount which reduces their income tax liability to nil i.e. the amount of relief an investor can claim in respect of a tax year for VCT investment cannot exceed their income tax liability for that tax year. Therefore in a situation where the income tax liability in a year (before the application of any tax relief) is less than 30% of the VCT investment, then relief can only be claimed up to the level of the income tax liability. (2) There is no minimum holding period in respect of dividend relief or CGT exemption. It should also be noted that there is no relief for losses on the sale of VCT shares. The case studies opposite illustrate the way in which an investor s tax and earnings position may restrict the amount of initial tax relief available on an investment in new VCT shares. 18 A Guide to VCTs
Examples of VCT initial tax relief Investor A Mr Wilkinson plans to invest 40,000, earns 60,000 per year and is calculated to be liable for around 17,000 income tax, including a substantial element of higher rate tax. Initial Investment 40,000 Tax relief (@30%) ( 12,000) Effective net cost (after benefit of tax relief) 28,000 Mr Wilkinson is able to benefit from the full amount of 30% tax relief as it ( 12,000) is less than his tax bill ( 17,000) for the year. Investor B Mr Greenwood decides to invest 200,000 in a VCT, and his income tax liability is calculated to be around 300,000. Initial Investment 200,000 Tax relief (@30%) ( 60,000) Effective net cost (after benefit of tax relief) 140,000 Mr Greenwood is able to benefit from the full amount of tax relief as his tax bill ( 300,000) exceeds the amount of tax relief ( 60,000) being claimed. As a result of the way they arrange their tax affairs, his wife is only expecting to pay 60,000 in tax, but she is also able to invest the full 200,000 into VCTs as it is possible for an investor to claim an amount of relief (at 30%) up to the amount of their tax liability for the year. Investor C Mr Robinson is reorganising his portfolio and invests 40,000, but will only pay 10,000 income tax for the year following retirement. Initial Investment 40,000 Tax relief (limited to amount of tax liability) ( 10,000) Effective net cost (after benefit of tax relief) 30,000 Mr Robinson is not able to benefit from the full amount of 30% tax relief as he is only paying 10,000 income tax for the year and can therefore claim a maximum of 10,000 in VCT income tax relief, which is less than 30% of the amount invested in VCTs. The examples set out above all assume the application of initial tax relief of up to 30% (on a maximum investment of 200,000 per individual per tax year) available in tax years 2014/15 and 2015/16 on investment into new VCT shares.
CHARGES with COSTS AND VCTs The levels and type of charges incurred with VCTs are higher and more varied than those typical with other asset classes and collective investment products. This reflects both the nature of VCT fund management and the considerably more specialist investment landscape (i.e. predominantly unquoted companies), but should also be seen in the context of the higher potential returns achievable relative to lower risk investment areas. Initial offer costs The costs of a new or top-up fundraising are typically 2.5% to 3% of funds raised, to cover the launch costs, including legal and sponsor s fees, printing, marketing and distribution costs. In addition an initial commission is often available to execution-only or online brokers, usually of up to 3%. Typically therefore the overall initial costs will be in the range 3.5% to 5.5%. Many brokers will choose to waive some or all of the commission, in the form of an advertised discount, to effectively reduce the offer cost for applicants. Some VCT fundraisings will also offer an early investment incentive for an initial period, whereby investors will be able to achieve a reduced initial cost in the form of additional shares being allotted. Since the implementation in 2013 by the FCA of the Retail Distribution Review (RDR) financial advisers are not allowed to receive commission. However an investor and their adviser may agree that a fee be paid to the adviser for the advice and service provided, which can typically be facilitated through a payment by the applicant as part of the VCT application. Annual and management fees The specialist nature of VCT investment and the requirement for highly resourced investment and administration teams, means that there are a variety of annual costs for VCTs. The main annual cost is the VCT management fee paid to the manager, which will typically be of the order of 2% to 2.5% of net assets plus VAT, and other costs include an administration & secretarial fee, audit fees, directors fees, listing and share registrar s fees. Overall annual fees will however typically be capped at around 3.5% to 4% of the VCT s net assets. 20 A Guide to VCTs
