venture capital trusts
Industry Update - december 2021
1. INTRODUCTION
The latest news, updates and statistics on VCTs
2. Market Update
3. Considerations for Investment
4. Industry Analysis
5. Managers in Focus
6. What's on the Horizon
7. Further Learning
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Opening Statement Q&A with Richard Stone, AIC Update Overview Key findings
1. Introduction
2. MARKET UPDATE
3. CONSIDERATIONS FOR INVESTMENT
4. INDUSTRY ANALYSIS
5. MANAGERS IN FOCUS
6. WHAT'S ON THE HORIZON
7. FURTHER LEARNING
Opening Statement Q&A with Richard Stone, AIC Update Overview Key Findings
Market Composition Targets
3. Considerations For Investment
What Advisers learned from the Woodford Debacle Thriving on Disruptive Innovation VCTs and the New Era of Retirement Planning
The Golden Age of Fundraising What is bringing Investors to VCTs The No-news Autumn Budget The Two Sides of the Great Fee Debate How to Use VCTs for Retirement Why Investments in Smaller Companies can be a Valuable Addition to a Client’s Portfolio What the Managers Say
2. market update
Blackfinch Calculus Downing Octopus Puma Comparison Table
5. managers in focus
Post-Covid: the New Normal The FCA &The ESG Renaissance Younger Investors are Discovering VCTs What the Managers Say
6. what's on the horizon
Learning Objectives CPD and Feedback About Intelligent Partnership Disclamer
7. further learning
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opening statement
Photography by Interview by
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eavers are brilliant. The channels and dams they make help reduce flooding, and the wetland habitats they create are home to otters, water shrews, fish, birds and dragonflies, along with countless other species. Unfortunately for beavers, however, they have other uses for humans. Their fur makes excellent hats, and their scent sacs can be used in perfume. As a result, the European beaver was hunted almost to extinction by the beginning of the twentieth century. It had already been absent from the UK for centuries. But things could be looking up. Various projects to reintroduce beavers to the UK are underway, from Knapdale in the Scottish Highlands to Braintree in Essex. The projects are experimental and are being closely monitored for the broader benefits that beavers could bring to the ecosystem, as well as their role in mitigating the impacts of climate change. It may seem a leap from beavers to VCTs, but the common theme is that small things can have a surprisingly large impact. The VCT industry is bigger than it has ever been before, but at £6.4 billion it’s still tiny in the context of closed-ended investment companies (2% of the sector), let alone the broader investment industry. Nevertheless, VCTs support a wide range of businesses across the UK – everything from nanotechnology to pet insurance. These companies create jobs, stimulating growth in local economies. And their products and services can have beneficial downstream effects. This year, for example, the ProVen VCTs have invested in Litta App, which makes rubbish clearance digitally accessible, more affordable and greener. Meanwhile, the Maven VCTs backed Snappy Shopper, which is helping local shops compete against supermarkets by launching delivery services. And just before the pandemic, the Puma VCTs invested in MyKindaFuture, which helps students and young people find jobs. All these companies have clear benefits for communities above and beyond their commercial potential. VCTs were also active in supporting smaller companies through Covid-19. Our recent report, Eager Beavers: Enhancing the UK’s commercial ecosystem found that they invested £695 million in the first half of 2020, including £219 million in follow-on investments. The latest batch of half-year reports suggest the pace of investment activity has not slowed – a good thing too, given the need to build back the economy. The companies VCTs back start small, but they can go places. Cazoo, a used-car website founded as recently as 2018 and backed by Octopus Titan VCT, recently floated on the New York Stock Exchange, valued at $8 billion. Parsley Box, which provides ready meals mostly for elderly customers, floated on AIM earlier this year, securing the Mobeus VCTs a fourfold return. Deals like these, as well as uplifts in valuation as the UK economy recovers from Covid-19, have led to the average VCT returning 22.7% in the year to date. Of course, not all VCT-backed companies succeed. But the VCT sector plays a vital role in the UK’s small business ecosystem. Investors in VCTs have enjoyed good returns as well as tax relief, but the feeling that their money is making a real difference to fledgling businesses and the broader economy could be equally satisfying.
B
- Name Surname
VCTs invested £695 million in the first half of 2020, including £219 million in follow-on investments.
nick britton
Head of Intermediary Communications The Association of Investment Companies (AIC)
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VCTs have outperformed in 2021 compared to the average investment company, with an average share price total return of 23% in the ten months to 31 October compared to 14% for all other investment companies.
Introduction
Market Update
Considerations for Investment
Industry Analysis
Managers in Focus
What's on the Horizon
Further Learning
Q&A with richard stone
The AIC has released the findings of its research into the impact of the collapse of Woodford Investment Management on private investors. Could you please elaborate on what the Woodford debacle means for the VCT sector? Regardless of the impact on any particular sector, the Woodford debacle has had a profound impact on investor confidence and trust across financial services. Our research showed that the suspension of Neil Woodford’s flagship fund and the eventual collapse of his investment management business led to a great deal of upset as well as financial loss for many investors. The message that comes out of it, loud and clear, is that when you invest in illiquid assets such as unquoted companies, you should use an appropriate structure. VCTs, like other investment companies, are closed-ended so they are purpose-built for holding illiquid investments. Many VCTs offer buy-back opportunities but there are no daily redemptions and no risk of a ‘run on the fund’. Advisers understand this distinction and we haven’t seen the Woodford collapse dent demand for VCTs or affect advisers’ confidence in VCTs. How did VCTs fare in 2021 compared to the other sectors the AIC is involved with? VCTs have outperformed in 2021 compared to the average investment company, with an average share price total return of 23% in the ten months to 31 October compared to 14% for all other investment companies. They have continued to bounce back strongly from the pandemic and many of the underlying companies are showing promising growth. There seems to be a VC-funding boom going on across the globe. What do you see as the impact on, or connection to, VCTs in the UK? Companies across the world are staying private for longer for a variety of reasons. This has also been accompanied by a raft of private capital backed M&A activity which has seen the number of listed entities fall markedly since the financial crash in 2008. With quantitative easing and low interest rates, many growth companies can meet their funding needs through venture capital without having to submit themselves to the onerous requirements of a public listing. The venture capital business itself has developed a great deal in recent years and VCs’ cross-border networks have flourished. While UK-based, VCTs are part of this broader international ecosystem and the companies they invest in may go on to attract investment from overseas backers. Importantly, however, they have to get off the ground first, and this is where VCTs are so important in providing that initial support. With the convergence of legislative, regulatory, and commercial commitments, sustainable investment continues to see momentum building up. Given the opportunities and challenges in this context, how well do you think VCTs will do? VCTs are excellent investments for those who want to invest with a broader social purpose. They support economic growth and employment throughout the UK, with our latest research showing that VCT investment supports 14,000 jobs among the 288 companies we surveyed – and this is the tip of the iceberg, as we can’t survey every VCT-backed company. VCTs back many companies that are developing more sustainable products or services, helping others reduce their carbon footprint, supporting a wide range of nascent technologies which need venture capital to help realise their potential and go on to be the solutions to the many issues around climate change and sustainability.
VCTS must find new ways to show their sustainable credentials
Many have said that 2021 could be a record year for the Venture Capital Trust (VCT) sector. We spoke with Richard Stone, who joined the Association of Investment Companies (AIC) in September as CEO, about the challenges and opportunities of a sector in full swing.
Unlike most other funds clients might invest in, they are raising new money to put into businesses where that money will have an immediate and tangible impact. The challenge for the VCT industry is to develop ways to demonstrate their sustainable credentials. We have made a start on this by enabling VCTs, along with other AIC members, to disclose their main ESG policies and strategies on our website. With the UK’s annual inflation rate at 3.1% in September and expected to rise by all accounts, how do you see the VCT sector faring in the new inflationary environment? With inflation rising will likely come higher interest rates. Rates will though have to rise very considerably (far ahead of any current expectations) to return to a point of positive real interest rates, and as such there will still be a very real inflationary cost to holding cash. This should mean demand for investments and thus for VCTs remains healthy – accepting that household incomes may become squeezed, reducing the amount available to invest. The impact on VCTs themselves, and their performance, will obviously depend on the nature of their underlying investments and the impact inflation has on those businesses. The specialist and early-stage nature of many of those underlying investments may help them weather higher levels of inflation. With the focus of VCTs being on growth capital, with those capital returns then typically paid out as dividends, the focus on dividends as income and their need to keep pace with inflation is less critical than it may be for other sectors The Budget seems to promise little direct impact on the tax-advantaged sector that VCTs sit in. Nonetheless, what new changes do you think will have the biggest direct impact? I’d agree that there seems little direct impact from the Budget on VCTs. That said, VCTs are well placed to deliver the government’s levelling-up agenda, with a majority of VCT investment directed outside London. VCT managers are based all around the UK and often have regional expertise and networks, helping to support the development of entrepreneurial businesses around the country. VCTs are also well placed to play a role in directing capital into sectors which are the focus of government attention, particularly around some of the emerging technologies in areas such as green energy by way of an example. What further changes would you like to see the government implement in the sector, and why? We are realistic. We know the government has a lot on its agenda and there is scope for the VCT sector to play an important role in some of those initiatives. Stability is most important to help the sector flourish and continue to deliver the social and economic benefits that it does, so the one fundamental thing we would most like to see is for the government to make a public, long-term commitment to VCTs.
richard stone, ceo, aic
We couldn’t do this without the help and support of a number of third parties who have contributed to writing this update. Their contributions range from inputting into the scope, sharing data, giving us their insights on the market, providing copy, and peer reviewing drafts. So, a big thanks to: Richard Stone and Nick Britton of the Association of Investment Companies (AIC); Nic Pillow and Reuben Wilcock of the Blackfinch Group; Francesca Rayneau of Calculus Capital; Tom Mullard and Rebecca Ward of Downing Investments; Jessica Franks of Octopus Investments; Charlie Stoop and Rupert West of Puma Investments. Their input is invaluable, but needless to say any errors or omissions are down to us. We have relied upon MICAP for most of the data. MICAP is part of the same group of companies as Intelligent Partnership. We also carried out our own extensive desk research and interviews to verify their data. The update is made possible by our sponsors, who have contributed copy to the update and supported us by helping to meet production and printing costs. So, a big thanks to The Blackfinch Group, Calculus Capital, Downing Investments, Octopus Investments, and Puma Investments.
update overview
learning objectives for cpd accreditation
Identify the main developments and news in the VCT market Benchmark products and providers in the VCT market against one another Evaluate the key fees and charges applied by VCT manage Describe key events and trends that are having major impact on the VCT sector Define some VCT-relevant themes and legislation for the post-Covid era
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Acknowledgements and Thanks
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EDITORIAL Mohamed Dabo CREATIVE Mar Alvarez SUB-EDITING Lisa Best & Mohamed Dabo RESEARCH Mohamed Dabo
MARKETING Carlo Nassetti DISTRIBUTION Michelle Powell SALES Chris White
key findings
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of advisers trust the industry less since the Woodford debacle
54%
of advisers say demand for ESG investments will increase in the next 12 months
89%
UK planned increase in public R&D investment yearly by 2024-25
£22 billion
raised by UK tech companies this year, beating all except US and China
£11.3 billion
planned dividend tax rates increase for 2022-23 tax year
1.25%
decline in AMC charged to investee companies
40%
of advisers cite tax relief as “primary reason” for VCT investment
92%
£685 million
£
fundraising (11% up from 2019/20 tax year)
%
?
This update has thrown up some interesting, sometimes alarming, sometimes revealing facts and figures. So we've selected a few to give you a flavour of the current context, some food for thought and some indicators of the fundamentals you should be aware of.
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VCTs: the golden age of fundraising What is bringing investors to VCTs The ‘no-news’ Autumn Budget The two sides of the great fee debate How to use VCTs for retirement Why investments in smaller companies can be a valuable addition to a client’s portfolio What the managers say
VCTs: the golden age of fundraising
As a result of the Covid-19 pandemic, the UK has seen a couple of tax years where people were reducing how much they were deploying to risk assets. Now, it seems, the pent-up demand is being unleashed and VCTs and other tax-advantaged investment schemes are the prime beneficiaries.
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The VCT season started earlier again this year, the market is seemingly awash in liquidity, and we’re seeing a record number of deals. After a bumper VCT season in 2020/21, there was every reason to expect further growth this year. The VCT sector raised £685 million during the 2020/21 tax year, according to the Association of Investment Companies (AIC). This represented an 11% increase compared with the 2019/20 tax year when the outbreak of the pandemic hit VCT fundraising and £619 million was raised. It was 6% below the year of 2018/19, when funds raised by VCTs totalled £731 million. “Much of the investment went to support healthcare, science and technology businesses which have helped in the battle against coronavirus and supported us to adapt to life in lockdown,” said Ian Sayers, AIC’s then Chief Executive.
vct total Fundraising per tax year (£ million)
Source: AIC
Rising trend of VCT fundraising
The number of VCTs raising funds in the tax year ending 2020 remained constant since that ending 2019 (42), according to the HMRC. “In the past, the amount of funds raised by VCTs and the number of VCTs raising funds have been closely linked. However, this has been less evident in recent years where similar amounts of funds have been raised by a smaller number of larger VCTs,” said the UK tax authority in a report. As shown in the below chart, Venture Capital Trusts (VCTs) have been merging over time to achieve economies of scale. Venture Capital Trusts (VCTs) issued shares to the value of £685 million in the tax year ending 2020, which is 4.3% lower than in that ending 2019 (£716 million).
Combined VCTs raising funds, managing funds and funds raised
- Ian Sayers, Former CEO, AIC
VCT fundraising is crucial to the UK’s younger companies, as they will benefit from the VCT investment and expertise they need to grow. VCT-backed businesses deliver vital economic, social and environmental benefits, with jobs more than doubling after VCT investment.
VCTs raising funds and amount of funds raised
Source: HMRC
As seen in the chart above, the amount of funds raised by VCTs has been on a rising trend in recent years and has more than doubled since 2009 to 2010. This year, despite a slower start – compared to previous years – demand for VCTs started to surge from January. We followed a number of interesting VCTs with great interest, and reached out to ask them about their fundraising activities:
£354
£267
£269
£420
£429
£458
£542
£728
£731
£619
£685
2010/11
2011/12
2012/13
2013/14
2014/15
2015/16
2016/17
2017/18
2018/19
2019/20
2020/21
£900m
£800m
£700m
£600m
£500m
£400m
£300m
£200m
140
120
100
80
60
40
20
0
£100m
£0
1999/20
2000/01
2001/02
2002/03
2003/04
2004/05
2005/06
2006/07
2007/08
2008/09
2009/10
1996/97
1997/98
1998/99
Number of VCTs
90
70
50
30
10
Funds raised (£million)
VCTs raising funds
VCTs not raising funds
Funds raised
Blackfinch Spring VCT: two new share issues done, one more to go
“We have definitely seen increased momentum from VCT investors this year. In the current tax year, we have so far completed two new share issues for the Spring VCT,” said Nic Pillow, Ventures Manager at Blackfinch. Despite the traditional summer lull, Blackfinch Spring VCT raised £922,379.41 at the end of June and £594,862.41 at the end of August (a total of £1,517,241.82), representing a threefold increase in VCT subscriptions over the equivalent period last year. “Since then, we have issued a new VCT prospectus, but we are yet to issue shares for a third share offer,” added Pillow. “Last year, we went on to raise a total of £6 million for the entire 2020/21 tax year, so we are well on track to exceed that total by a significant amount.”
