A venture capital trust (VCT) is a tax-efficient investment vehicle that provides capital to small, growing businesses in the United Kingdom. A specialized investment manager manages the fund, and the investors are primarily individuals. Below is an overview of a typical venture capital trust structure:
Venture Capital Trust – Overview
Venture capital trusts were first introduced in 1995 by the UK government to boost investment in new local businesses. VCTs are structured as closed-end investment funds whose units list on the London Stock Exchange.
Like business development companies in the United States, venture capital trusts are a form of publicly traded private equity funds. Investors can purchase units of the fund directly in a primary issue or the secondary market via the London Stock Exchange.
Types of Venture Capital Trusts
Venture capital trusts come in multiple variations and typically break down as follows:
Generalist VCTs: Invest in a diverse group of unlisted companies from various industries and sectors.
Specialist VCTs: Investment focus is on specific industries and sectors.
AIM VCTs: Invests mainly in companies listed on the AIM exchange. It can have a specialist or generalist approach.
2. Time Horizon
Evergreen VCTs: With an indefinite lifespan.
Limited Life VCTs: Set a minimum holding period of at least five years, at which point the wind-down process begins, and the manager allocates capital back to the investors.
VCT – Life Cycle
After inception, the VCT manager is given three years to find and invest at least 80% of the portfolio’s assets into qualified investments. Until then, the manager invests in money markets or bonds to generate returns for investors without jeopardizing the investable assets.
VCT – Investment Criteria
A qualified investment involves taking a debt or equity position in a UK-based company that is either privately-owned or listed on the Alternative Investment Market (a sub-market of the London Stock Exchange focused on smaller, less developed companies). Unlike most private equity firms, VCTs only invest in minority stakes of companies.
VCT – Tax Benefits
For investors who purchase shares of the VCT in the secondary market (via an exchange), the following tax benefits apply:
Income tax exemption on VCT share dividends
Capital gains tax exemption on disposal of the shares
For investors who purchase VCT shares in the primary market (directly from the VCT), they enjoy all the same benefits as above, in addition to 30% income tax relief on the principal investment amount of up to £200,000 in a given tax year.
The tax relief is conditional on the investor holding shares for five years. Because shares purchased in the secondary market do not allow for this additional benefit, they often trade at a discount to reflect this reduced subsidy.
VCT – Fee Structure
Since venture capital trusts require a specialized skill set and very high touch service from fund managers, the fees are often much higher than more traditional investment vehicles. VCT managers typically charge an initial upfront fee of as high as 5% of the initial investment amount. Managers also charge an annual management fee, usually of around 2%.
VCT – Risks
Like other venture capital investments, the returns on venture capital trusts can be potentially very large. However, there is a significant amount of risk involved since many small businesses fail. Such a risk can lead to substantial losses for investors, although proper diversification can help lower the overall risk of the portfolio.
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