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| VCTs are high risk, long-term investments.
Be sure you understand the snags before being seduced by the
tax breaks. |
Venture Capital Trusts (VCTs) are a special form of
Investment Trust. If you invest
you become a shareholder, you may disinvest by selling your shares
in the market (when you can, see 'liquidity' below) and you can
see the value of your shares quoted in the newspaper every day.
So far so normal.
Where VCTs are different is that they are structured
so that the initial investors can take advantage of a set of tax
breaks designed to encourage investment in new and growing companies.
VCTs must restrict their investments to such companies and obey
a few other rules to retain 'VCT status'.
Tax breaks
The tax breaks change periodically and it's much safer that you
look up the current regulations yourself. As we write you have to
hold the shares for a minimum of three years and be the first buyer
of the shares.
But there are snags:
Liquidity
Because your shares have a quoted price does not mean you can sell
them. After the initial launch the tax concessions disappear. So
who wants to buy a trust without the financial incentives that are
its raison d'etre?
Well, there's always somebody - at a price. The moral
is that you should plan to hold this investment for a long time.
You must get your rewards from the long term success of the VCT's
investments, paid out to you in dividends and - eventually - capital
profits on the disposal of individual investments by the Trust.
A sale of your shares is always likely to be a distress measure.
To be fair, this aspect of VCTs is now receiving
attention from sponsors. Many new issues have share buyback programmes
to provide occasional liquidity at a reasonable price. The likely
effectiveness of these programmes, and their effect on the remaining
shareholders of the Trust, is a complex matter for discussion at
another time.
Homework
Every VCT is different: different investment objectives, different
cost structures, different performance incentives, different liquidity.
To understand what you are investing in you will have to read the
prospectus (which will typically be a 40-page document), or trust
your adviser to read it for you.
Here are some things to look out for:
Pressure to invest
VCTs must find suitable investments. They are not allowed to stay
in cash (an anti-avoidance measure). Nor can they chose to put money
into non-qualifying companies (meaning bigger or foreign companies).
Nor can they put too much into any one company. If they fail on
any of these points the VCT either fails to launch or loses its
qualifying status - with all sorts of nasty financial consequences
(for the investor).
Worse, VCTs have to find opportunities in competition
with everyone else who is launching VCTs and with all the private
equity firms who are in the same game on their own account. £500
million was raised through VCTs in 2004/5 and the target was £750
million in 2005/6. That is a lot of small start-up companies.
Trust managers are remunerated as a percentage of
the size of the fund, not as a percentage of its beauty.
So you can imagine there is some pressure, when looking
at a potential investment, for the VCT manager to suppress doubts,
accentuate the positive, say 'what the hell!' and put your Trust's
money into it.
Costs
A typical VCT will incur annual running costs of 3.5%. These will
(should) be detailed in the prospectus. The biggest item will be
the investment manager's fee (say 2.5% + VAT). Then there will be
other expenses such as directors fees and admin and secretarial
services. So over a reasonable investment horizon of seven years
the Trust will incur expenses of 24.5%.
Your VCT may also pay performance
fees, which we dislike.
The costs of launch will be born by the initial investors
- typically 5%. You may have to pay a further introductory commission
- up to 5% depending on who you buy from.
Your fund may pay a trail commission to your financial
advisor - 0.5% per year. This should already be included in the
expenses detailed in the prospectus.
Arrangement fees
Investment trust managers are allowed to charge arrangement and
syndication fees to companies they help to finance. This goes to
them, not to the VCT that is doing the investing. There's nothing
immoral in this - it's the way the game is played. But don't you
think there is a teensy weensy bit of conflict of interest here?
And re-read the earlier section - 'Pressure to Invest'.
Conclusion
Think of VCTs as high octane, illiquid small company funds. If you
can find an adviser who can chose one of the best VCTs for you they
may have a small place in a rich man's portfolio.
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