Calculus VCT: raised double the amount raised last year
Between September and mid-November, Calculus VCT raised £2,000,000, double the amount raised at this point last year. “Since this offer launched in September 2021, the Calculus VCT has raised just over £2,000,000, which is more than double the amount raised at this point last year,” said Francesca Rayneau, Director, Marketing and Investor Relations at Calculus Capital. “The last VCT offer (from September 2020 to August 2021) was our highest fundraising amount since the launch of the Calculus VCT in 2016. If the momentum continues, we should see another record-breaking year for the VCT,” she added.
downing four vct: three share classes with sector focus
“There has definitely been increased inflows and enquiries for VCTs this year. Considering we’re not yet in the VCT season yet, we’ve had inflows this tax year of over £10 million across Downing FOUR VCT and Downing ONE VCT,” said Rebecca Ward, Product Development Manager at Downing. “Following demand for more sector specific VCTs, we opened Downing FOUR VCT with three share classes: Ventures, Healthcare and a new AIM share class. “Downing has been an active investor in VCT qualifying AIM companies for over 10 years (through our combined strategy in Downing ONE VCT). More recently we have seen an increase in the number of interesting VCT qualifying businesses which, coupled with increasing demand in this market, we believe makes it a good time to launch a sector specific AIM VCT. “We have also found that investors have been extremely interested in UK healthcare companies, where during the pandemic, the UK has proved to be a world leader. “Since opening in August, we’ve had apps worth around £3 million across the three share classes. Considering previous years inflows, we expect this to ramp up towards the end of the tax year. Our early bird offer (0.5% discount for new investors and 1% discount for existing investors) ends on 11 February 2022.”
Octopus VCTs: fundraising at record speed
“Octopus’ VCTs have reached capacity within a matter of weeks, raising over £280m across the four VCTs. This demonstrates the appetite within the market for venture capital investing and the confidence investors have towards VCTs as a vehicle to access high growth smaller companies,” said Jessica Franks, Head of Retail Investment Products at Octopus Investments. To find out more about Octopus and their smaller company investing products please click here.
Puma VCT 13: Strong fundraise and attractive returns
“We have seen strong interest from VCT investors this year. Puma VCT 13 has raised close to £10 million to date in the current tax year, which is a 600% increase on the same period in the previous tax year,” said Sam McArthur, COO at Puma Investments. “Puma VCT 13 has just released its interim Report where it announced a return per share of 8.34p for the six months to 31 August 2021, a successful exit of its investment in Pure Cremation (realising a 3.9x return on funds invested) and an interim dividend of 6.5p per share declared, payable in December 2021,” he added.
What is bringing investors to VCTs
Tax relief is the primary reason for investing in VCTs for 72% of private investors, AIC survey data shows.
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For a great majority of investors (88%), it is important that VCTs help support the UK economy. And 84% believe that by using VCTs they’re helping UK entrepreneurs. Supporting cutting-edge science (such as healthcare and technology innovations) through their VCT investment was important to 81% of investors. Nearly three quarters of investors (74%) were attracted by the growth potential of backing young companies early; and two thirds (67%) appreciate they can support green technologies by using VCTs. The goal of most VCT investors is saving for retirement (56%), while 44% use them for saving for their families. The AIC’s survey also found that more than four-fifths of VCT investors (84%) are satisfied with their experience of VCTs and that just over three-quarters (76%) would recommend VCTs to other investors.
“VCT managers will have the Prime Minister and his Chancellor to thank; their announcement of a tax hike on dividend payments to help pay for the NHS and for social care makes VCTs look more attractive than ever,” David Prosser noted in an AIC blog. The government’s plan is to increase dividend tax rates by 1.25 percentage points from the beginning of the 2022-23 tax year. For higher-rate taxpayers with equity portfolios generating more than £2,000 of dividends, the tax on the excess will therefore rise from 32.5% to 33.75%. And while there will still be no tax to pay on dividends from shares held within an individual savings account (ISA), the £20,000 annual allowance limits investors’ options. Many will be looking for other strategies to manage their tax exposures, Prosser said. Pension contributions are limited by both an annual allowance and a lifetime allowance. Once you’ve exceeded those allowances, pensions become a less efficient way to invest for retirement. These restrictions combined with the pitiful gilt rates mean that getting a decent investment income from most retirement products has become next to impossible. Now that the lifetime allowance has been frozen until 2026, we expect to see increased demand for tax-efficient alternatives, such as VCTs, to complement pension planning. Savvy investors and advisers recognise that over time pensions have probably been the most tax-efficient way to save for retirement. With pensions now becoming less tax-efficient, VCTs are providing a powerful alternative although the much higher risk profile must always be considered. Undoubtedly, this particularly strong VCT fundraising year reflects the popularity of the sector among investors. Looking ahead, managers are reporting a growing interest from young people, an indication of future expansion.
Softening the blows of pension constraints and dividend tax hike
of investors believe in supporting cutting-edge science
81%
VCT managers will have the Prime Minister and his Chancellor to thank for their announcement of a tax hike on dividends payments.
The ‘no-news’ Autumn Budget
The UK’s second 2021 budget delivered on 27 October in the House of Commons yielded surprisingly few surprises, leaving many in the tax-advantaged investment sector with mixed feelings.
“No news can be good news. There were no specific changes relating to Venture Capital Trusts (VCTs) in the budget but the government announced an ambitious programme for levelling up the country,” said Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC). She reminded that “VCTs play a vital role in levelling up by investing in SMEs around the UK. They invested £695 million in SMEs through the first six months of 2020, supporting these companies through the pandemic.” However, the budget was lambasted for the things it did not tackle. It addressed neither VCTs nor the Enterprise Investment Scheme (EIS) directly. The Enterprise Investment Scheme Association (EISA) has denounced “the failure to acknowledge private investment.” While welcoming the Chancellor’s statements “on boosting innovation in the UK,” the official trade body for the EIS expressed disappointment that “he has failed to recognise that much of the initial investment that supports the early stages of new innovative businesses comes from the private sector, making use of the Enterprise Investment Scheme.” Director General of the EISA, Mark Brownridge commented: “The investment gap for early-stage growth businesses that are unable to attract funding through the banking sector, whether supported by government schemes or not, sits at in excess of £2.5 billion. He said his organisation would continue to lobby the government to recognise the part that private investors play in starting and driving innovative businesses, “underpinning the positive projections that the Chancellor has cited”.
- Chancellor Rishi Sunak
Giving reassurance to the private investors who provide this much needed capital that the scheme will continue beyond the current sunset date of 2025 is critical.
The clue, for attentive listeners, that the budget would not have much of an impact on the sector came halfway through the speech when Sunak said, “Now is not the time to remove tax breaks on investment,” a positive endorsement of the important role of tax reliefs in driving funding. That hunch proved accurate for the most part. Nonetheless, a few of the changes will likely have an indirect impact on the sector. For example, the government will not be abolishing business rates, choosing instead to ‘make the business rates system fairer and timelier’. “We on this side of the House are clear that reckless, unfunded promises to abolish a tax which raises £25 billion every year are completely irresponsible. It would be wrong to find £25 billion in extra borrowing, cuts to public services, or tax rises elsewhere, so we will retain business rates. But with key reforms to ease the burden and create stronger high streets.” The improvements include more regular revaluations, with additional temporary measures such as the cancellation of the previously announced business rate multiplier for 2022 and a 50% deduction for businesses in the Covid-hit retail, hospitality and leisure sectors in 2022/23 up to a maximum of £110,000. This decision is in contrast to Labour’s, which has pledged to scrap business rates and close tax relief schemes that “do not benefit the taxpayer or the economy.” “We will look at every single tax break. If it doesn’t deliver for the taxpayer or for the economy then we will scrap it,” Shadow Chancellor Rachel Reeves said in September. Another change to business rates, this one called for by the Federation of Small Businesses and the British Property Federation, is the introduction of a new investment relief to encourage businesses to adopt green technologies like solar panels. It is backed by incentives totalling £750m. This ‘Go Green’ drive will have an impact. Small businesses, which on aggregate have a high environmental footprint (especially those in the manufacturing sector) are critical for the green transformation. Since they and the business rates improvements are also the focus of tax-advantaged investments, their resulting reduced costs and enhanced growth will naturally benefit existing and potential investors in schemes like EIS and VCT. Renewable energies are among the commonly recognised trades in Business Relief (BR). BR plays an important role in supporting family-owned businesses and growth investment in the Alternative Investment Market (AIM) and other growth markets. A major appeal of investing in AIM-listed companies is the possibility of 100% relief from future Inheritance Tax (IHT) on such investments, as many AIM shares qualify for Business Relief (BR). As discussed in our recently published AIM Update, the current success of the AIM market receives a sizable boost from those looking to invest in BR-qualifying companies.
Business rates cuts, R&D incentives, green investment, and draught relief
On another front, English pub owners could raise a toast to the Chancellor for introducing a new draught relief, which will apply a lower rate of duty on draught beer and cider. “It will particularly benefit community pubs who do 75% of their trade on draught”, Rishi Sunak said, adding the measures, which are ‘not temporary,’ represent the ‘the biggest cut to cider duty since 1923,’ ‘the biggest cut to fruit ciders in a generation,’ and ‘the biggest cut to beer duty for 50 years’. The tax breaks are good news for VCTs that invest in pubs, and might help to boost VCT investment in this area.
A toast to the Chancellor?
The Chancellor confirmed the government’s target of increasing investment in research and development (R&D) to £22bn. Combined with the tax reliefs, total public investment in R&D is increasing from 0.7% of GDP in 2018 to 1.1% of GDP by the end of this Parliament. This level of public investment compares to an OECD average of just 0.7%, with Germany investing 0.9%; France, 1%; and the United States, just 0.7%, Sunak said. R&D isn't something only big corporations can do. Small businesses have been known to leverage R&D to compete on, and even lead, their markets. For VCTs that invest in such companies, including the knowledge-intensive companies, the tax relief could make a significant difference. A few of the pre-budget pundits predicted that the government would cut down the tax relief on VCTs. Perhaps the Chancellor’s decision to leave VCT and EIS tax reliefs unassailed is a recognition of their crucial role in Britain’s economic recovery from the Covid-19 pandemic. However, some in our industry believe that was not nearly enough, arguing that an economic agenda that the Chancellor said aims to “create jobs, lift growth, and spur innovation,” calls for a decisive increase in the levels of VCT tax reliefs.
UK to invest in late-stage innovation, doubling Innovate UK’s annual core budget
£1bn
R&D incentives
- Rupert West, Managing Director, Puma Private Equity
The most important thing the government can do for our sector is to show support to UK SMEs and provide stability (and predictability) in the regulatory landscape.
While the controversy surrounding investment-related fees is typically informed by emotions, myths, and misconceptions, the issues involved are hardly black and white in nature.
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Over the past few years, there has been considerable focus on the fee structures of Venture Capital Trust (VCT). These close-ended investment companies typically charge an annual management fee of around 2% of the net asset value (NAV) of the fund. In addition, many VCT funds charge portfolio companies arrangement, monitoring, and director fees, which are essentially paid by the shareholders of the investee companies. Charges can make a difference in any investment, but when investors are locked in their position for a minimum of five years, the issue of fees takes on added importance. It’s therefore no surprise then that over the years, VCT managers have been criticised for imposing high charges on investors.
The two sides of the great fee debate
The defence: “The fees are appropriate to the complex, intensive investment process”
The claim of a ‘fortress-like VCT community,’ closed off to new entrants is clearly refuted by the data. In the last five years, 4 new VCTs have launched. This represents almost 10% of the 42 VCTs raising money in 2019/20, according to HMRC. According to HMRC figures, “The number of companies operating as Venture Capital Trusts has increased in 2019 to 2020 and the amounts claimed as tax relief have grown by a small amount in 2018 to 2019.” Given the nature of the VCT business, VCT managers say, it’s inevitable that costs would be higher than those for mainstream investments. VCTs are private equity models that invest mainly in unquoted companies. Running a trust that invests in small, early-stage companies is very complicated, and more difficult than running a mainstream investment. First of all, these businesses require more laborious due diligence. Then, they need more help to be shaped, which means managers have to get more involved, put in more effort and deploy more money. Many of the companies are not even investor ready when VCTs get involved. Managers often have to take seats on the board, actively advise the business, agree a strategy, and ultimately steer it towards an exit. The fees reflect this reality. Another cost factor is that VCTs don’t typically have a stockpile of listed companies to draw from. Instead, they have to source new deals all over the country, by conducting scores of due diligence exercises and negotiations with as many management teams. It normally takes months of hard work and intense negotiations to make one investment. All these activities, VCT managers contend, represent a huge investment of time, labour, and money. As for charging their portfolio companies, the managers point to the fact that none of the VCTs investing in AIM companies charged initial fees or annual management charges to them. In their case, much of these chores—such as the due diligence and the non-execs on the board—was done when the company listed on the exchange. In addition, AIM VCTs’ regulatory reporting absolves them of the monitoring that the other VCTs have to do. As Nick Britton, head of intermediary communications at the Association of Investment Companies (AIC), explained to FTAdviser: “Fees charged to investee companies help fund these operations. VCT shareholders don’t bear the full cost of these fees, because they are borne by all shareholders in the investee company, in which the VCT will have only a minority stake (...) Advisers should remember that VCT boards are in place to protect the interests of their clients as shareholders in the VCT, and that fees to investee companies will be considered as part of the overall negotiation between a VCTs board and its manager." Size is another factor in the business. VCTs are very specialised vehicles, small in size, that have to operate within the complex framework of qualifying investments that change. When VCT funds are small in size, the annual management charge does not typically cover the costs of the intense activity mentioned earlier. Among the reasons for this is the high level of fixed overhead costs. However, scaling up is not always easy, as VCTs are restricted in the amount of investment they can make into individual companies year on year. Managers point out that fees have been falling over the years. While this has not always been the case from one year to the next, this year at least witnessed a significant fall in both the initial charge to investee companies (a 39% decline) and Annual Management Charge (AMC) imposed on investee companies (a 40% drop). The annual performance fee saw a 12.6% decline, while the total AMC went down by 10.5%.
