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A comment on VCTs from Seneca’s Investment Director

A comment on VCTs from Seneca’s Investment Director

Seneca Partners Investment Director John Davies discusses VCTs and some major themes affecting the sector.

Tax advantaged investing is regarded by the UK government as a mechanism for driving the engine room of the economy. The younger, growing companies in the tax advantaged space are essential to the well-being of the Country as a whole, creating employment, prosperity and delivering revenues into the exchequer. Last year saw record inflows into VCTs alone with circa £800 million committed by investors across the UK and when combined with EIS, the figure rose to around £1.5 billion. With new pension restrictions fully in force, investing in VCTs or EIS continues to be a popular way for investors to utilise tax reliefs. The upfront tax relief of 30%, the potential for tax free growth and the dividends are all compelling although subject to qualifying rules.

Investing in VCTs is high risk and is not for everyone. For those investors it‘s suited, the government allows tax reliefs to encourage investment in these younger, growing businesses where the inherent risks are normally greater than investing in more mature, longer established businesses. These younger businesses must also meet strict rules to qualify as a VCT company so the Government can ensure that tax advantaged capital is reaching its desired destination. For that reason, and as should always be the case, investors need to adopt a sensible and appropriate balance within their overall portfolios and recognise that investing in young companies does come with risks attached.

Mitigating Risks – a manager’s perspective

One way that VCT Managers can mitigate risk is by setting a VCT capacity level that acts as a screening mechanism to ensure the investment process remains selective. Depending on the manager’s investment style and methods, restricting the capacity may allow more time to work with the companies for a more ‘hands on approach’. This could involve attending board meetings, providing support and guidance and in some cases even resources (other than monetary) to help them through their growth journeys. Such techniques allow managers to ensure companies are tracking to the investment plan and interfere with corrective action where needed.

In terms of portfolio selection, to help reduce the risks associated with earlier stage companies, the exposure should be spread across a number of companies – the number of which will be defined by the capacity limit and fund manager’s expertise.

VCT Managers should also have a healthy pipeline of investable opportunities allowing for any unexpected changes in the portfolio and to ensure opportunities are not missed.

VCTs and the Patient Capital Review

The government’s Patient Capital Review was designed to ensure that capital reaches the younger, less established companies who may ordinarily struggle to access it from more traditional sources. By definition, the types of transaction which are permitted have now changed and investment cheque sizes have also reduced as a consequence. The old model permitted large scale, leveraged buy-outs which had served VCT providers very well historically but these are no longer permitted and many providers are now having to pivot their strategies and find substantially more investment opportunities at lower values and if that conveyor belt doesn’t exist then it is bound to cause deployment issues. No investor wants to see their cash un-invested for a prolonged period and anecdotally some providers have opened up capacity again this year before investing funds raised last year.

VCTs and Brexit

Brexit obviously remains a major headwind which has naturally resulted in investor caution generally. In the tax year ended 5th April 2018, most VCT investments took place in the Autumn of 2017 ahead of any anticipated Patient Capital Review rule changes. Normally, VCT ‘season’ concentrates in Q1 and all the indicators suggest that will be the case for the current tax year. It is likely that investors will wait as long as possible with Brexit in mind but ultimately, the tax relief attractions mean that to take advantage for this tax year then they will need to do promptly.

Please note that investing in a VCT will put your capital at risk. Before investing in a VCT you should seek advice from a financial adviser.

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