Performance fees It is standard practice for a VCT manager to receive a performance related incentive fee based on a target or minimum level of performance (often referred to as a hurdle ), as determined by the Board and often linked to a minimum level of total return being achieved over discrete periods (i.e. based on increases in the NAV and the aggregate funds paid out as distributions). The level performance fee and hurdle does vary between VCTs. Typically the level of return used to calculate a performance related fee will then become the base figure for the calculation of any further performance fee, so that only one performance fee can be paid for a specific increase in returns. Why are VCT charges relatively high? Whist VCT charges are higher than those typical of other collective investment vehicles, that generally reflects the specialist asset class and the additional management requirements relating to VCTs. Size and economies of scale By contrast with other investment vehicles, VCTs are relatively small, typically with assets of between 2m and 40m. Consequently the fixed cost element of managing a VCT is being spread over a smaller asset base than other investment companies and will therefore represent a higher percentage. Complexity and specialist nature of asset management VCT managers are not only working in a specialist investment space but are typically investing across a wide range of industry sectors, and are also required to ensure that a certain level of VCT qualifying investment is maintained at all times. As most VCTs invest predominantly in small private companies, the requirement to ensure the quality of assets is paramount. The level and quality of information readily available is however often fairly poor, which means that the VCT manager must: have a well resourced investment team; devote a significant amount of senior management expertise and time to asset selection; employ a thorough independent due diligence process; and work closely with all portfolio businesses, including a very proactive and hands-on involvement in establishing the strategic direction of the business.
TYPES OF VCT There is a wide range of VCTs available to investors, and the choice of where to invest will likely be determined by a combination of the underlying asset class, potential returns, investment horizon and risk profile (see Factors in Choosing a VCT on page 14). One key distinction in understanding the types of VCT available is in terms of their lifespan i.e. whether they have a target disinvestment date or otherwise will be evergreen and continue subject to shareholder approval. Evergreen Most VCTs have no specific end date and are therefore subject to a periodic continuation vote. Such VCTs look to provide a long term tax-free dividend stream, with a continual turnover of assets achieved through profitable exits which generate proceeds to finance further investments and dividends. Planned Exit These VCTs (sometimes also referred to as Limited Life VCTs) have an objective of returning investor funds within a pre-determined timescale, at net asset value, in order to maximise the benefit of the initial income tax relief. Whilst this can help to mitigate concerns over the ability to exit at fair value, potential returns are constrained by the requirement to dispose of assets according to a fairly restrictive timeframe. 22 A Guide to VCTs
VCTs are also generally differentiated in terms of their investment approach and associated underlying sector or asset class. Generalist These VCTs tend to focus on investment in unquoted private companies, often across a wide range of industry sectors, and require significant SME expertise within the VCT management team. A well resourced VCT manager, with access to a good quality flow of introductions and employing a highly selective investment process, might expect to invest in as little as 1% to 2% of the introductions it sees. Specialist Specialist VCTs focus on investment in a specific sector or a limited number of related sectors, such as technology, media, leisure, healthcare and renewable energy. Investment in such narrow areas seeks to exploit specialist investment expertise and the potential for significant returns, but can be perceived as very risky and overly exposed to sector specific issues, particularly in the context of what are already smaller businesses. AIM AIM VCTs invest predominantly in the initial public offerings (IPOs) of companies listed on AIM, the junior market of the London Stock Exchange, and are therefore subject to the movement and volatility inherent in the AIM market. They are similar to traditional investment trusts in that the manager can invest in the shares of target companies, but VCT qualifying investments must be only in new shares. AIM focussed VCTs have at times struggled to find new VCT qualifying investments relative to generalist VCTs, due to the significantly reduced number of IPOs, but also as a result of restrictions around the size of companies in which VCTs can invest which means they cannot invest across the whole of the AIM market.