The criticism: “High fees increase investor risk and make VCTs less tax efficient”
Critics have argued that when VCTs levy charges on the companies in which they invest, it’s not just the shareholders of those companies that end up paying. The investors in those funds will also be paying at least a portion of these fees. Through these charges, the VCTs are effectively taking back some of the money they have invested, or so the argument goes. And the portion of fees taken in an initial charge by the VCT manager, rather than being invested into the VCT itself, reduces the proportion of the overall investment on which tax reliefs can be claimed by the investor. VCT managers are able to get away with the lofty fees, their detractors claim, because they benefit from a high barrier to entry. Investors prefer well-established VCTs, with track records, that are already paying dividends. This discouraging situation for potential new entrants in the field, the argument goes, produces no incentive for managers to reduce their costs or increase transparency. The allegation is that VCT managers have largely escaped the pressure to discount fees that asset managers in other sectors have been facing for the past few years.
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nvestors place almost £700m into Venture Capital Trusts (VCTs) each year as many of us now use VCTs as a key part of retirement planning alongside our pension. They are a tax efficient way of saving for retirement and then drawing income once in it. This is more important than ever because over the past 15 years the government has squeezed much of the benefit out of pensions for high earners. The pensions squeeze Back in 2006, when the lifetime allowance was first introduced you could hold up to £1.8m in your personal pension and pay in up to £255,000 each year. Today the threshold for annual pension contributions is just £40,000 for most and less for many. The annual allowance of £40,000 may be ‘tapered’ if your ‘threshold income’ is over £200,000. In the meantime, the lifetime allowance has shrunk to £1,073,100. This is forcing many higher earners to look for other ways to invest for their retirement. They have limited options. In 2017 the Chancellor at the time, Philip Hammond, reduced the tax-free allowance on dividends from £5,000 to £2,000. He and his predecessor George Osborne also imposed a series of restrictions on buy-to-let investing, making that once popular option less attractive. The VCT alternative For many advisers VCTs are now the go-to pensions companion. Benefits of VCTs in the retirement build up HMRC does not include VCTs within its pension-related investment limits. It currently sets the annual contribution cap on VCTs at £200,000, regardless of income. So, when high earners hit their pension allowance limits, they can find extra tax-efficient saving headroom in VCTs. VCT investors can claim an income tax deduction of 30% on the amount invested. This income tax deduction can be particularly helpful for those nearing the end of their career who are being offered a lump sum “golden handshake”. Of course, investments in VCTs are higher risk and this tax benefit is meant to help mitigate that risk. If the investment does well there is an additional bonus as any capital gains are also free from tax. Benefits of VCTs in retirement Dividend payouts from a VCT are tax free. This is significant when you remember that additional-rate taxpayers face a 38.1% tax if they receive more than £2,000 a year in dividends outside tax wrappers, and this will increase in tax year 2022/23 to 39.35%. This makes VCTs useful for generating a tax-free income boost in retirement. We are targeting an annual tax-free dividend of 4.5% in the Calculus VCT as well as long-term growth. Earlier this year we introduced a Dividend Reinvestment Scheme for those seeking to reinvest dividends – perhaps still at the pre-retirement accumulation stage. Some things to remember You must hold any investment in a VCT for at least five years, if not you risk losing the tax relief benefits. HMRC could force you to pay them back. The government offers VCT tax reliefs to encourage investment into smaller up-and-coming growth companies. This entails greater risk than investing in large, public market companies. To benefit you must have paid or owe as much income tax as you are claiming back. You may find it hard to sell your VCT if you unexpectedly need the money – you should consider it an illiquid investment. VCTs offered on the secondary market do not come with tax reliefs. The minimum investment you need to make will depend upon the VCT in question. For the Calculus VCT it is set at £5,000, although investors can subscribe up to £200,000 per tax year.
I
HMRC does not include VCTs within its pension-related investment limits. It currently sets the annual contribution cap on VCTs at £200,000, regardless of income. So, when high earners hit their pension allowance limits, they can find extra tax-efficient saving headroom in VCTs.
francesca rayneau
Director, Investor Relations and Marketing calculus capital
thought leadership
How to use VCTs for retirement
www.calculuscapital.com 0207 493 4940 info@calculuscapital.com
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nvesting in smaller companies can increase diversification, help with a client’s tax planning and boost the UK economy – and now is a great time for advisers to learn more. Larger companies will typically make up the majority of a client’s pension and ISA investments. But exposure to smaller companies within a diverse portfolio can deliver valuable benefits. What’s more, now could be an ideal time to invest and back the next generation of pioneers. That’s because these businesses have a great opportunity to shape the future of the UK economy following the shock of a global pandemic. Nimble and adaptable Smaller company investing comes with more risk. Because these companies are less established, they have a higher rate of failure and the shares can be less liquid than the shares of larger businesses. However, this doesn’t mean all smaller companies aren’t resilient. In fact, early-stage companies can often adapt best to shocks. New businesses tend to operate on more modern, technology-driven business models, meaning they can react better to shocks, and are potentially in a stronger position to come out the other side of the pandemic. Growth potential One way to increase personal wealth is to make an early investment into shares of a small business that goes on to achieve significant growth. Smaller companies have the potential to grow earnings faster than larger companies, injecting growth into a client’s portfolio. Over the long term, it’s typical for small companies to outperform large ones. However, it’s important that clients go in with open eyes. Smaller company investing is high risk and investors need to understand those risks. For example, volatility may be an issue. Thriving environment Right now, the UK is a thriving place for early-stage smaller companies. Some recent examples of businesses Octopus has sold stakes in, on behalf of investors, include Depop and WaveOptics – both delivering excellent outcomes for investors this year. Depop, a second-hand fashion app, was bought by global e-commerce platform Etsy for $1.6 billion, while augmented reality innovator Waveoptics was snapped up by Snapchat for more than $500 million. Octopus Titan VCT was also an early investor in car retailer Cazoo, the UK-based ‘unicorn’ which floated on the New York stock exchange this summer. The UK is now the world’s fourth most prolific country at taking innovative tech firms from start-ups to the public market or sale to global businesses. How to invest in smaller companies Investing at an early stage is key to achieving the greatest growth, and this often occurs at the fastest rate before a company reaches IPO or is sold. However, this has typically been the realm of venture capital firms, or private equity investors as it carries a high risk profile. It is very difficult for individual investors to source the diamonds from the coal. With so many fledgling companies out there, it is not easy to spot those worth exploring further, let alone to undertake detailed research into their potential risks and rewards. Investing in a VCT or EIS portfolio run by a manager experienced in smaller company investing can be a great way for investors comfortable with the risk to access these high growth potential investments. Risk and reward Small, early-stage companies have the potential to grow significantly. Where tax benefits exist, however, these tend to compensate for some of the additional risks taken by investing in small companies. The value of the investments discussed, and any income from them, can fall as well as rise. Investors may not get back the full amount they invest. VCT shares and the shares of smaller companies are by their nature high risk, their share price may be volatile and they may be hard to sell. Tax treatment depends on individual circumstances and tax rules may change in the future. Tax relief depends on portfolio companies and VCTs maintaining their qualifying status.
jessica franks
Head of Retail Investment Products octopus investments
Why investments in smaller companies can be a valuable addition to a client’s portfolio
Lipper, taking the average return by investment horizon of the FTSE All-Share TR and IA UK Smaller Companies TR, over a 1, 3, 5 and 10-year period.
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www.octopusinvestments.com +44 800 316 2295 support@octopusinvestments.com
New businesses tend to operate on more modern, technology-driven business models, meaning they can react better to shocks, and are potentially in a stronger position to come out the other side of the pandemic.
what the managers say
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There seems to be a VC-funding boom going on across the globe. What do you see as the impact on, or connection to, VCTs in the UK?
As 2021 draws to a close, how have Covid-19 and the resulting economic environment impacted investment in early-stage companies?
Necessity is the mother of all invention, and the global pandemic has certainly been a catalyst for the development of new technology. Weaker companies have struggled, with some failing, but stronger more resilient teams are now starting to thrive. Many companies are offering highly targeted products and services focussing on post-pandemic recovery, while capitalising on an altered set of market dynamics for consumers and businesses. Some VCTs will have seen significant drops in NAV as legacy high street assets take a hit. The Blackfinch Spring VCT is still young and we’re fortunate to have made our first investments after the first lockdown. This means we’ve been able to invest in companies that offer technologies targeted at the post-pandemic future, rather than less relevant legacy firms.
DR Reuben Wilcock
Head of Ventures Blackfinch
So how are the managers feeling about the VCT market and overall investment market conditions? Here's what they have to say.
With the convergence of legislative, regulatory, and commercial commitments, sustainable investment continues to see momentum building up. Given the opportunities and challenges in this context, how well do you think VCTs will do?
Blackfinch has an ESG mandate across all of its products, and our Spring VCT is no exception. We believe investing in companies with the potential for high returns, but that are also doing good, and are working towards a sustainable future. The momentum building behind ESG investing is growing, and rightly so. It is no surprise companies that are aligned to social benefit and good governance, and that support a positive environmental impact are likely to thrive, producing strong returns. The net result of this shift for VCTs will be a positive future, wiser investment decisions and a greater benefit to the world around us.
There is certainly a global VC-funding boom, with a huge amount of funding flowing into early-stage companies in the fastest growing sectors globally, as well as in the UK. Therefore, the availability of funding for UK-based companies is strong, further supporting the start-up ecosystem that exists and increasing the number of potential investment opportunities for VCTs. The Calculus VCT is aligned with the recent growth, by investing in the three fastest growing sectors in the UK economy: technology, healthcare and media.
The pandemic impacted businesses both large and small. Covid-19 and government mandated lockdowns created a very uncertain economic outlook and companies across the board took measures to strengthen balance sheets and preserve cash. The impacts were not felt equally and sectors such as consumer, leisure and retail were hit the hardest. We remain positive about the long-term growth prospects in the areas in which we invest. Demand for many technology companies’ products accelerated over the last 12 months. The technology heavy NASDAQ market rose by over 40% in the course of 2020, compared to a fall of 14% for the FTSE100. The vital role healthcare and biotech companies must play in our society has been brought into stark relief by Covid-19. UK based healthcare companies which are transforming lives for the better and which have demonstrated some incredible science.
For investors looking for a positive impact opportunity, VCTs offer access to early-stage high growth companies crucial to the rebuilding of the UK economy and VCT investors support UK entrepreneurs and stimulate innovation. Often in areas such as healthcare and technology, these smaller, agile companies usually fit within ESG criteria.
Director, Investor Relations and Marketing Calculus
We are seeing the effects of this on both sides of our VCTs, with particularly strong deal flow opportunities at the moment, but also with record fundraising taking place in the VCT market this year. We think there is a good chance that VCT fundraising will set a new record this year, exceeding the nearly £800m raised in 2005/06 when the income tax relief level was 40%.
Many early-stage companies are technology focused and agile, and have been able to quickly adapt. Despite some sector specific challenges, we believe early-stage companies are now better positioned to take advantage of the structural changes which have occurred since covid.
There are some obvious areas where sustainable investment is already a clear fit, such as Healthcare or Clean Tech, and any VCTs that have a focus in these areas should benefit from the momentum. There will also be plenty of investment opportunities into new businesses as sustainable investment and the need for lower carbon living, cleaner energy sources and new technologies grows, and VCTs and VCT managers should be well placed to support these businesses.
Tom Mullard
Director, Product Development & Strategy Downing
The UK has supported and encouraged investment into smaller companies for decades through investment incentives such as EIS and VCT. This environment has contributed to UK the being fourth biggest producer of unicorn companies1 (those valued at over $1 billion). Examples of such companies include Cazoo and Zoopla, which have both been backed by Octopus Titan VCT.
Covid-19 and the global climate crisis has exposed the importance of innovation in areas like healthcare, scientific research and sustainability. We have seen high levels of interest in these areas from advisers and investors alike as people are more conscious of the massive impact that smaller companies can have on solving the world’s biggest problems.
We are living through a period of unprecedented change. Whole industries are transforming, almost overnight, creating value for investors at a very fast rate. Smaller companies are on the front line of developing solutions to some of the world’s biggest problems such as rising levels of inequality, the massive impact of climate change and a creaking healthcare system. This combination of factors creates a huge opportunity for investors.
Head of Retail Investment Products Octopus Investments
Global investors are increasingly seeing the UK as an attractive market for investing in high-growth technology companies. This global rising tide of VC activity has acted to encourage greater investment into VCTs as individuals look to diversity their portfolios and gain exposure to a market in which returns are increasingly attractive. We expect to see this increase in 2022. Greater availability of capital has the dual effect of increasing the number of follow-on and exit opportunities for our portfolio companies, as later-stage funds continue to gravitate down the value chain towards earlier stage opportunities, while creating fiercer levels of competition for the best deals. We’ve found that our team of ex-founders and our value-add approach really helps Blackfinch stand out in this environment.
The global increase of private capital investment into early-stage companies is great news for the UK VCT sector. This has translated into more seed stage companies being funded and graduating to scale-up growth SMEs, expanding the pool of investable opportunities for VCTs. In addition, the increased liquidity is presenting new exit channels for VCTs, as larger institutional investors look to place their substantial liquidity pools.
The last two years have had a disruptive impact on the economic landscape, in all sectors. SMEs have had to be adaptive in responding to change. Many have transformed difficult conditions into an opportunity to grab market share off incumbents and grow into new commercial channels. We have seen a number of impressive growth stories during this period.
VCTs have supported UK SME growth over the last 26 years and have always been flexible to changing market conditions. As consumer habits evolve and sustainable commercial models begin to take a more prominent role in our society, SMEs will need the flexibility and support of VCTs more than ever.
rupert west
Managing Director Puma Private Equity
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Market Composition Performance Targets
market composition
In this section we will take a look at how the VCT market breaks down and what the open offers look like following the traditional autumn fundraising season. Unless otherwise stated, the analysis is based on data obtained from MICAP and is correct as of 18 November 2021.
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In our last VCT Update published in January, we predicted that 2021 could be another big year for VCTs, on the strength of an impressive 5 new funds already launched midway through the first month of the year. The prognosis has proved accurate, as investors flock to their generous tax breaks while backing up-and-coming, exciting businesses that have become hot property in recent years.
vct assets
Source: AIC, October 2021
2016
2017
2018
2019
2020
2021
2013
2014
2015
2011
2012
2
4
6
8
£billion
Data from MICAP shows that the number of open offers has declined further this year to 18, continuing the downward trend of the past few years.
There were 25 open offers on the MICAP platform as of 27 January 2020, a number that had dropped to 22 by January 2021, in a trend that belies a healthy growth in the VCT sector. It's looking increasingly like current VCT drivers are distorting the usual fundraising season, bringing it earlier and earlier. This means that advisers will be well-advised not to leave their VCT tax-planning and investing to the last minute this tax year, as the high demand is leading some VCTs that have opened earlier, to close earlier too. Concentrated on the UK economy, the VCT sector has shown remarkable resilience, braving the storms of Brexit and Covid to emerge stronger than before. Despite the disruption caused by the pandemic, the opportunities available to VCT investors remain as strong as ever.
