Mark Bower-Easton, Business Development Manager, Oxford Capital
On the face of it, EIS (Enterprise Investment Scheme) and VCTs (Venture Capital Trusts) look to be similar opportunities. Both are high risk investments, investing in early-stage unquoted businesses, and both provide investors with some attractive tax benefits that provide a tax efficient alternative to annual ISA and pension contributions.
However, look beyond these top-level similarities, and you will see some significant differences.
Below is a summary table of the key features and benefits of both:
At present, VCTs are by far the more popular option for advisers to provide exposure to clients in venture capital. It is understandable why this is the case – the VCT is a fund-based approach, which will be familiar to anyone who advises and invests in more traditional assets such as unit trusts or pension funds. VCTs also reduce the administrative burden by providing just one Income Tax Relief Certificate to claim income tax relief shortly after initial investment. In comparison to investing into an EIS fund and waiting to receive individual EIS3 certificates for 8-12 companies, over a deployment period of up to 18 months in some cases.
Also, a VCT has a reputation for being slightly more liquid. Although the minimum holding period to maintain income tax relief is five years, compared to three years, the fact that a VCT must be listed on a recognised stock exchange means that there is a market to buy and sell holdings in VCT stocks. The reality, however, is that the market still relies on there being a willing buyer of the shares, and these markets usually operate at a significant discount to NAV. Whilst the minimum holding period for EIS is three years, the likelihood of a successful exit after three years is slim. Realistically, an EIS will need to be held for 5-7 years. The reason for this is simple – VCs invest in business at their earliest stages, and it takes effort and time to build a successful business to a point where it is big enough to IPO, or attractive enough to be purchased.
If a client simply has a requirement to gain income tax relief and generate a tax-free income, then VCTs are certainly the way to go, as unlike EIS, dividends generated from VCTs are tax-free. The way VCTs and EIS generate their returns are different. VCTs generate their returns by providing investors with tax free dividends, which are paid out from the revenues generated by the underlying companies, and upon exit, VCT investors will ordinarily receive their initial investment amount back. With EIS, the focus is on increasing the value of these businesses, so they become as attractive as possible for a successful exit, so it makes no sense to pay out dividends, especially as dividends are taxable.
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