Patient Capital Review: Sharpening The Focus Around VCTs

by | Apr 6, 2018

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Sharpening The Focus Around VCTs

The government has used the Patient Capital Review to make it explicitly clear what it expects from alternative investing, says Paul Latham, Managing Director of Octopus Investments

The government’s Patient Capital Review, announced in November 2016, looked at how best to make sure innovative firms can access the capital they need to scale up. A year later, the 2017 Autumn Budget gave us the first indications of its impact.

We can get a good idea of the government’s priorities in this area by looking at how the most recent Budget affects VCTs. It was good to see the government assert the importance of rewarding investors for taking on the risks of backing early stage companies. There was no change to the tax reliefs VCTs offer, meaning VCT investors can still benefit from income tax relief, as well as tax-free dividends and capital gains.


The Budget did announce some technical changes for VCTs. The good news is these don’t impact investors. Instead, they’re aimed at ensuring VCT funds direct capital to innovative and growth companies in a timely manner.

For example, the Budget singled out knowledge-intensive companies for special treatment. This reflects a finding from the Patient Capital Review that these kinds of companies need the most financial support. Knowledge-intensive companies will be able to raise up to £10 million each year from VCTs, an increase from £5 million at present.

To encourage investment managers to direct more capital to high-growth businesses, the Budget also introduced the following changes:

  • At least 30% of all new funds raised after 5 April 2018 will need to be invested in qualifying holdings within twelve months of end of the accounting period in which the VCT issues its shares.
  • From 6 April 2019, the proportion of funds that VCTs must hold in qualifying investments rises from 70% to 80%.

In addition, VCTs will have more time to reinvest or distribute gains when they sell an investment. Currently, they have six months to do this. From 6 April 2019 this will double to 12 months. This will give VCTs more flexibility, and more time to re-invest money properly into deals that fit the mandate.

A clear focus on growth, not capital preservation

These sorts of tweaks are fairly normal for VCTs, and experienced providers will be very used to accommodating them. What’s more, they represent a continuation of broader changes that were already well underway before the Patient Capital Review kicked off.

What’s become clear from recent Budgets is that the government wants to make sure tax efficient investments are directing long-term capital into genuine growth companies, and not into schemes more geared towards capital preservation.


In the case of VCTs, the 2017 Budget included an announcement that VCTs can no longer offer secured loans to investee companies. Any loans must be unsecured, and any returns on loan capital above 10% must represent no more than a commercial return on the principal.

Before that, the 2015 Budget included the removal of so-called ‘grandfathering’. This was the mechanism by which VCTs have been able to invest in ways that were allowed when that money was raised, even if they wouldn’t be permitted for money raised now. Grandfathering provisions will end from 6 April 2018.

The 2015 Budget also introduced higher investment and headcount limits for knowledge-intensive companies. These are companies that meet certain conditions about how many skilled employees they have and how much innovative activity they undertake. They tend to have high research and development costs, which is why they qualify for additional funding support.


All these changes will help to accelerate the shift towards growth-focused investing.

Finding a growth-focused VCT

In truth, encouraging growth investing has always been the core purpose of tax-efficient investments like VCTs. What we’re seeing is the government tweaking the rules to maintain and sharpen this focus. There’s no radical shift here.

However, recent rule changes do mean it’s more important than ever to find a VCT manager with expertise in finding early stage companies with high growth potential.


So how do you do that? Well, let’s start by looking at the different types of VCTs available.

Generalist VCTs, which covers most VCTs available today, invest in unquoted companies across a range of different sectors. They have significant flexibility to invest where they believe the best opportunities are, because they’re not restricted to particular sectors.

AIM VCTs invest in companies listed on the AIM. An AIM listing means portfolio companies have to meet minimum regulatory and governance requirements, and conform to higher levels of reporting than unlisted companies. AIMlisted companies can also be easier to sell than unquoted companies.


The third VCT category is specialist VCTs, which operate within a specific sector or market, such as environmental, infrastructure, and technology. They are often smaller in size, due to the sector restrictions on available investments, and can have higher fixed costs relative to the size of the fund. But they also have the potential to do particularly well if that chosen sector outperforms.

There’s no right or wrong answer when it comes to a VCT’s structure. What you’re looking for, especially in light of recent rule changes, is a VCT that’s specifically set up to invest in small companies with high growth potential.

One reason is that it’s important for managers to have access to the best deals. This can be a challenge, particularly when it comes to unquoted companies whose shares don’t trade on a stock exchange. Entrepreneurs tend to prefer raising funds from managers with a proven track record of previous successes, and who can offer additional support beyond the money they put in.

That can include follow-on funding, helping entrepreneurs develop valuable contacts, as well as offering mentoring, for example when a business wants to break into overseas markets.

As well as finding a VCT that can find the best investments, you want to be confident the managers will make the most of their successes. Look for VCTs that have made several successful exits. VCT providers have an obvious incentive to talk about their successes, so if they’re not, you should wonder why.

For the right investors, VCTs offer great opportunities

The government’s commitment to supporting innovative businesses is good news for the UK economy, and good news for investors too. The entrepreneurial scene is thriving, so investors comfortable with the risks of VCTs can get exposure to some really exciting early stage businesses. At Octopus Investments we’ve launched a record-breaking fundraise this year for Octopus Titan VCT, the UK’s largest VCT, as we look to double the number of investments we make into qualifying companies.

Of course, investors need to be aware VCTs put their capital at risk, so they may not get back the full amount they put in. Tax treatments depend on individual circumstances and may change in future, and tax reliefs depend on the VCT maintaining its VCT-qualifying status.

Also, because there’s a limited secondary market for VCT shares, they can be harder to sell than other shares listed on the main market of the London Stock Exchange. It’s also important recognise that investments in small, unquoted companies can be more volatile.

To sum up, then, the government appears committed to rewarding investors for taking on these risks, as part of its broader effort to direct more capital to innovative, high growth potential companies

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