Open offers
One hundred percent of the open offers have adopted a growth and income strategy, a trend that is hardly unexpected and that has persisted for several years. While the pandemic continued to wreak havoc on economies, three sectors stood out because of their superior performance: pharmaceutical groups boosted by their hunt for a Covid-19 vaccine; technology giants buoyed by the trend for working from home; and retailers offering lockdown necessities online. Interestingly, however, these are not the sectors that most VCTs are focusing on. Only 16.7% of them are devoted solely to technology, even with the government’s avowed commitment to that sector and an Autumn budget that backs it up. And just 5.6% of the funds specialise in pharmaceuticals. Successful VCTs have used both the specialist and the generalist approaches to deliver outstanding results for their investors. The vast majority of VCTs (77.8%) are now concentrated on general enterprise. These typically invest in unquoted companies across a range of sectors, although some larger VCTs will also hold AIM-listed shares. The lack of specialisation is not an attempt by VCTs to ignore those booming sectors, but rather a game plan that allows them to take advantage of all of them, and not be anchored down to a single one. So, generalist VCTs can and do invest in pharmaceuticals, technology, and retail. Choosing to have their fingers in all the pies reflects the prudent view that diversification is as important as returns. These multi-sector VCTs use a range of different approaches. Some focus on young companies that aren’t yet profitable but have strong potential. Others look at more mature businesses and some take an asset-backed approach.. That great diversity of the available choices is the appeal of the general enterprise sector.
open offers by investment sector
77.8%
5.6%
16.7%
General Enterprise
Pharmaceuticals & Biotechnology
Technology
Half (50%) of the open VCTs are invested in early-stage companies, a rather big jump from the 13.6% that did so back in January. Rule changes introduced by the government in recent years — with the latest one initiated in 2018 — have required VCTs to shift towards younger companies. Beyond that, confidence in the future prospects of the UK economy, the expectation of fast growth from the Covid-induced slump, and the benefits of ‘getting in on the ground floor’ might all account for this newfound predilection for baby companies. In a booming economy, there are fewer business failures, and ‘the lower you start, the higher you can climb,' as an old adage goes.’ Later-stage companies get 14.3% open VCTs to invest in them. This continues a rising trend that was at 8% in January 2020 and 9.1% in January 2021. At the later stage, a company has found its footing and is aiming for growth and expansion. Traditionally, venture capitalists invest at this stage, when the risk is lower than in the earlier stage. AIM-listed companies are the second choice of VCTs, with 35.7% of them invested in companies quoted on the London junior market. Investing in public companies offers greater liquidity and transparency. Since January 2020, when Covid reached the UK, VCTs have invested £695 million in small UK businesses including £219 million in follow-on investment, according to the AIC.
Investee companies
VCT investee companies
It’s worth noting that optimism about the UK’s economic growth prospect has tempered as we go to press in early December. Government figures out in recent weeks show that the economy slowed between July and September as supply chain problems hindered the recovery. While the economy grew by 0.6% during September, the Office for National Statistics said the economy is 2.1% smaller than in the final three months of 2019, before the coronavirus pandemic hit. Sterling fell to its lowest level of 2021 against the dollar following the news. The economic slowdown comes after the Bank of England held off from raising interest rates despite rising inflation. Business leaders expressed caution about the outlook, with Suren Thiru, head of economics at the British Chambers of Commerce, saying the data points to the UK economy “only likely to return to its pre-pandemic level next year, behind many of our international competitors”.
The UK’s economic prospects grew dimmer in the final months of 2021
This year has witnessed some rather notable reductions in certain fees. The biggest change (a 40% drop) was seen in the annual management fee (AMC) charged to Investee companies, while the initial fee to investee companies also dropped by a similar amount. Managers have justified these fees by invoking the fact that VCTs, especially those investing in private companies, will be much more involved with the businesses, doing due diligence, agreeing the strategy, and placing directors on the boards.
Fees and charges
of VCT managers invest in a higher proportion of female-led businesses than five years ago
60%
open offers by investee company type
From January 2020 to January 2021, the AMC levied on the portfolio companies actually rose from 2.06% to 2.14%, suggesting that the plunge we’re now seeing occurred just in the past several months. Of course, one slump doesn’t make a trend. This fee compression might be driven by fierce competition, as the massive amounts of money raised by VCTs vie for the most desirable companies in the midst of a global pandemic. Interestingly, the AMC and initial fees paid by investors were largely unchanged, suggesting that inflows from investors have remained strong, dragging down the overall totals of both. VCTs raised £685 million in the tax year to 5 April 2021. This represents an 11% increase from the 2019/20 tax year when the outbreak of the pandemic hit VCT fundraising and £619 million was raised. In the fray, the total AMC paid by investors fell by more than 10% and the annual performance fee by over 18%. Where there was an increase in charges, it was very modest. For example, the AMC charged to investors went up by just over 2% and the initial charge to investors, excluding adviser fee, rose by about a third of a percent. All in all, more fees decreased, and by a greater amount, than increased in 2021. The following table shows the ranges and some numerical mileposts.
Early Stage
Later Stage
Aim Listed
66.7%
11.1%
22.2%
vct charges comparison
Initial Charge to Investor Excluding Adviser Fee Initial Charge to Investee Company Total Initial Charge AMC Charged to Investor AMC Charged to Investee Company Total AMC Annual Performance Fee Annual Administrative Charge Annual Performance Hurdle
2.92 1.25 3.75 1.97 0.75 2.39 16.39 0.09 8.06
nov 2021
2.93 0.76 3.39 2.01 0.45 2.14 14.32 0.09 6.59
jan 2021
+0.34% -39.2% -9.6% +2.03% -40% -10.5% -12.6% N/A -18.2%
change
Avg
mode
median
maximum
minimum
2.5 0 2.5 2 0 2 20 0
2.5 0 2.5 0 0 1.75 0 0
2.75 0 3 2 0 2 20 0
4.5 5 7.5 2.5 2.5 4.5 20 0.035 120
vct charges (november 2021)
A unicorn is a private company valued at $1 billion (£718 million) or more. Worldwide, the growth in the number of unicorns has paralleled the global funding increase for new ventures and tech startups. The term unicorn was introduced by venture capital investor, Aileen Lee, in 2013. The moniker was meant to reflect the particular attributes of a unicorn: something highly desirable, but very difficult to obtain.
Source: theaic.co.uk
£10m
turnover by 16 VCT-backed companies
of investee company turnover was earned overseas
30%
people employed by the 288 SMEs surveyed
14,000
invested in R&D by 181 companies in the last financial year
companies reported R&D spending averaging £1.97m per SME
181
£357m
- Francesca Rayneau, Director, Marketing and Investor Relations, calculus
We remain positive about the long-term growth prospects in the areas in which we invest. Demand for many technology companies’ products accelerated over the last 12 months.
performance targetS
As the UK economy struggled through two years of a devastating global pandemic, VCTs held their own, continuing to play a vital role in the survival and growth of early-stage companies.
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In 2020, the average VCT delivered a positive total return of 4%, while the FTSE All Share delivered a 10% loss in the calendar year. At the same time, UK GDP shrank 9% between January and November of that year, according to the Association of Investment Companies. Not surprisingly, managers reported that portfolio businesses in the healthcare, technology and e-commerce sectors had benefited most from the pandemic, with leisure, hospitality and tourism holdings being the hardest hit. If VCTs performed well in 2020, despite the challenges of the Covid-19 pandemic, this year has outdone its predecessor by miles. As 2021 draws to a close, what kind of returns are the open VCTs targeting?
Target returns
The target average returns for open offers currently stands at 4.89%, a shade higher than the historical target average returns of 4.82% despite the challenging times. Historical refers to those offers launched prior to the current tax year (i.e., prior to April 2021 - April 2022). Since VCTs invest in small companies, one can be forgiven for thinking that returns are mostly in the form of capital growth. But that is not the case. Regular, tax-free dividends are actually one of the chief attractions of investing in successful VCTs.
target return of open offers
“As the VCT sector has matured, so too have returns, with good long-term performance together with a strong tax-free income,” said Annabel Brodie-Smith, communications director of the AIC. “The performance figures do not take into account the tax benefits VCT investors receive, to offset some of the higher risk which comes with supporting small and growing UK companies at the coalface of the economy. "These figures demonstrate that as well as being higher risk, VCTs can also be high reward; however, the old adage ‘don’t let the tax tail wag the investment dog’ is as true as ever.”
Dividends are both an important part of an investment return and a vital source of income, something which many mainstream investors have become more reliant on in recent years while interest rates have been so low. But dividends are the first things to go in times of crisis. This is what happened at the height of the Covid pandemic when some big players, such as banks, stopped paying dividends altogether. Now companies are starting to pay dividends, though the situation is a little more nuanced. In reality, just 10 firms are expected to pay out 75% of the FTSE 100’s 2021 dividend, according to investment broker AJ Bell. In that context, this year’s target dividends among the open VCT offers are rather interesting. They range from 3% to 7%, with 5% being the most common. Among the current open offers, the target average dividends is 4.89%, a notch higher than the historical target dividends of 4.83. This compares to an annual average of 5.57% across VCTs that did pay dividends, since inception for VCT offers. Of course, with VCTs, the dividend story has a part 2. Many VCTs have automatic reinvestment schemes which allows investors to use the dividend to buy more shares in the trust. With some exceptions, usually the shares are newly issued rather than bought in the market, meaning that the amount reinvested qualifies for 30% income tax relief as a fresh VCT subscription.
Target dividends
Target dividends for open offers
Starting April 2022, tax on dividend income will increase by 1.25% to help support the NHS and social care. Currently, the rates are as follows:
tax rates
The VCT fundraising season got into full swing in September and was a time of several rounds of impressive fundraising. During the pandemic and at a time when the UK’s young companies have needed it most, the VCT sector has raised £685 million for investment in small, innovative UK businesses. Where reported, open VCT offers target an average £1,000,000 in fundraising, less than the historical average minimum fundraise of £2,400,000. Whatever the reason, lower fundraising targets bring in more investors. That is what happened last year, when a 7.5% drop from the previous year allowed the most popular offers to be filled well in advance of the end of the tax year. Overall, 13 of the year’s 22 offers (comprising 20 of the 30 individual VCTs raising funds) were fully subscribed before 5 April 2021. Much of the investment went to support healthcare, science and technology businesses which have helped in the battle against coronavirus, said the AIC. “It demonstrates that demand for VCTs and the benefits they bring investors remains high at an extremely difficult time,” said former AIC boss Ian Sayers.
Target fundraising
On average, the open offers require a minimum subscription of £3,944, which makes VCTs very much accessible to retail investors. The historical average minimum subscription of £4,216 implies that this affordability has increased over time.
Target subscriptions
minimum subscription of open offers
average
basic rate
4.89%
5.00%
3.00%
7.00%
higher rate
additional rate
7.5%
32.5%
38.1%
Tax band
Tax rate on dividend
£3,944
£3,000
£6,000
minimum fundraise of open offers
£1,000,000
n/A
So, it’s been quite a time for the VCT industry, which turned 26 earlier this year. Meanwhile, some VCTs that have just launched had their first listing at 0 investee companies. Richard Stone, Chief Executive of the Association of Investment Companies (AIC), said: “VCTs support a wide range of SMEs, from healthcare to technology and generate new jobs to help create a more resilient and responsive economy. Their unique contribution makes a compelling case for VCTs to receive continued backing from the government and policymakers across the political spectrum. “As the UK looks to build back a more stable and competitive economy, VCTs have a vital part to play in the business ecosystem making significant investments in ambitious young companies.”
Target number of Investee companies
Historical
The VCT fundraising season got into full swing in September and and featured several rounds of impressive fundraising. During the pandemic and at a time when the UK’s young companies have needed it most, the VCT sector has raised £685 million for investment in small, innovative UK businesses. Where reported, open VCT offers target an average £1,000,000 in fundraising, less than the historical average minimum fundraise of £2,400,000. Whatever the reason, lower fundraising targets bring in more investors. That is what happened last year, when a 7.5% drop from the previous year allowed the most popular offers to be filled well in advance of the end of the tax year. Overall, 13 of the year’s 22 offers (comprising 20 of the 30 individual VCTs raising funds) were fully subscribed before 5 April 2021. Much of the investment went to support healthcare, science and technology businesses which have helped in the battle against coronavirus, said the AIC. As far as former AIC boss Ian Sayers is concerned, “this demonstrates that demand for VCTs and the benefits they bring investors remains high at an extremely difficult time.”
Number of firms expected to pay out 75% of all FTSE 100 dividends in 2021
44.05 90 0 40 90
49.50 82 0 43 90
Source: AJ Bell
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What advisers learned from the Woodford debacle VCT-backed unicorns: masters of disruptive innovation VCTs and the new era of retirement planning
What advisers learned from the Woodford debacle
The implosion of Neil Woodford’s fund empire, which sparked the biggest British investment scandal of a decade, has left financial advisers less trusting of the investment industry. This erosion of trust has important implications.
19
A survey by the Association of Investment Companies (AIC) has revealed that advisers are a lot more cautious about trusting a fund manager’s reputation or investing in a fund that has exposure to illiquid assets. A majority (54%) said their trust in the industry had been weakened; and among those advisers who had clients impacted by the suspension, 62% trusted the industry less than before. The lessening of the trust level is found among savers and investment managers and advisers alike. This is concerning because trust is at the core of the adviser/personal investor relationship and that advice is essential for individuals to be able to build their own personal finances. Moreover, lack of trust in retail funds, which are supposed to be well managed and regulated, has an impact on the whole industry. The Woodford drama came to a head in June 2019 when superstar fund manager Neil Woodford was forced to suspend trading in his £3.7 billion flagship Equity Income fund. The fund fell into difficulties when too many of its investors demanded their money back at the same time. Woodford, who had invested in assets that were illiquid, could not sell the assets fast enough to meet investors’ demand for cash.
Jan
May
4.8
£bn
4.6
4.4
4.2
4.0
3.8
3.6
Source: Morningstar, FT
LF Equity Income Fund, asset under management
1) High proportion of unquoted companies (62%)
most common reasons for the collapse:
The two most commonly cited reasons for the collapse were the high proportion of unquoted companies (62% of respondents) followed by liquidity issues (55%). One of the most common lessons advisers have learned from Woodford is to give more consideration to liquidity when choosing investments (47% of respondents). Financial advisers have generally adapted to their post-Woodford perceptions of the market risk level through compensatory behaviour. The most common behaviour change involves checking the level of exposure to unquoted companies in funds (37%).
