Investing in VCTs: What you should know first
Investing in a fledgling business can deliver returns and tax incentives, but this needs to be carefully balanced with the risks of doing so. Start-ups might offer high growth potential, but a significant portion of new firms also end up failing, with investors potentially losing their money.
One of the easiest ways to invest in new businesses is through a Venture Capital Trust (VCT). These are investment companies that are listed on the London Stock Exchange and are set-up to invest in particular small or early-phase businesses. These firms need capital to achieve their growth ambitions and have the potential to deliver high returns. However, it’s riskier than investing in companies that are already established.
Despite the risks, investing in smaller companies is growing in popularity. According to HM Revenue and Customers (HMRC) figures, VCTs issued shares to the value of £745 million in 2017/18. The figure represented a 30% increase from the previous tax year and is the highest amount raised since 2005/06. Since the introduction of VCTs in 1995, it’s estimated they’ve raised around £7.7 billion.
While the increasing popularity of VCT capital is partly due to a strong start-up culture in the UK, it’s also due to the tax benefits investors receive, designed to encourage them to financially back riskier companies.
What do you need to know about VCTs?
If you’re tempted to invest in VCTs, there are some key things you should know before going any further:
- Annual limit: Should you decide to invest in VCTs, the annual limit you can claim tax relief on is £200,000. If you’re interested in investing more than this amount over the course of a year without incurring a tax charge, there are other options available, such as an Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS), please get in touch for further information on either.
- Income Tax benefit: You’ll receive Income Tax relief on newly issued VCTs, currently at a rate of 30% on investments up to the annual limit. The tax relief is set against the Income Tax you pay and can’t exceed this amount.
- Other tax breaks: There are other benefits of investing in VCTs too. Firstly, you won’t have to pay Income Tax on any dividends from VCT shares. Secondly, when you sell your VCT shares you won’t be liable for Capital Gains Tax either.
- Selling your shares: You can sell VCT shares at any point. However, there are two points to note here. The first is that you have to hold shares in a VCT for a minimum of five years to keep the tax incentive benefits. The second is, while growing, the VCT market is still considered relatively niche. This can make it more difficult to sell your shares should you decide to.
- Charges: Compared to other investment vehicles, charges on VCTs tend to be higher. They may also be more complex. For example, you could be charged a performance fee that’s linked to how well the VCT performs, eating into your potential returns. It’s important to fully understand all charges before choosing where to place your money.
- Risk: VCTs effectively allow you to pool your investments with other investors. This gives you an opportunity to spread the investment risk over a number of small companies. However, while the risk is more spread out, compared to you investing directly in a start-up, VCTs might still present greater risk than investing through more traditional stocks and shares.
There are many reasons you may be considering using a VCT due to the tax incentives. If you’re a higher earner, for example, your annual pension allowance may be as low as £10,000, limiting your tax saving advantages for retirement. If this is the case, a VCT may provide you with an alternative solution. Of course, there are other options too; have you already used your ISA subscription, for example?
Before making any investment decision, it’s wise to look at your financial situation and security as a whole. To assess which investment vehicle, if any, is right for you. It’s important to answer questions such as:
- What’s your capacity for loss?
- How long will you invest for?
- What is your ultimate goal?
- What is your attitude towards risk?
- Do you know of any likely changes in your short-term circumstances?
If you’re looking for ways to grow your wealth and take advantage of tax breaks, please contact us. We’re here to help you assess your financial strategy and how to get the most out of the options open to you.
Please note: The value of your investments can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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