Jack Rose, Head of Tax Products at LightBridge Partners, reveals how to pick a VCT manager who has what it takes
Even with two months still to go before 5 April, fundraising for VCTs had already seen records tumble this year and as things stand it shows no signs of slowing down. Estimates from Tilney indicate over £500 million has now been raised with £300 million of capacity still remaining. So we could possibly be on for the largest ever year for VCTs, certainly since the initial income tax relief was set at 30%.
Supporting smaller businesses
The VCT market is now reasonably mature, having been established to encourage investment into smaller companies. It is this investment in SMEs where the tax benefits of a VCT come into play – as they are designed to compensate for the increased risk associated with investing in smaller, less liquid companies.
The tax incentives for VCT investors include 30% income tax relief on the initial investment, subject to a maximum of £200,000 per investor and a five year minimum holding period. Plus, dividends paid are tax free and there is no capital gains tax (CGT) to pay when the VCT is sold. However, in the current record-low interest rate environment and with continuing pressures on pensions for many; it is the tax free income of a VCT which make them attractive for the majority of investors.
As VCTs become increasingly popular driven by pension restrictions, more advisers are considering them for their clients. So if you’re considering investing in a VCT, how do you spot a good manager?
A good VCT manager needs lots of experience and specialist expertise to spot real potential for success in a small business. There are lots of SMEs looking for funding, so a good VCT manager needs to be able to sort the wheat from the chaff. Often this involves meeting the management team and getting under the bonnet of the business and the investment team must be well resourced, as this company research can be very time consuming. The manager will be following a robust, disciplined and proven investment process founded on relevant experience in the underlying asset class in question, whether that be the AIM, infrastructure finance or growth capital for example.
One indication of whether the manager ‘has what it takes’ is by looking for a proven deal flow, with a track record of positive investment outcomes – where the underlying companies have achieved or exceeded market expectations. That way you’ll know if they can spot a business that has the potential for success, even perhaps to become a future household name.
Playing by the rules
The rules the manager must adhere to in order to maintain a VCT’s qualifying status are becoming increasingly complicated, especially after rule changes last year. It is important to choose an experienced manager who understands the rules to the letter and manages the VCT accordingly.
The rule changes have had implications on which investee companies will qualify for VCT investment. This has focused and narrowed the potential investment universe, which may have implications for a manager’s deal flow. It is important to be clear on a manager’s ability to deploy new monies into appropriate qualifying investments that fit the VCT’s mandate.
Looking at whether a VCT manager’s deal flow is appropriate to the level of fundraising they are seeking will be critical to ensure they are not overstretching themselves and putting themselves under pressure to invest the capital.
Because of the numerous rules which VCTs must adhere to, in order to qualify for tax breaks, it is important to choose an experienced manager with relevant expertise.
Choosing a VCT
There are four main types of VCT, so it is important to understand the differences. They all invest in smaller UK companies but the market splits them into Generalist VCTs, AIM VCTs, Specialist VCTs and Limited Life or Planned Exit VCTs. Each of these will have their individual investment approach, risk and return profile, so each will suit different investors according to their needs and their risk appetite.
As the name suggests, they invest in a general portfolio of companies across the smaller and private equity universe, often across multiple sectors.
Focus on companies listed on the AIM market. These are the only listed companies (daily priced) that “qualify” under VCT rules. AIM has been around since 1995 and is now a mature exchange, with more than +£90bn raised with c. 1,100 companies operating in +100 countries across 40 sectors
Focus on companies in a specific sector, such as renewable energy, leisure, media or technology, where the manager believes they have an edge.
Limited Life or Planned Exit VCTs
Similar to Generalist VCTs but tend to focus on lower risk, lower return companies with the main objectives of capital preservation and providing liquidity as soon as possible after the minimum five year holding period.
Matching investment objectives
It is important to consider the investor’s requirements and match their investment objective to the type of VCT selected – the manager’s strategy and the structure of the VCT must fit the investor’s requirements. An experienced manager focused on a specific sector often builds a high level of expertise that can translate into investment success.
VCTs are sometimes mistakenly considered as being solely focused on achieving returns through capital growth, but in reality many VCTs deliver regular income via tax-free dividend payments. Look for a manager who has delivered sustained dividend flow, usually most effectively combined with a mature portfolio.
VCTs can have a variety of different income profiles from those that pay a consistent and regular dividend to those that look to pay larger ad-hoc special dividends alongside a much lower regular dividend. Finding a VCT with an income profile matched to your client’s requirements is crucial. Investors considering a VCT as a supplementary pension planning tool may be better suited to a VCT with a track record of consistent dividend payments, especially the older investor. Younger investors who are less reliant on regular income might prefer something that offers the opportunity of some special, but less consistent, dividends. At the end of the day it’s up to the client and their requirements, but looking at a dividend track record of any VCT should help.
New offer or top up?
One last thing to consider when considering a VCT manager is whether theirs is a new offer, or a top-up offer. A new offer will be for a new share class of an existing VCT (VCTs can have multiple share classes with different pools of assets), while a top-up will offer the opportunity to gain exposure to an existing portfolio of assets within a share class of a VCT. Again it depends on the preferences of a client, but both have merits and drawbacks, according to what you are looking for.
Meeting investor needs
Without doubt there have been a number of significant changes to VCT legislation in the last two years, putting additional pressures on managers and their deal flow, while at the same time the demand for VCTs continues to grow and shows no signs of slowing. Advisers do need to carefully consider the merits of a VCT and its manager, to ensure both match investor needs – so knowing how to spot a good VCT manager is a definite benefit.