Unquoted shares can still be valuable
The Woodford debacle should not be seen as a reason to completely dismiss out of hand the opportunities presented by unquoted shares. Of course, one of the main investment targets of VCTs is unquoted companies, but there are some important distinctions to make between the investment structure used by Woodford and VCTs: The Woodford Equity Income fund operated under UCITS rules, which permit a maximum of 10% of a fund’s assets to be invested in less liquid assets such as unlisted securities. However, Woodford ‘inadvertently’ broke this illiquidity threshold on a number of occasions. It was also an open ended structure promising daily redemptions. The promise of daily liquidity was somewhat misleading for investors since a large portion of the assets held in the fund were likely to take longer to sell in an orderly way. “Advisers clearly identify the Woodford fund’s exposure to unquoted companies as the number one reason behind its suspension and eventual failure. Whenever open-ended funds hold hard-to-sell assets, there will be a risk of such problems,” said AIC’s CEO, Richard Stone.
VCTS are not like the Woodford fund
Unlike the Woodford Equity Income fund, the investment trust structure is particularly well suited to invest in illiquid assets, such as unquoted companies, because it is close-ended. One reason for this is that managers do not have to worry about money coming in and leaving the fund, as investment companies have shares which are bought and sold on the stock exchange. When negative news hits, the share prices will fall but the portfolio itself will be unaffected. Investors may not like the fact that share prices have fallen, but they normally will still be able to sell their shares if they wish to. Indeed, many VCTs offer share buy-back facilities to existing investors at a small discount. VCTs also keep a portion of their holdings in cash reserves or other liquid assets mainly for redemption purposes. In short, if the Woodford fund had been a VCT, it might still be in business today. VCTs being long-term investments, the temporary liquidity problem--caused in Woodford’s case by incompatible illiquid instruments and daily dealing, which no VCT would promise--would resolve itself well within most investors’ investment horizon. VCT investors go in with neither promise nor expectation of daily liquidity. Rather, the upfront 30% income tax relief, the tax-free dividends, and tax-free growth are far more important to them. In respect to the Woodford Fund, some of the portfolio companies listed their shares on The International Stock Exchange (TISE) on the tiny British Channel Island of Guernsey. Seemingly from a regulatory perspective, these companies were classified equally alongside companies with much greater capitalisations and lengthy reporting histories listed on the main board of the London Stock Exchange. However, the companies listed on the TISE traded infrequently if at all, while many investors remained under the hopeful impression that their listed investments could be realised to satisfy redemptions if required. As redemptions and underperformance diminished the liquid assets, the share of illiquid investments as part of the fund’s total capital continued to grow. Not being a VCT (whose investors buy in not anticipating early redemption, particularly since a minimum five-year holding period is required to claim the income tax relief on offer), the fund was hit by mass redemption requests it could not sustain. Far from being a handicap, having the freedom to hold unquoted companies is a major benefit of the investment company closed-ended structure. Investors are interested in the opportunities that fast-growing unquoted companies within a wider portfolio of investments can bring. As more firms are deciding to stay private for longer (see the section on the Unicorn phenomenon), more value is to be found among unquoted companies; and it could be argued that the potential reward more than justifies the risk - that is, when accessed through an appropriate investment vehicle like a VCT.
Risk compensation is a theory which suggests that people typically adjust their behaviour in response to perceived levels of risk, becoming more careful where they sense greater risk and less careful if they feel more protected.
What is risk compensation?
2) Liquidity issues (55%)
- aic
75% of advisers have changed their behaviour in some way as a result of Woodford.
thriving on disruptive innovation
Since their introduction in 1995, VCTs have championed British entrepreneurship; and their contribution to the ‘unicorn’ phenomenon is a showcase of the scheme’s success at underwriting British innovation.
Just past the quarter-century threshold, the Venture Capital Trust (VCT) scheme has come of age and has delivered on its promise of fostering young, innovative businesses in the UK.
The VCT-funded unicorns: masters of disruptive Innovation
New data from Dealroom and the Digital Economy Council reveals that a further 132 companies now have a credible chance of securing the one-billion-dollar valuation in the near future. These are known as ‘futurecorns’—or unicorns of the future—fast-growing firms with a value of between $250 million (£179 million) and $1 billion (£718 million).
Unicorn companies are a rare breed. Millions of businesses are launched every year, but only a tiny number go on to be valued at $1 billion. By one estimate, a business only has a 0.00006% chance of becoming a unicorn, and it takes an average of seven years for nascent startups to grow into unicorns. To date, the UK has created more than 100 unicorns, and VCTs played a part in this achievement. this remarkable performance places the UK third in the world in terms of the number of unicorns, with only the US and China having a better record. For a decade now, Britain has been racing ahead of its European counterparts in this tech-driven area. The figures show that between 2010 and the end of 2020, the number of unicorns in the UK increased from just eight to 81, as businesses such as Betfair, Admiral Group and Ocado became household names. During the same period, France went from having no unicorn companies to 17, while Germany went from one to 31.
150
200
number of unicorns in the last 6 years
Source: Eqvista, data analysed from CB Insights
Number of unicorns in Europe as of April 2021
united kingdom
27
germany
france
switzerland
3
sweden
netherlands
spain
lithuania
ireland
croatia
estonia
luxembourg
belgium
Source: Statista
The theory of disruptive innovation, invented by Harvard Business School professor Clayton Christensen, simply says that a smaller company with fewer resources can unseat an established, successful business by targeting segments of the market that have been neglected by the incumbent. That principle seems to guide the VCT-backed companies, most of whom are entrepreneurial businesses that have disrupted their industries and transformed the way we live and work. They are prime illustrations of VCTs’ role in bolstering Innovation-driven entrepreneurship (IDE), the main driver of economic growth among all forms of entrepreneurship. Following is a brief look at some of the VCT-backed unicorns.
Zoopla was the first company backed by a VCT to achieve unicorn status. It is a property web portal and app that provides estate agents with advertising through its own website and its affiliated partner websites. Founded by Alex Chesterman and Simon Kain in 2008, just as the financial crisis was getting started, the company nonetheless got VCT backing in 2009. In 2014, Zoopla Property Group floated on the London Stock Exchange with a market capitalisation of $1.56 billion. However, in May 2018, US private equity firm Silver Lake acquired Zoopla for $3 billion and parent group ZPG delisted from the London Stock Exchange.
Zoopla (estate company)
Founded in 2012, Bought By Many is a pet insurance provider known for introducing pet insurance and wellness policies, such as cover for pre-existing conditions. It was the first pet insurance provider in the UK to offer online claims. VCT-backed since 2016, the insurtech saw its latest series D funding round of $350m hike up its value to more than $2 billion, propelling it to unicorn status. The insurance disruptor, Co-founded by Stephen Mendel and Guy Farley in 2012, plans to use the funding for expansion: to support its growth, develop new products, and create new job opportunities internationally.
Bought By Many (insurance company)
Founded by Simon Beckerman in 2011, Depop is a social marketplace where people buy and sell items, most of which are used and vintage pieces of clothing. Users can open their own Depop shop and sell items via their phone by taking a photo or video. Depop received its first VCT funding in January 2018, which was augmented in a further funding round in 2019, coming to a total VCT investment of £8.8 million.
Depop (peer-to-peer social e-commerce company)
One of the very first subscription-based meal-kit providers, Gousto is now the UK market leader in recipe box delivery. Co-founded by Timo Boldt and James Carter, the food industry disruptor received VCT backing after failing to secure financing on the BBC’s Dragon’s Den in 2013. The Covid-19 lockdowns were a boon for the business: revenues rose to £189 million in 2020, up from £82.5 million in 2019. The business is now profitable with EDITDA of £18.2 million. After raising £25 million from new and existing investors in late 2020, Gousto achieved a valuation in excess of $1 billion.
Gousto (meal kit retailer)
For technology breakthroughs that have impact, the UK ranks among the most promising countries in the world, according to the latest KPMG Technology Innovation Hub Report. In the UK and everywhere, tech-focused unicorns dominate the unicorn world. Government data shows that tech companies across the UK raised a collective £11.3 billion in funding last year. That’s more than every other country except China and the United States, and 250% more than the EU’s largest economy, Germany. Since 2015, total UK venture capital investment has been higher every year than that in France, Germany and Israel. Overseas investors from the US and Asia have been increasingly attracted to the UK’s fastest-growing companies. Venture capital investment used to be concentrated on early stages, with 64% of funding going to companies at Seed, Series A and B rounds in 2016, for example. However, for the past two years, more than half of VC investment has been at later stages. This is helping to build the UK’s next generation of tech stars, contributing significantly to the maturity of the UK tech sector, and the increasing number of potential unicorns across the country. VCT managers will often diversify their portfolios across different funding stages in order to balance the risks with the potential for strong growth. Some also reinvest in the same company at a later stage as it develops and proves its value. VCT investors can feel confident they are helping innovative smaller firms to create jobs, prosperity and economic growth across the country. Meanwhile, the UK continues to be one of the world’s most successful markets for entrepreneurial small companies. As emerging and maturing technologies continue to disrupt and transform incumbent industries and tackle some of our biggest challenges, VCTs will be there to back them up. And, every once in a while, one will grow to be a unicorn.
UK: a technology innovation hub
Leading unicorns in uk as of April 2021, by market valuation (billion dollars)
11.1
7
5.5
5.4
5
2.8
2.7
What defines a unicorn?
- Richard Stone, CEO of AIC
Companies across the world are staying private for longer for a variety of reasons.
top countries and jurisdictions for innovation
singapore
new york
tel aviv
beijing
london
shangai
tokyo
bengaluru
hong kong
9
austin
seattle
Source: KPMG Technoology Industry Survey 2021, n=504
- Jessica Franks, Head of retail investment products, Octopus Investments
Right now, the UK is a thriving place for early-stage smaller companies. Some recent examples of businesses Octopus has sold stakes in, on behalf of investors, include Depop and WaveOptics – both delivering excellent outcomes for investors this year.
VCTs AND THE NEW ERA OF RETIREMENT PLANNING
Retirement planning is changing, in terms of clients’ portfolios, their long-term goals, and the duration of the retirement itself. In this new era of retirement planning, VCTs are an effective tool that advisers can use as part of their centralised retirement proposition (CRP) frameworks.
21
The Bank of England made a surprise decision to hold interest rates down at 0.1% on 4 November; the central bank also forecast inflation to peak at 5% in April 2022, up from 3.1% in September, its highest level in over a decade—both events are bad news for savers. The double whammy of record-low interest rates and worrying inflation forecasts paints a bleak picture for both pensioners and retirement planners. Without creative planning, building a comfortable retirement pot will simply be out of reach for many. The search for a solution is leading savvy advisers to Venture Capital Trusts (VCTs) as a tax-efficient complement to pension savings. The many advantages offered by VCTs become more enticing as more and more income is needed to retire comfortably. As advisers place greater focus on managing income and cash flow modelling of higher-risk investments later in life, a CRP is becoming an increasingly attractive option. VCTs have a place in this process. In October, the Pensions and Lifetime Savings Association (PLSA) published its latest guidelines for the level of income that will be adequate to lead a comfortable lifestyle in retirement. While generating investment income remains difficult, particularly in view of the rock-bottom interest rates, the amount of income needed for a stress-free retirement keeps rising year after year. If you factor in the gradual but continuous increase in life expectancy and the consequent higher income needed, it’s hardly surprising that the significant potential returns of VCTs are increasingly appealing to retirement investors and their advisers. The PLSA commissioned the Centre for Research in Social Policy (CRSP) to produce reports on the impact of Covid-19 on people’s plans for retirement and retirement living standards in the UK in 2021. Pitched at three different levels – minimum, moderate and comfortable – the Retirement Living Standards they produced are designed to help people understand the costs of the lifestyle they want when they retire.
Retirement living standards in 2021
What standard of living could you have?
house
food & drink
transport
holidays & Leisure
clothing & personal
helping others
DIY maintenance and decorating one room a year
A £67 weekly food shop
No car
A week and a long weekend in UK every year
£460 per person each year
£10 for each birthday present
Some help with maintenance and decorating each year
A £74 weekly food shop
3-year old car replaced every 10 years
2 weeks in Europe and a long weekend in the UK every year
£750 per person each year
£30 for each birthday present
Replace kitchen and bathroom every 10/15 yearss
2 cars, each replaced every 5 years
3 weeks in Europe every year
Up to £1,500 per person each year
£50 for each birthday present
Covers all your needs, with some left over for fun
More financial security and flexibility
More financial freedom and some luxuries
minimum £16,700 a year
moderate £30,600 a year
comfortable £49,700 a year
A £41 weekly food shop
£460 each year
A £47 weekly food shop
£750 each year
minimum £10,900 a year
moderate £20,800 a year
comfortable £33,600 a year
A £59 weekly food shop
2-year old card replaced every 5 years
£1,000-£1,500 each year
couple
single
Source: The Pensions and Lifetime Savings Association (PLSA)
The changes to the ‘baskets’ from 2019 to 2021 are the result of developments in technology, increased costs, and shifting social norms. High-net-worth individuals particularly underestimate how much money they need for the retirement they want, with the average respondent misjudging by almost half, according to research from Saltus, a financial planning and investment management company. “If anything, the perception gap between expectations of what will be needed and what is actually needed could get bigger as life expectancy continues to grow - living to 100 could become commonplace, and the impact that will have on retirement planning could be huge,” said Michael Stimpson, partner at Saltus. The table on the left sets out the weekly budget and annual expenditure needed at each retirement living standard in 2019 and in 2021.
UK Retirement Living Standards
Source: Centre for Research in Social Policy
comfortable
Weekly Budget Annual expenditure
£633 £33k
£644 £33,6k
moderate
£387 £20,2k
£399 £20,8k
£196 £10,2k
£209 £10,9k
£911 £47,5k
£953 £49,7k
£558 £29,1k
£587 £30,6k
£301 £15,7k
£320 £16,7k
Never-ending pension rule changes favour VCTs
Recent changes in pension legislation have placed further restrictions on the amount you can invest into a personal pension, both annually and over your lifetime—prompting savers to seek other kinds of tax-efficient investments. As things stand in late 2021, there’s an annual allowance which caps the amount that can be paid into your pension without a tax charge. This is £40,000 for most people, but it might be lower if you’re a high earner or have accessed your pension already. There’s also a lifetime allowance which effectively limits the total value of all your pensions. This is currently £1,073,100 and is set to stay at this level until April 2026. Exceeding the annual allowance will mean that you do not receive pension tax relief on any contributions over the cap and you’ll be faced with an additional tax bill called the Annual Allowance Charge. While you don't pay a fine directly, this charge is added to the rest of your taxable income for the year in question to work out your overall tax liability. All these headaches have created a pension-driven demand for VCTs that is likely to continue for some time.
