Written by Jack Rose, Head of Retail Sales at Triple Point Investment Management
2023 looks set to be a decisive year for investors and advisers alike. While there are signs that the UK economy has turned a corner as inflation gradually begins to climb down from its highest levels in four decades years, the outlook for investors remains uncertain.
Rising taxes and volatile macroeconomic conditions are placing significant pressure on investment returns, encouraging more investors to seek out alternative investment vehicles which can provide much needed tax relief.
Furthermore, in the context of a volatile investment environment and pension rule changes, many advisers are seeking to complement their client’s retirement planning funds in instances where they are at risk of breaching their lifetime allowance. Venture Capital Trusts (VCTs), such as Triple Point’s Venture Fund, remain an attractive solution to addressing both these demands.
Putting your client’s money to work
The government’s decision last year to freeze the inheritance tax threshold and reduce tax allowances may not have caught financial advisers off guard, but it has since raised the question of how they can put their clients’ money to work in an efficient way.
In spite of January’s rally in the equities markets, the macroeconomic backdrop is not a recipe for decent investment returns in the public capital markets. Furthermore, with the government planning to halve the Dividend Allowance and Capital Gains Tax Annual Exempt Amount from April 2023, advisers must look for alternative forms of investment which can maximize their client’s tax-free allowance.
VCTs represent one of the most tax-efficient solutions investors can have in their portfolio, with investors able to claim up to 30% income tax relief on up to £200,000 invested in a single tax year (provided shares are held for at least five years) and benefit from tax-free capital gains and dividends.
As well as delivering upfront tax relief on investments, having access to capital invested after the minimum holding period can be an attractive option for those who want a relatively short lock-in period, or for re-investment into another VCT for additional upfront tax relief after the initial five years.
The new VCT investor in 2023
Advisers typically think that VCTs are only for high-net-worth individuals, dismissing their utility as an investment tool that could assist clients with more modest capital and income levels. However, this image
of a VCT investor could not be further from the truth. Although the maximum a client can in a VCT is £200,000, the average investment in 2020 to 2021 was around £33,000.1
Furthermore, data gathered by the Venture Capital Trust Association showed the average age of the current VCT investor in 2022 was 56, down from 67 in 2017.2 This demographic shift can be attributed to changes in pension rules, which have meant that younger investors have begun to see the appeal of VCTs as a supplementary pension planning product.
Advisers should also consider recommending VCTs for business owners. Many SME business owners have traditionally reduced their income tax liability by investing large sums into their pension or paying themselves dividends. Changes to the tax-free dividend allowance can potentially have a significant impact on their financial and pension planning if they are not addressed.
By investing in a VCT, business owners and other investors who have used dividends as a vital source of income can significantly reduce their financial exposure to the costly shifts in the UK’s tax and pension planning regulations, which look likely to occur over the next decade.
Remaining resilient during a recession
Another key aspect of VCTs which will undoubtedly draw more investors and advisers towards investment is their performance during periods of economic uncertainty. Over the last decade, VCTs have proven themselves to be both a reliable and resilient investment vehicle, with the 10 largest generalist VCT managers successfully delivering an average net asset value (NAV) return of 97.7%, outperforming the UK stock market. 3
This success is due to their focus on smaller private companies and a portfolio approach to investment. Furthermore, from a value perspective, in the context of potentially overvalued and frothy mega cap stocks, nimbler early-stage businesses are more appropriately valued to reflect the current situation and therefore offer better value as their potential is realised.
In the pivot from an inflationary period to a recessionary period, these businesses will be more adapted to accelerate their growth and boost their value.
Selecting the right VCT
However, in order to make sure that their clients can truly capitalise on the benefits of a VCT investment, advisers should look to invest in VCTs which they think have the best strategy. With over 20% of start-ups failing within the first five years, a VCTs investment strategy is key to addressing the most significant risks facing promising young companies.4
A successful VCT strategy follows investment criteria which ensures that each early-stage company has both an appetite for growth and a clear path to long-term profitability. Part of this process involves identifying companies that have already established a demand for their products or services.
Strategic VCT investments, for example, enable innovation in young companies, helping create local and highly skilled jobs while allowing the investor to back high-quality and better capitalised companies with lower valuations.
Triple Points Venture Fund VCT, for example, adopts a challenge-led approach to investment which primarily focuses on pre-series A B2B technology businesses. With such high-growth B2B technology companies accounting for 77% of all exits in 2019, this sector tends to offer better valuation on entry and better returns.5
Supporting the next generation of British businesses
While advisers and investors will both see the tax relief and potential for attractive exits as the primary appeals behind a VCT investment, it is important to pay attention to why the government grants VCTs a special tax status by the government.
In 2022, VCT fundraising surpassed the £1 billion milestone for the first time in history, raising £1.13 billion to be invested into small and innovative companies.6 This money plays a vital role in the UK economy and will allow investors to both support and capitalise on a wave of British entrepreneurialism that will ultimately take hold once the country emerges from this recessionary period.
For the next generation of British businesses, VCTs can also act as an effective tool through which they can efficiently extract profits from their companies at a time when the UK government is slashing the dividend tax allowance.
Advisers and investors alike would be wise to take advantage of the benefits provided by incorporating VCTs into their existing investment portfolios. With changes to the UK’s pension and tax system on the horizon, and the global macroeconomic outlook still uncertain, VCTs provide a flexible and efficient tool for advisers looking to protect their client’s legacy.