CLAIMING VCT TAX RELIEFS Note: this information applies in respect of investors who are entitled to claim VCT reliefs i.e. are individuals, aged 18 or over, subscribing for or acquiring VCT shares worth 200,000 or less in the tax year. Initial tax relief Investors will receive a certificate of entitlement to income tax relief for each VCT subscription (i.e. for each VCT in which they invest). These tax certificates will usually be issued by the VCT s registrar at the same time as the share certificate, and should be retained for future reference and in a safe place. An investor should enter the gross subscriptions (i.e. aggregate amount invested across all VCTs in the tax year) on their tax return. Alternatively, or where an investor does not receive a tax return, they may apply to their tax office for income tax relief during the tax year as described: Tax Code Adjustment a copy of the tax certificate should be sent to the tax office, accompanied by a letter requesting a change to their tax code to reflect the VCT subscription. OR Reduction in Payments on Account an investor may apply for a reduction to their payments on account (payable on 31 January and 31 July each year) by completing form SA303 - Claim to Reduce Payments on Account, which can be downloaded from HMRC s website at www.hmrc.gov.uk by typing SA303 in the search box. 24 A Guide to VCTs
Capital gains tax (CGT) disposal relief Investors do not have to pay CGT on gains from the disposal of VCT shares, but may be required to enter details of the disposal on the Capital Gains Summary form of the tax return found at www.hmrc.gov.uk/forms/sa108.pdf. Supporting notes are available from HMRC at www.hmrc.gov.uk/worksheets/sa108-notes.pdf. For further detail on capital gains aspects of VCTs see HS298 - Venture Capital Trusts and Capital Gains Tax which can also be found at www.hmrc.gov.uk by searching for HS298. Dividend relief Dividends from VCTs are tax-free and do not need to be entered on a tax return. VCT dividend vouchers do show a tax credit, however this can be ignored except in unusual situations where the VCT dividend is taxable e.g. if an investor has subscribed more than 200,000 to VCTs in the tax year.
SELLING VCT shares Please note that Maven Capital Partners cannot provide investment or taxation advice. The VCT tax rules have changed on a number of occasions, so any shareholder who is unsure about whether to sell shares, or about the tax implications of doing so, should seek professional advice before acting. VCT shares can be traded just like any other shares listed on the London Stock Exchange, via a stockbroker or broking service. Anyone interested in buying or selling shares in a VCT should contact their broker or broker service, who would normally contact the broker for the VCT. In general terms an investor should not consider an investment in a VCT if they feel they are likely to need to sell those shares in the short to medium term, and it should be noted that an investor needs to hold new VCT shares for a minimum of five years to retain the tax benefits. The market for VCT shares is also generally illiquid, with low levels of trading compared to trading in the shares of listed companies. As a result the share price may be trading at a discount to NAV (i.e. lower than the NAV) at the time of sale. Also dealing spreads are often wide where there may be only one or two market makers for some shares. These factors can have a significant impact on the price a shareholder will receive. Most VCTs have the authority to purchase their own shares in the event of a large discount developing and no buyers emerging in the market, so a broker will generally investigate that as an option depending on the prevailing market for the VCT s shares. Most VCTs will look to buy back shares (see Exit Mechanism on page 15) when the discounts are at certain levels, typically in the range 5% to 20%. 26 A Guide to VCTs
A Guide to VCTs Venture Capital Trusts Maven Capital Partners was established in 2009 to acquire the Private Equity business of Aberdeen Asset Management, and is one of the UK s leading private equity and VCT managers, specialising in structuring and administering private company investments throughout the UK. Maven invests on behalf of more than 11,000 VCT investors and manages over 340m (at 31 August 2014) for a range of client funds including six VCTs. Its highly experienced executives operate from six regional offices and invest in dynamic later-stage companies across a wide range of industry sectors. Aberdeen 6 Queens Terrace AB10 1XL T / 01224 517 120 Birmingham Baskerville House Centenary Square B1 2ND T / 0121 503 2250 Edinburgh 2 Walker Street EH3 7LB T / 0131 306 2201 Glasgow Kintyre House 205 West George Street G2 2LW T / 0141 306 7400 London Fifth Floor 1-2 Royal Exchange Buildings EC3V 3LF T / 0207 199 3500 Manchester Queens Chambers 5 John Dalton Street M2 6ET T / 0161 233 3500 W / mavencp.com E / enquiries@mavencp.com