Tax-free dividends are a great advantage of VCTs, and will be even more so once the new rate of dividend tax comes in next April. At present, the tax rate on qualified dividends is 0%, 15% or 20%, depending on your taxable income and filing status. The tax rate on nonqualified dividends is the same as your regular income tax bracket. In both cases, people in higher tax brackets pay a higher dividend tax rate. Everyone has a £2,000 dividend allowance. Only if your total income is more than your personal allowance, and you also exceed the dividend allowance, will you start paying tax on your dividends. Basic-rate taxpayers currently pay 7.5% on any dividends they get over the dividend allowance. From April 2022, this will rise to 8.75%. For higher-rate and additional -rate taxpayers, this will rise to 33.75% and 39.35% respectively. Although most VCTs are growth investments, and any growth is tax free, the majority of returns (if any) are normally paid through tax-free dividends. A diverse, well established VCT portfolio can produce a satisfying stream of dividends throughout the year. If you don't want income now, and you are planning for your future retirement, then many VCTs offer a dividend reinvestment scheme.
Dividend tax boosts demand for VCTs
While VCTs are not a like-for-like replacement for a pension, they can offer an attractive line of supplementary income after working life. For starters, the annual contribution limit to a VCT, at £200,000, is significantly higher than the tax reliefs available on a private pension. VCT investors also get upfront income tax relief of 30%. While this is lower than the higher-rate relief paid on pensions, it’s available on the full £200,000 allowance, as long as the investor has enough income tax liability to offset. In addition, investments in VCTs are free of income tax on dividends and capital gains tax on profits. That applies no matter how large the investor’s portfolio. But there is more to VCTs than just tax relief and tax-free dividends. Long-term exposure to companies with the potential to grow rapidly—an obvious benefit for retirement savings—is often a major attraction of VCTs for many investors. With many existing funds now having good long-term performance track records, VCTs are good investment vehicles for many purposes, including retirement planning. Admittedly, VCTs are not for everyone. But for the right investor, they can add diversification to an overall investment portfolio, a much-needed element in a time of economic uncertainty.
VCTs as key part of the retirement planning
What is a Centralised Retirement Poposition (CPR)
While there is not a universally agreed definition of what a centralised retirement proposition (CRP) is, the following might be a neat way to sum it up: a consistent approach to retirement advice that extends across an entire firm.
- aic survey, april 2021
The goal of most VCT investors is saving for retirement (56%), whilst 44% use them for saving for their families
22
Blackfinch Calculus Downing Octopus Investments Puma Investments VCT Solutions Comparison
manager video content
23
dr Reuben Wilcock
Head of Ventures
blackfinch.com 01452 717070 enquiries@blackfinch.com
24
Nick Priest
sales director
downing.co.uk 020 7630 3319 sales@downing.co.uk
video content
rebecca ward
Product Development Manager
25
charlie stoop
Business Development Manager
pumainvestments.co.uk 020 7408 4070 advisersupport @pumainvestments.co.uk
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Blackfinch Spring VCT 2019 £621,134,812.05 / £10,793,280.16 Generalist The Blackfinch Spring VCT targets investment into early stage high-growth technology enabled companies with a focus on research & development and innovation, with the potential for high growth and an exit within a reasonable time frame. 11/11/2019 Growth & Income New Share Issue Up to £20m, with a £10m over-allotment facility if required Targeting dividends of 5% p.a. from 2024 onwards, along with ‘special dividends’ through earlier exits £3,000 2.5% 2.5%; with 0.5% rebated in order to faciliate any Adviser Ongoing Charges, Executiononly Intermediary Ongoing Fees and Direct Investor Ongoing Fees. Any money left over from the rebate will be used to buy additional VCT shares for the investor. 20%; of the amount by which the performance value per share at the end of an accounting period exceeds the high water mark. This is the higher of 130p and the highest performance value per share at the end of any previous accounting period. Please see 'Fees and Charges' section of our brochure (pages 26 and 27) for more information on all of our fees, available at the following link*
Calculus VCT 2016 £26m Generalist The VCT provides exposure to a diversified portfolio of smaller, growing UK companies. As of August 2021, the Calculus VCT holds investments in 37 qualifying companies across a wide range of sectors. Sept 2021 The offer will be used to invest in companies with growth potentiaThe VCT provides exposure to a diversified portfolio of smaller, growing UK companies. As of August 2021, the Calculus VCT holds investments in 37 qualifying companies across a wide range of sectors.l across the fastest growing sectors in the UK. New Share Offer £10million with over allotment of £5million Target annual dividend 4.5% of NAV £5,000 3% for advised investors (currently 0% fee offer) 1.75% charged to the Calculus VCT 20% subject to a hurdle of 105p
Octopus Titan VCT 2000 £1.3 billion Generalist Octopus Titan VCT invests in tech-enabled businesses with high growth potential. Managed by one of Europe’s most experienced investment teams, it currently has a portfolio of over 90 early-stage companies operating in a diverse range of sectors. We’ve backed some of the UK’s most successful entrepreneurs, including the founders of Cazoo, Depop and Zoopla Property Group. 2007 Capital growth and dividends New share offer £200 million (now closed) 5% £3,000 3% Up to 2% 20% + VAT Admin and accounting charge 0.3%
Offer Name Year Founded AUM (total)/AUM (VCT) Type of VCT Description of offer Launch date Investment Objective Type of fundraise Target fundraise Target return/yield Minimum investment Initial fee AMC Performance fee Other fees
Downing FOUR Ventures Downing FOUR VCT was created in 2015 from a merger, the original VCT was founded in 2009 2016 £32m/£50m (as at 30/06/21) Evergreen This share class will focus on unquoted technology companies in three main sectors: healthcare, deep tech (knowledge intensive) and enterprise. The current fundraise will provide follow-on fundraising for current portfolio companies as well as facilitate investments into new companies. Downing Ventures look to invest in companies with a proven technology and who have a global proposition. Downing Ventures has Venture partners who are located around the world to help source the best deals. August 2021 Provide investors with the opportunity to invest in a range of businesses at different stages in the development life cycle. Provide investors with a regular income through a target annual dividend of at least 4% of its net assets. Prospectus £10m (plus £15m over allotment) No target return/target yield of 4% of net assets p.a. £5,000 into D4 which can be split between 2021/22 and 2022/23 tax years and between share classes. Minimum investment into one share class is £1,000 2.5% for advised investors 2% 20% of dividends paid when total return is above hurdle rate Administration fees: expected to be less than 0.25% of NAV p.a. Arrangement fees: up to 3% of sum invested Monitoring fees: up to 0.5% p.a. of sum invested
Downing FOUR VCT Downing FOUR VCT was created in 2015 from a merger, the original VCT was founded in 2009 2016 £16m/£50m (as at 30/06/21) Evergreen This share class will focus on investments that will typically be in early and mid-stage healthcare investments including life sciences and bioscience companies, who may already be revenue-generating. The current fundraise will provide follow-on fundraising for current portfolio companies as well as facilitate investments into new companies. August 2021 Provide investors with the opportunity to invest in healthcare and life science businesses at different stages in the development life cycle. Provide investors with a regular income through a target annual dividend of at least 4% of its net assets. Prospectus £10m (plus £15m over allotment) No target return/target yield of 4% of net assets p.a. £5,000 into D4 which can be split between 2021/22 and 2022/23 tax years and between share classes. Minimum investment into one share class is £1,000 2.5% for advised investors 2.50% 20% of dividends paid when total return is above hurdle rate Administration fees: expected to be less than 0.25% of NAV p.a. Arrangement fees: up to 3% of sum invested Monitoring fees: up to 0.5% p.a. of sum invested
Downing FOUR AIM Downing FOUR VCT was created in 2015 from a merger, the original VCT was founded in 2009 2021 nil - brand new share class/£50m (as at 30/06/21) AIM This share class focuses on investments that will typically be in revenue-generating, AIM-quoted companies, and has a generalist sector approach. The share class will invest in AIM IPOs and secondary raises of VCT qualifying companies. A minority of investments are also likely to be in companies which are likely to seek a quotation on AIM. Although the investment strategy is sector agnostic, Downing Fund Managers (who manage this share class) will use the sector expertise from inside Downing. August 2021 Initially to use the fundraise proceeds to invest in a portfolio of 15-20 AIM companies, potentially including a minority of companies which are likely to seek a quotation on AIM. Target growth on the portfolio. There is no target dividend policy although it may have the potential to pay dividends in the future. Prospectus £10m (plus £15m over allotment) No target return/no target yield - may look at paying dividends in the future £5,000 into D4 which can be split between 2021/22 and 2022/23 tax years and between share classes. Minimum investment into one share class is £1,000 2.5% for advised investors 1.75% None Administration fees: expected to be less than 0.25% of NAV p.a. Arrangement fees: up to 3% of sum invested but these don't apply to AIM investments Monitoring fees: up to 0.5% p.a. of sum invested
Offer Name Year Founded AUM (total)/AUM (VCT) Type of VCT Description of offer Launch date Investment Objective Type of fundraise Target fundraise Target return/yield Minimum investment Initial fee AMc Performance fee Other fees
Puma Alpha VCT July 2019 £1.4bn / £99m Generalist Puma Alpha VCT plc is our 14th VCT. It aims to deliver compelling returns through investments in companies that have graduated from ‘start-up’ to ‘scale-up’, while delivering the full range of tax reliefs that come with VCT investing. Relaunched November 2021 Its objective is to deliver the best-possible risk-adjusted returns, so investors experience less volatility and more consistent yields. New share issue £15m with an over-allotment facility of £5 million The VCT intends to pay a regular annual dividend commencing from 2023 (although there is no guarantee). From then on, it expects to achieve an average dividend payment equivalent to 5p per Share per annum (including the 2023 dividend) over the rest of the life of the VCT. £5,000, thereafter in multiples of £1,000 3% (plus VAT if applicable) 2% (plus VAT if applicable) 20% over 120p hurdle or high watermark Annual costs cap of 3.5% of net assets. Refer to Prospectus for full details.
P
Calculus VCT 2016 £26m Generalist The VCT provides exposure to a diversified portfolio of smaller, growing UK companies. Sept 2021 The offer will be used to invest in companies with growth potential across the fastest growing sectors in the UK. New Share Offer £10million with over allotment of £5million Target annual dividend 4.5% of NAV £5,000 3% for advised investors (currently 0% fee offer) 1.75% charged to the Calculus VCT 20% subject to a hurdle of 105p
*https://blackfinch.ventures/assets/Blackfinch_Spring_VCT_Brochure_d6d4d33c25.pdf
vct solutions comparison
Puma VCT 13 July 2017 £1.4bn / £99m Generalist Puma VCT 13 is Puma's 13th of 14 VCTs and builds on the company's 25-year track record of investing in SMEs. Puma VCT 13 invests into businesses that have graduated from start-up to scale-up yet are still small enough and young enough to grow and create meaningful returns for investors. Relaunched September 2021 The company aims to give investors exposure to quality operating businesses with strong management teams in sectors providing structural support for growth. New share issue £25 million with an over-allotment facility of £5m "Targeting average dividend payment in the range 4p to 6p per share p.a., plus potential for special dividends. The Company is also targeting two interim dividend payments between November 2021 and March 2022" £5,000, thereafter in multiples of £1,000 3% (plus VAT if applicable) 2% (plus VAT if applicable) 20% over 110p hurdle or high watermark Annual costs cap of 3.5% of net assets. Refer to Prospectus for full details.
Post-Covid: the ‘new normal’ for VCTs The FCA & the ESG renaissance Younger investors are discovering VCTs What the managers say
Post-Covid: The ‘new normal’
The unexpected arrival of the Covid-19 pandemic raised fears that the shock will shut off the venture money tap, starving early-stage companies out of business. But the alarm has proved unfounded.
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When it came to Venture Capital Trusts (VCTs), 2020 proved to be a time of remarkable resilience, as they withstood both the devastation of Covid-19 and uncertainty of Brexit. The average VCT delivered a positive total return of 4% during the year, while the FTSE All Share delivered a 10% loss in the calendar year and UK GDP shrank 9% between January and November.
As much of the world is poised to transition to what has been called ‘the new normal’ of the post-pandemic era, many of the relevant VCT-related trends are already in place today. In the past, these trends have yielded some very consistent cause-and-effect results, which makes it relatively easy to gauge their future impact on the sector.
UK’s long-term growth prospect good despite a 2.6% November drop in GDP As we go to press, the UK economy, struggling with supply chain disruptions and high energy prices, expanded by 1.3% in the quarter, down from growth of 5.5% in the previous three-month period. GDP growth slowed between July and September, leaving the economy still around 2% smaller than it was before the pandemic and trailing the recovery in other G7 nations. Kallum Pickering, senior economist at Berenberg, said UK growth was "slightly below" his bank's own 1.4% prediction, but added that the country remained "on track" to return to its pre-Covid level of GDP in the first quarter of 2022. This momentum is expected to be sustained for a number of years. In fact, the UK’s long-term economic growth could outpace leading EU countries like Germany, France and Italy, even despite some medium-term drag from Brexit, according to new analysis by PwC.
The second year of the pandemic, 2021, has been variously described as a ‘a bumper year of opportunities,’ ‘a time of optimism’, and even ‘the best year ever’ for the sector. Venture Capital Trusts raised £685 million in the 2020/21 tax year. This is 11% higher than in 2019/20, and the third highest amount in the last 10 years. Now that the success of the vaccination drives in various countries and a new Covid pill on the horizon have renewed hopes of an end to the global pandemic, what can VCTs look forward to in the aftermath of the Covid crisis?
trends that will stick post-covid
Economic growth will lead to increased revenue and profitability Economic growth is the increase in the value of an economy's goods and services, which creates more profit for businesses. As more jobs are created, incomes rise. Consumers have more money to buy additional products and services, and purchases drive higher growth. In periods of economic growth, young companies have more chance to survive and prosper, consequently reducing the risk of investing in them. This greater chance of survival and higher profitability should encourage more VCT investment.
Small businesses will fuel economic growth Small businesses are the backbone of the UK economy, driving growth, opening new markets and creating jobs. For a true economic recovery, small businesses will need more support, not only from the government but also from private-sector schemes like VCTs. Once the country has recovered from Covid, VCT investments will continue to help small businesses grow, create employment and wealth and benefit the wider economy. These entrepreneurial firms, in turn, boost economic growth by introducing innovative technologies, products, and services. Many of these innovative young companies depend on a steady inflow of VC money.
real gdp
Technology sector will drive recovery and growth The UK has one of the world’s largest technology ecosystems with thousands of tech start-ups, built around a strong entrepreneurial culture. The tech sector has demonstrated its resilience through continued job creation and investment deals. Small tech companies are popular among VCT managers. Many of these companies have been highly adaptable during the pandemic, and will be vital to the post-pandemic recovery. During the pandemic, the tech sector has been deployed to keep the economy going and to keep people connected, healthy and safe. After the pandemic, it will continue to demonstrate its worth through innovation, job creation, and investment deals. The VCT sector stands to benefit from the substantial and continuing government support for the tech sector. There are plans to increase R&D investment to £22 billion, in addition to the generous R&D tax reliefs already in place. “We are making this country a science and technology superpower,” the Chancellor of the Exchequer said in his Autumn 2021 budget speech. Knowledge-intensive firms, that have more generous VCT qualification criteria, will be among the big winners of the ambitious government initiatives.
