Small companies remain the lifeblood of the UK. They are creators of jobs. They are creators of growth. However, support for growing businesses isn’t always widely available. With traditional lenders remaining parked on the sidelines, Venture Capital Trusts (VCTs) can be an important source of funding and guidance for businesses in early stage growth, and investing in them can provide the growth component to your investment portfolio.
The end of the tax year saw a flood of money into VCTs with savvy investors taking advantage of the excellent growth opportunities and the tax benefits associated with them. So for investors, the benefits of investing in VCTs are clear, for an SME looking for that next stage in growth, VCTs could well offer an effective solution.
It is worth reminding ourselves what a VCT is
A VCT is a form of investment company that invests in small, largely unquoted companies in the UK of up to £15 million in size. The aim is to invest in these companies to support their growth over five or so years at which point the successful companies will be ready to ‘fly the nest’, progressing to ownership under later stage investors, trade exits or in some cases via IPO (Initial Public Offering).
The initial funder will sell them and reinvest the proceeds in younger growing businesses, although special dividends to investors on investment exits are frequent.
HMRC grants investors 30 per cent tax relief on a VCT investment. So if an end investor invests £10,000 in a VCT, they get £3,000 knocked off their tax bill. In addition, dividends and growth in the value of the investment is tax free.
Most of the profits are paid out as dividends so investors get a regular stream of tax free cashflows every six months. If you take into consideration that their net cost is only 70 per cent thanks to the tax relief, their net dividend is effectively magnified by the HMRC scheme.
The tax-efficient nature of a VCT is clearly an important aspect for investors and makes them suitable for longer term savings, alongside pensions and EIS funds, but, in the eyes of the government, a VCT’s primary purpose should be to seek ‘higher than average growth’ from small, unlisted firms. Their tax-efficient nature should be ‘the icing on the cake.’
Indeed, 2015 rule changes by HMT and HMRC has meant that all VCTs now need to be focused on more typical venture capital investments, rather than buyout opportunities. In other words, what they were originally designed for – backing growth opportunities in UK businesses. And it is about growth – at the point of investment our portfolio companies employed fewer than 200 people, today those same companies employ over 5000.
Many of the smaller companies VCTs invest in, might well be names that you’ve actually heard of. In our case, you could eat at Five Guys, dressed in clothes by ME+EM, and ride home on a bike guided by a Blaze headlight (the bike light firm that has just been installed on every Santander bike in London and New York) to book a plumber online at rated Rated People. All of these companies were funded by via our VCT and have grown at a rate that would not have been possible without that investment.
The UK is a nation of small businesses and there is a large pool of them that have promise and proven capability that just need access to capital. This is what VCTs can and should provide, and at the same give investors the tax breaks to invest in their growth. The added benefit to investors… they are funding the UK’s entrepreneurial spirit and helping to create jobs.
Andrew Wolfson is managing director of Pembroke VCT.