25 years of VCTs: how venture capital trusts came full circle

As venture capital trusts celebrate their silver anniversary, Cherry Reynard examines their evolution and the rewards for investors.

It has been 25 years since the first venture capital trust launched, designed as a means to direct capital to early-stage businesses while also giving investors a juicy tax break.

They have been through a number of incarnations over the years, while investor enthusiasm has ebbed and owed. Nevertheless, they continue to attract considerable interest, a testament to the resilience of the structure.

VCT sales figures hit £619 million in the 2019/20 tax year. This is down on the previous year, which was a record-breaker, but is nonetheless a creditable performance in the middle of a pandemic. Key to their appeal have been the tax breaks, which have been prudently used by those locked out of pension savings because of a high salary or a large pension pot.

Tax relief changes

The tax breaks have remained in place for much of their quarter-century, with some tinkering around the edges – notably to the minimum holding period for retaining tax relief (currently five years) and the ability to defer capital gains (which no longer exists).

The annual allowance has remained unchanged for 16 years, at £200,000 per year, while the income tax relief has been through various phases. It started at 20% in 1995/96 and increased to 40% in 2004/05, before being pared back to the current level of 30% in 2006/07.

This has impacted investment levels. Jason Hollands, head of business development at Tilney, says: “The move from 20% to 40% resulted in a tenfold increase in fundraising, and when it was shaved back, funds raised dropped by nearly two-thirds. The chancellor would do well to study this piece of history at a time when many young, early-stage growing companies are in need of capital due to the Covid-19 pandemic.”

The underlying permissible investments have been subject to greater change. Ben Yearsley, co-founder at Fairview Investment, says: “VCTs have gone full circle. Initially, they were designed as a tool to back early-stage entrepreneurial businesses. The sector was hijacked for a while by lower-growth, later-stage investments, such as the renewables craze. However, over the last five years, it has reverted to earlier-stage, higher-growth companies once again.”

This recent shift is a result of three major changes: the decision to no longer allow investment in renewable energy businesses benefiting from other subsidies, such as renewable obligations certificates and renewable heat incentives, in 2014. All power generation activity was excluded at the end of 2015. The November 2015 Finance Act refocused the scheme on early-stage companies by restricting the size and age of qualifying companies.

Hollands says: “It also stipulated that funding must be used to finance growth, not acquiring existing shares, and in so doing ended management buy-outs, one of the most prevalent deal types.” He says the other important change was the introduction of a new ‘risk to capital’ clause in 2017, which meant HMRC could reject deals if they looked as though they had been constructed to achieve a tax benefit, with little real risk involved.

“This has put an end to limited life VCTs that invest in schemes where capital preservation is the key objective, such as asset-backed deals.” For Hollands this reversion is welcome: “At last, VCTs really are focused on true venture capital. That makes them riskier for sure, but the types of businesses they are investing in are also typically innovative.”

Investment managers

This circularity that has characterised the investments held in VCTs has also been seen in the investment managers. Nine VCTs were launched in the first year and many of those names will be familiar to VCT investors today – Downing, Northern, Baronsmead.

However, this apparent continuity masks a new issue fervour in 2004 and 2005, with fund companies with little or no venture capital experience jumping on the bandwagon, notes Yearsley. Most have since exited the scene.

The final question is whether they have served their purpose. Have they created good businesses that have created employment and growth? Yearsley believes VCTs have generally been worth the cost of tax breaks for the government in terms of job creation and growth. “They have really justified their existence. Taxpayers are getting a good bang for their buck.” He points to companies such as online property portal Zoopla, which were originally VCT-backed .

VCTs have managed to survive a range of different governments and remain in place. This suggests that they are doing their job – directing capital to early-stage businesses, helping them to grow and create employment. As he strives to rebuild the economy post-Covid, Chancellor Sunak should take note.