- Rishi Sunak, autumn 2021 budget
We are making this country a science and technology superpower.
Tighter pension rules will push more investors into VCTs Almost all advisers who allocate client capital to venture capital trusts (VCTs) do so with the tax advantages in mind, according to research from the Association of Investment Companies (AIC). In an AIC survey earlier this year, 92% of advisers questioned said the tax relief was the “primary reason” for doing so. Restrictions on pension contributions have left many clients looking for additional tax-efficient ways to invest towards their retirement. Over the next few years, these constraints on pension savings are likely to be a big driver of VCT demand.
Your annual pension allowance applies to all of your private pensions, if you have more than one. This includes:
What counts towards the annual allowance
The Annual Allowance is the limit on the amount of pension savings that can benefit from tax relief in a single tax year. This limit is equal to 100% of your annual earnings, or £40,000 in each tax year, whichever is lower. The government has removed the annual link to the Consumer Price Index increase for the next 5 fiscal years and so maintains the standard lifetime allowance at £1,073,100 for tax years 2021/ 2022 to 2025/2026. While it is important not to be driven by tax alone, VCTs are one of the most tax-efficient investment products available to UK investors. VCT shares entitle you to 30% income tax relief on investments up to £200,000, tax-free dividends, and tax-free capital growth. There is no restriction on the number of VCTs an individual invests in, subject to the overall total investment not exceeding £200,000 in any one tax year. In the right circumstances it is possible to combine a VCT investment with Self Invested Personal Pension Plan (SIPP) to further enhance the tax advantages and the net effect of retirement funding, effectively obtaining two levels of tax relief.
High dividend tax will prompt more of high earners to consider VCTs The government is raising dividend tax rates to help fund its £12 billion-a-year plan to help clear NHS waiting list backlogs and fund social care. Speaking in the House of Commons in September, Prime Minister Boris Johnson, said: “It would be wrong for me to say that we can pay for this [coronavirus] recovery without taking the difficult but responsible decisions about how we finance it.”
dividend tax rates
2021/22
7.50%
32.50%
2022/23 onwards
8.75%
33.75%
39.35%
Additional rate
Higher rate
Basic rate
The dividend tax hike could be seen as the main driver of investments into VCTs. It’s one of the reasons that have brought many high-net-worth individuals to VCTs, lured by both income and tax efficiency. This advantage is likely to remain in the coming years. Dividends on the Alternative Investment Market (AIM) market are expected to rise 32.2% for the full year 2021 on a headline basis to a total of £1,076m. The underlying increase is set to be 21.9%, which is significantly faster than Link Group’s forecast for the wider market. Ian Stokes, managing director of corporate markets EMEA at Link Group, said: "We are confident AIM’s dividends can regain their previous highs by some time in 2023, almost two years sooner than our expectation for the main market.” Not limited to wealthy folks, the high dividend tax will hit anyone holding investments outside of a stocks-and-shares Isa, investors who have exceeded their dividend tax allowance, and people who run their own businesses and pay themselves dividends. Meanwhile, most diverse, well established VCT portfolios will continue to produce satisfying streams of tax-free dividends throughout the year. If your VCT pays dividends, there is no tax to pay. You won’t even need to declare them on your tax return.
Tax-free capital gains will continue to lure investors The Chancellor chose not to announce any significant changes to CGT in the budget, suggesting that reform may now be off the agenda. Still, capital gains are currently taxed at 20% for higher or additional rate taxpayers. If you’re a basic rate taxpayer, the rate you pay depends on the size of your gain, your taxable income and whether your gain is from residential property or other assets. If you decide to sell your VCT shares and you make a profit, the proceeds won’t be liable for capital gains tax. This means that the expected rise in asset value from the current and coming inflation will yield tax-free gains for VCT investors.
The future looks bright for startups and those who invest in them. It has become common for startups, companies in the initial stages of business, to burst into an industry and outperform the legacy incumbents in pretty much all parts of the business. The cost of capital is lower for these bold intruders, although the value on offer to investors close to the beginning of their business journey is often very high. Their operating structure is far more effective in solving the needs of today’s consumer. In an era of Zoom and communications technologies, which make it effortless to communicate across the globe and to work remotely, these young companies have more access to talent than ever before. The UK leads European countries in startup funding, bringing in €17.2 billion in venture capital funding in the first half of 2021. This abundant flow of venture finance fuels the growth of young companies, with obvious implications for VCTs, a structure designed to invest in ‘growth’ companies. Growth signals higher sales, profits, and returns to investors. This perennial trend, independent of any legislation or transitory event, should continue to bolster VCTs post-Covid and well beyond.
The new era of the startup
110
105
85
95
75
2023
2022
2024
2025
2026
2027
Mar 2020 forecast
Oct 2021 forecast
Mar 2021 forecast
q4 2019 = 100
• the total amount paid in to a defined contribution scheme in a tax year by you or anyone else (ex. your employer) • any increase in a defined benefit scheme in a tax year
Source: Office for National Statistics
- Tom Mullard Director, Product Development & Strategy, downing
Despite some sector specific challenges, we believe early-stage companies are now better positioned to take advantage of the structural changes which have occurred since covid.
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Irresistible forces around the globe are pushing ESG (environmental, social, and governance) investing to the top of agendas, heralding a true revival of ethical investing.
Governments, regulators, fund managers, advisers, and investors have all jumped on the bandwagon. Greenwashing notwithstanding, companies big and small, are now swearing by ESG. Many small companies, including early-stage startups, have discovered a natural superiority over their bigger counterparts, and a determination to press home their advantage. The FCA is working hard to foster this surging tide. The regulator's core objective is to support the financial sector in driving positive change, while also aiming to build trust in green financial markets and increase transparency around sustainability matters. “We aim to embed climate and wider ESG considerations in everything we do,” said the CEO of the Financial Conduct Authority (FCA), Nikhil Rathi, speaking at the COP26 summit. Hosting the 2021 United Nations Climate Change Conference (also known as COP26) held in Glasgow, Scotland—from 31 October to 12 November 2021--the UK government revealed its ambition to work towards ‘making the UK the world’s first net zero financial sector’. A similar theme was repeated by country after country, from the US to Australia, from Japan to South Africa. “Countries committed themselves to further accelerating their decarbonisation plans and, specifically, to strengthening their emissions-reduction targets for 2030 by next year, rather than in 2025 as per the five-year schedule set out under the Paris agreement,” wrote the Economist magazine. ESG is clearly enjoying a massive tailwind coming out of the global pandemic. When ESG began gaining prominence in the early 2000s, many held the mistaken belief that it was just a PR exercise to manage reputational risk. Over time, however, as more and more large companies began to incorporate ESG principles into their business decision making, the truth became apparent to businesses of all sizes. Incorporating ESG isn’t just good for people and the planet, it’s good for business.
The FCA & The ESG renaissance
Small businesses may have limited resources, but they make up for that through a range of advantages: being community- and locally-focused, closer relationships with customers and suppliers, swifter decision-making processes, less bureaucracy and greater flexibility. Early-stage businesses are increasingly aware that both investors and consumers show their support for companies with ethical and transparent business practices, including those with a positive environmental impact and sustainable operations. For example, managers of venture capital trusts (VCTs) are increasingly realising that allocating cash to socially responsible investments can boost investor outcomes. While ESG risks can vary greatly depending on the company, product, service, or market, early-stage investors can play an active role in educating startups about the risks.
ESG and the virtues of small businesses
The vast majority of financial advisers are interested in ESG investing and have already begun researching it, according to a recent survey by the Association of Investment Companies (AIC). Nearly nine-tenths of financial advisers (89%) expect demand for ESG investments to increase over the next 12 months. Only 2% thought it would decrease slightly, and not a single respondent said it would decrease significantly. The data reflect a growing recognition among advisers that while investors are interested in competitive returns, they increasingly want their investments to align with their values. Fortunately, a growing body of evidence suggests that using sustainable investments generally has not reduced risk-adjusted returns to date. At the same time, 23% of the financial advisers surveyed consider themselves early adopters with a further 48%, stating that they had recently become more knowledgeable about it. Among discretionary fund managers (DFMs), these figures were higher, 34% and 51% respectively.
Most advisers are excited about ESG
Personal experience of ESG investing among financial advisers and DFMs
Source: AIC/Research in Finance. Percentages are % of respondents who agreed with each statement. Respondents could select only one statement
I would consider myself an early adopter of ESG investing and have been researching and discussing this area with clients for years now
34%
28%
I have recently become more knowledgeable about ESG investing and how to make this part of the offering to clients
51%
49%
I have recently become interested in ESG investing and have started to research this area
8%
14%
DFMs
All respondents
Financial Advisers
I have not thought about ESG investing too much but am planning to start researching in the future
ESG investing is not of great interest to me
23%
48%
18%
2%
6%
5%
3%
4%
As for VCT investors, many of whom delight in supporting smaller UK businesses, more than half (54%) believe the pandemic has made ESG considerations more important. Research shows that most investors think the pandemic has made supporting smaller companies in the UK more important than before, said Annabel Brodie-Smith, AIC’s Communications Director. “VCTs can play a vital role in helping us build back better. They bridge the funding gap for small, growing companies and offer support and expertise to businesses in diverse areas, from machine learning to green technology. “It’s clear that VCT investors value the opportunity to support UK entrepreneurs and stimulate innovation, alongside the range of tax benefits that VCTs offer.”
VCT investors say Covid makes ESG important
Importance of considerations when choosing investments (on a scale of 1 to 5)
The pandemic has been an opportunity for fund managers to rethink company performance to better reflect pressure from investors, consumers, and regulators for progress on companies’ ESG targets. Post-Covid and beyond, performance indicators are already starting to broaden from traditional areas such as financial return to include newer and larger stakeholder concerns about the environment, sustainability and diversity. Meanwhile, a growing number of investee companies within the VCT sector are now at the forefront of developments across a number of industries. These include the environmental, educational and healthcare sectors where the dynamics driving change have been huge. Going forward, concerns about climate change, renewable energies, and the increased health demands of an aging population will continue to dominate.
VCT managers increasingly active in ESG
Performance record
Under 45: 4.2 Over 45: 4.6
level of fees and charges
Under 45: 4.3 Over 45: 4.3
4.5
4.3
fund manager's skill and reputation
Under 45: 3.9 Over 45: 4.2
4.1
Asset management company’s reputation
Under 45: 4.0 Over 45: 4.1
ESG factors (environmental, social, governance)
Under 45: 3.8 Over 45: 3.3
3.4
Source: AIC/Research in Finance. Respondents ranked each issue on a 1-to-5 scale, where 5 meant “very important” and 1 meant “not at all important”
Men
Women
Britain’s main financial regulator may also be the country’s biggest champion of ESG. The industry seems to approve. Four out of 5 respondents to the FCA’s last Financial Lives Survey believe that businesses have a wider responsibility than simply to make a profit. “This has already translated to investment behaviour, with responsible investment funds accounting for almost 40% of net UK retail fund sales last year,” the regulator said. On the day of Chief Executive Rathi’s speech at the Cop26 summit, the FCA released its new Strategy for Positive Change. “The themes of building trust in the market for ESG products, and ensuring transparency along the value chain, remain at the core of our Strategy,” the CEO said. Referencing the government’s green finance ambition, he said: “So today, we have also launched a Discussion Paper on Sustainability Disclosure Requirements and investment labels. The feedback we receive will guide our policy design, ahead of consultation on new proposals next Spring.” Consistent with the FCA’s wider transformation to become more data led, the agency is leveraging the capabilities of its Innovation Division to support its work on ESG. On 4 November 2021, jointly with the City of London Corporation, the FCA announced 12 successful applicants to its Digital Sandbox Pilot on ESG data and disclosure, which goes live early next year.
Post-Covid regulation is ESG-focused
A responsible investing strategy looks at more than a company’s fundamentals and future potential. Responsible funds took in £6.7 billion of investment in the first half of 2021, according to the AIC. That is some £2.4 billion more than the previous year. This growing demand has created more opportunities than ever to invest in ESG-focused companies and funds. Morningstar data shows that 21 ESG funds launched in the UK, compared to 372 worldwide, in the first half of this year. The relevant VCTs typically invest in early-stage companies aiming to address sustainability challenges. Their investment approach has changed over the years. Early ESG investors used exclusionary screening and value judgments to choose a company. Nowadays, decisions are driven by both the search for better long-term financial value, and a pursuit of better alignment with values. It’s worth noting that there isn't really a typical ESG VCT fund. Each individual VCT will have its own methods of assessing ESG considerations, and there are differing levels of focus, particularly while there are limited regulatory requirements. However, a lot of progress is being made in this area, and VCTs are disclosing more about their ESG strategies and the risks and opportunities they face. Given the extent of due diligence necessary, ESG investing remains an active management process. The entire process, from initial investment appraisal and due diligence through to ultimate exit, can be quite involved. Therefore, many VCTs developed their ESG strategy in collaboration with ESG sector experts. They use a framework to plan and review their ESG priorities and to address any key points arising from the initial ESG due diligence. Some funds provide regular updates regarding the ESG responsibilities of their portfolio of investee companies. The portfolios typically cover a wide range of industries, with each company having very different ESG challenges, opportunities and priorities. The companies also vary greatly in size, from less than ten employees to over 250 or more. In the early years of ESG, small businesses and start-ups lagged behind when it came to incorporating ESG principles into their business model. As we head out of the pandemic, that has changed with the realisation that small businesses are capable of huge contributions to the planet. Those small businesses and entrepreneurs that have a clear sustainability agenda and aim to make a social or environmental impact with their products and services have more chances to attract ESG-conscious VCTs.
How VCTs do it
advisers believe that businesses have a wider resonsibility than to make profit
4 in 5
Number of advisers who expect demand for ESG investments to increase over the next 12 months
Managers are reporting that an increasing number of younger investors are coming to VCTs. This phenomenon is observed as many VCT funds, now having track records of ten years or more, seem to be attracting more ‘mainstream’ investors looking for established funds run by well-known fund managers.
In particular, VCTs that invest in young companies that are believed to be the winners of tomorrow tend to attract a different type of investor. For example, because people like to invest in the things they understand and use almost daily, young investors naturally gravitate towards technology. One of the VCT managers that reported a growing turnout of younger investors, provides exposure to a range of software and healthcare companies across such themes as cybersecurity, fintech, digital health and data analytics. With an investment horizon often spanning multiple decades, young investors can target trends of the future like artificial intelligence, driverless cars, or advanced manufacturing, making huge gains on their money over their future investing lives. VCTs invest in companies that are poised for growth, and younger investors are drawn to growth-oriented funds to kickstart their wealth creation. The managers spend a lot of time identifying dynamic, growing companies. Like most investors, the young like the potentially rapid capital appreciation growth funds can deliver.
Younger investors are discovering VCTs
VCTs targeting businesses that are developing innovative products for a large target market are well positioned to attract younger investors. Faster growth, however, goes hand in hand with higher risk. It goes without saying that VCTs are considered high-risk investments as they invest in small companies, which are more likely to fail than large ones. Therefore, it is key that investors of any age are aware of the risk profile of a VCT before making the decision to invest. That said, young investors may not have buckets of experience, but they do have one key advantage: time. People who start investing young generally have the flexibility and time to take on risk and recover from their losses. So, a young investor may knowingly decide to invest in a company that has higher risk but greater upside potential over the long term.
Technology, growth and social trends
Beware of the common perception about age and willingness to take risk: that the older you are the more risk-averse you become. On the contrary, there are increasing signs that today’s young investors are more security conscious than their parents were at the same age. The bigger picture is of a generation that is increasingly insecure, feeling 'poorer than their parents at every stage of life' according a study by the Institute for Fiscal Studies (IFS). Today’s young investors, who have been through two market crashes, have developed scepticism and mistrust towards financial markets, with some even preferring to save and forgoing investing all together. So, the young people willing to try VCTs are not thrill-seeking investors caught up in the excitement of putting money in the market. Rather, smart young people can see in VCTs the opportunity to diversify their portfolios while at the same time getting exposure to solid companies with potential long-term upside. They can see that VCTs provide a truly unique combination of benefits, of which capital appreciation, diversification, and professional money management are just the beginning.
Young investors are not thrill-seekers
One of the big advantages of VCTs is that they tend to invest in unique assets, so they can be a useful tool to increase portfolio diversification. They also show a preference for game-changing sectors like technology and biotech. But VCTs are perhaps best known for their favourable tax breaks. Investors can claim back up to 30% of their VCT investment amount in a given tax year against their income tax, up to the total value of income tax payable. The maximum amount you can invest in VCTs in the 2020/21 tax year is £200,000. So, depending on your personal tax circumstances, you could lop off as much as £60,000 from your income tax bill. And, at the end of the day, you’ll pay zero capital tax gains and zero dividend. So essentially, VCTs offer tax-free dividends and tax-free growth on top of all the other benefits. Young investors represent a huge untapped potential for the adviser community. Given their burden of student debt, the collapse in home ownership, market volatility, low wages and higher levels of self-employment, this generation arguably needs greater financial advice than their elders did at their age. Unfortunately, shunned by traditional advisers, many are left to use apps and digital platforms, instead.
There’s a massive wealth transfer looming as the greying and asset-rich baby boomers transition to heaven in the coming years and decades. Attracting the next generation of clients now, even if their net worth may be puny, could be key to the continuity of many financial advisory businesses. Post-pandemic, three quarters of both generation Z and millennials (75% and 74%) already have or would consider investing, according to a recent survey. However, the next generation of clients thinks differently about wealth and the markets, and because they’re not multi-millionaires, they're typically not sure sure whether they’re qualified to work with a financial adviser, according to a T. Rowe Price survey of younger investors. There is no one-size-fits-all investment strategy for people in their 20s and 30s. Still, the findings of the research involving American youth may hold lessons for UK-based financial advisers as well.
Young investors and traditional advisory services: How to attract the next generation of clients
5 tips for advising younger investors
To better serve younger clients, advisers need to know how to talk to them. This means striving to avoid, as much as possible, those important-sounding technical words and phrases that are peculiar to our trade. If nothing else, transparency requires it. Unfortunately, the culture of the financial industry is often – consciously and unconsciously – exclusive rather than inclusive. The language can be complex and off-putting for most people regardless of their age, background, or gender. One recommendation is for firms to do an audit of their communications, and take a look at what kind of materials they are sending to clients and how they are speaking with them.
01
Ditch jargons and buzzwords
Whether you are a younger or more seasoned investor, investing in growth poses a predicament: how to identify which companies will grow rapidly in the near future. The average investor has no way of consistently figuring out which growth company to buy into -- and when. Understandably, this discourages many people from trying to hunt for growth prospects and forces them to fall back on other strategies. When you invest in a VCT, this will not be an issue for you. You have a professional money manager, or team of money managers, always working to identify robust growth companies for you. Ultimately, a VCT creates a rather passive way for you to invest, while at the same time providing growth for your portfolio.
VCTs and the growth-investor’s conundrum
the generation most likely to invest
generation z
millenials
generation x
baby boomers
silent generation
Source: Finder.com
75%
69%
74%
41%
- Nic Pillow, Ventures Manager, blackfinch
Greater availability of capital has the dual effect of increasing the number of follow-on and exit opportunities for our portfolio companies, as later-stage funds continue to gravitate down the value chain towards earlier stage opportunities, while creating fiercer levels of competition for the best deals.
The one thing a financial adviser must have in today's online market is a well-designed and engaging financial website. Referrals are still the top way that clients find financial advisers, but the internet is a close second. Young clients instinctively turn to Google for their questions, including where to find a financial planner. A social media presence is almost as vital as a website, an important way to engage with existing clientele. In a recent survey by the Financial Conduct Authority (FCA), 58% of people aged under 40 said that what they see on social media and in the news determines their investment decisions.
Get online — or get better at it
With the average UK adviser in their mid-50s, in a profession facing a wave of retirements in the next few years, there’s a clear need for younger financial advisers. There’s a growing class of young professionals of all genders, and younger advisers are well-suited to help these ‘early asset accumulators’. Younger professionals are more plugged into digital tools and can help bring many advisory practices up to speed on the latest technology. Beyond the moral imperative, fostering a diverse workforce can also improve client numbers and other aspects of the business.
Diversify your team — and your focus
While traditional clients put much greater value on investment expertise, the next generation of clients are looking for someone to help with their whole financial life, not just their portfolios. Young clients in the T. Rowe Price survey said they want someone who will motivate them and help them take methodical steps toward their goals.
Be a financial coach, not just an adviser
Studies show that the economic chaos of 2008, which erupted during the formative years for many young people, inflicted scars on millennials that are shaping their investing decisions today and possibly hindering their future retirement prospects. This attitude is understandable given that young people have seen nothing but high-volatility markets during their investing lifetime. Advisers could help alleviate market scepticism by educating younger clients on investing fundamentals and the market.
Build trust to alleviate market scepticism
VCTs unique benefits
Click for next tip
To better serve younger clients, advisers need to know how to talk to them. This means striving to avoid, as much as possible, those important-sounding technical words and phrases that are peculiar to our trade. If nothing else, transparency requires it. But the culture of the financial industry is often – consciously and unconsciously – exclusive rather than inclusive. The language can be complex and off-putting for most people regardless of their age, background, or gender. One recommendation is for firms to do an audit of their communications, and take a look at what kind of materials they are sending to clients and how they are speaking with them.
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With the UK’s annual inflation rate at 3.1% in September and expected to rise by all accounts, how do you see the VCT sector faring in the new inflationary environment?
Inflation will have an impact across many areas of our society and early-stage technology investing will be no exception. At the portfolio level, we are likely to see a greater demand from investors across all sectors to put their money to work in investments that beat inflation (versus storing money in bank accounts, for example) which will lead a continued increase in asset values. We expect to see this impacting the value of existing portfolio companies positively, while recognising that valuations we pay for new investments will likely increase. At the level of individuals companies, salaries are the biggest single cost in a startup, and we expect these to increase. However, with option schemes still an important component of remuneration packages, increases may not be as great as more established firms. On the fundraising side, higher salaries will attract greater tax bills, and a greater need to mitigate this through tax-efficient investing. For this reason, we expect inflows to increase. We are still confident in the return potential of the best opportunities, despite a turbulent economic landscape.
The budget seems to promise little direct impact on the tax-advantaged sector that VCTS sits in. Nonetheless, what new changes do you think will have the biggest direct impact?
Its pleasing to see that the incredible benefits that VCTs bring to the UK’s economic growth and job creation will continue with no direct changes as part of this budget. This aside, it is disappointing to see that additional support has been offered only in particular sectors, few of which VCT’s typically target.
What further changes would like to see the government implement in the sector, and why?
McKinsey’s recent report on Europe’s top 1000 tech start-ups confirmed the incredible statistic that 319 of these came from the UK, more than double the next best country, Germany, with 149. It is without question that attractive tax reliefs through VCT and EIS products are a direct driver of this success, helping attract private capital into our most innovative companies. With the tech landscape changing so quickly we would like to see the limit for VCT investment raised and the tax benefits made more attractive for EIS investors, to help further boost this important lever for UK economic growth.
With inflation rates rising, small growing UK businesses may struggle to access funding as borrowing becomes more difficult and expensive. VCT investing will become an even more important funding option for these businesses, often in very high growth areas crucial to building economic growth, whilst giving investors generous tax incentives.
Although little impact to the sector, the decision to increase dividend tax rates by 1.25% should make VCTs more attractive, as they offer tax free dividends.
It is clear from our conversations with the Treasury that what we may like for investors (such as increased tax relief) must also work for UK PLC. It would be beneficial to see annual and lifetime caps for VCT investing increase, to provide increased funding, which is so crucial to these smaller growing companies.
If the high levels of inflation lead to an increase in interest rates, that could dampen economic growth and slow earnings growth, which may affect both the performance of small businesses and fundraising capacity for the VCTs. Nevertheless, with its medium to longer term investment outlook, the VCT sector is supporting growing businesses that looking to develop throughout the different stages of the economic cycle.
From a fundraising point of view, the change to the dividend tax rate is already probably having the biggest impact, combined with the continual restrictions of pension contributions. Looking at venture companies, enhancements to R&D tax credits to include data and cloud computing should enable more companies to take advantage of them, particularly in some of our focus areas such as Enterprise/SaaS.
The gross assets rule has not been changed for a number of years now, and does prove restrictive, both with new investments and when VCTs are looking to support their portfolio companies with follow-on rounds, alongside a syndicate of other investors. It would also be beneficial to have a relaxation of the 7-year rule, as this is still restricting us supporting genuine growth SMEs in some cases.
tom mullard
VCTs invest mainly in technology-enabled companies looking to disrupt their sector, this means they are less exposed to economy-wide macro trends than larger companies. VCTs also typically employ high-skilled labour, and therefore minimum wage rises or other inflation-led pressures are less pronounced than low-skilled sectors.
There were few changes announced in the budget that will impact VCT and smaller company investing more widely. The VCT framework has been in place since 1995 and has been enormously successful at directing money from suitable private investors into UK smaller companies, we expect this to continue under the current budget and government legislation.
VCTs are well established as incentives to encourage investment into smaller companies where the risks are typically higher. In our experience it takes time for tax reliefs to become well understood by all the parties in order for investee companies, investors and advisers to have confidence in them. We think it is the lack of change and continuation of existing support that is important for consistent funding to remain available through these channels.
There are a wide range of VCTs operating in the market, but some look specifically for proven commercial models which are looking to grow faster than the rising tide. The tax relief and downside protections of VCT are also meaningful, supporting the potential of high returns coming from an acquisitive market, as trade buyers and larger institutional investors come under increasing pressure to deploy their funds.
The government has shown loyalty and support to UK SMEs through its fiscal policy, as it has done through the turbulence of the pandemic. Confirmation of business rates discounts and support to the retail and hospitality sectors continue to support sectors which are facing material operating challenges, but policies around labour availability and minimum wage are likely to have the most impact in the short-term. In the long-term, as ever, infrastructure and education policies ill have the most impact on the productivity and profitability of UK business.
The most important thing the government can do for our sector is to show support to UK SMEs and provide stability (and predictability) in the regulatory landscape. The investment cycle is typically 5 to 7 years, so medium term visibility is always key.
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Learning objectives CPD and feedback About Intelligent Partnership Disclaimer
learning objectives
How did you do?
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Covered in section 2, Market Update
Benchmark products and providers in the VCT market against one another
Identify the main developments and news in the VCT market
Covered in section 5, Managers in Focus
Describe key events and trends that are having major impact on the VCT sector
Covered in sections 4 Industry Analysis and 6, What’s on the Horizon
Define some VCT-relevant themes and legislation for the post-Covid era
Covered in section 6, What’s on the Horizon
Evaluate the key fees and charges applied by VCT managers
Covered in section 3, Considerations for Investment
CPD and feedback
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Intelligent Partnership has achieved accredited status from the CII and PFS. Members of these professional organisations represent the majority of the insurance, investment and financial services industry.
Readers of the VCT Quarterly Update can claim up to two structured CPD hours towards their CII or PFS member CPD scheme for the time spent reading this Update (excluding breaks). The review process included an assessment of the technical accuracy and quality of the material against CPD Accreditation standards. Achieving the recognised industry standard afforded by these organisations for this Update, and our training, demonstrates our commitment to delivering only balanced, informative and high quality content to the financial services and investment community. In order to test your knowledge and obtain a CPD certificate readers will need to complete a short online test and provide feedback on the update. This includes 10 multiple choice questions to demonstrate learning and a feedback form to assist in the compilation and improvement of future reports. To claim your CPD visit: intelligent-partnership.com/cpd
Intelligent Partnership actively welcomes feedback, thoughts and comments to help shape the development of these Quarterly Industry Updates. Greater participation, transparency and fuller disclosure from industry participants should help foster best practice and drive out poor practice. To give your feedback please email: publications@intelligent-partnership.com
about intelligent partnership
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Intelligent Partnership is the UK’s leading provider of insights and education in the tax advantaged and alternative investments space.
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disclaimer
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This publication is not included in the CLA Licence so you must not copy any portion of it without the permission of the publisher. All rights reserved. No parts of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means including electronic, mechanical, photocopy, recording or otherwise, without written permission of the publisher. This publication contains general information only and the contributors are not, by means of this publication, rendering accounting, business, financial, investment, legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Neither the contributors, their firms, affiliates nor related entities shall be responsible for any loss sustained by any person who relies on this publication. The views and opinions expressed are solely those of the authors and need not reflect those of their employing institutions. Although every reasonable effort has been made to ensure the accuracy of this publication, the publisher accepts no responsibility for any errors or omissions within this publication or for any expense or other loss alleged to have arisen in any way in connection with a reader’s use of this publication. This publication is based on the authors’ understanding of the structure of the arrangements detailed, the current tax legislation and HM Revenue & Customs practice as at November 2021 which could change in the future. It is not an offer to sell, or a solicitation of an offer to buy, the instruments described in this document. This material is not intended to constitute legal or tax advice and we recommend that prospective investors consult their own suitably qualified professional advisers concerning the possible tax consequences of purchasing, holding, selling or otherwise disposing of VCT-qualifying shares. Intelligent Partnership is not authorised and regulated by the Financial Conduct Authority and does not give advice, information or promote itself to individual retail investors. It is the responsibility of readers to satisfy themselves as to whether any arrangement contemplated is suitable for recommendation to their clients. Tax treatment depends on an investor’s individual circumstances and may be subject to change. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.
