It’s been a stressful week for fund managers of venture capital trusts.
As vehicles that invest in start-ups and tech companies, VCTs were rocked by the sudden collapse of Silicon Valley Bank. After a fretful weekend running the rule over which of their portfolio companies may have banked with its UK subsidiary, HSBC’s rescue deal came as a blessed relief.
Nevertheless, it underlined the risky nature of investing in early-stage businesses and why tax breaks are on offer to those who do. But the week’s drama was not over.
Days later, the chancellor doled out some unexpected largesse to the wealthy at the Budget by raising the annual tax-free allowance on pension contributions to £60,000 and scrapping the lifetime allowance altogether.
The political fallout continues, but if pensions expand their role as a tax-efficient investment vehicle for the wealthiest, what could the future hold for riskier VCTs?
With a few weeks left until the end of the current tax year, VCTs have raised an impressive £821mn according to statistics compiled by Wealth Club, the second-best year on record after the £1bn barrier was broken last year.
But what could the next tax year look like?
Venture capital trusts typically invest in young, privately owned companies with assets of £15mn or less, and fewer than 250 employees.
Some could turn out to be damp squibs, but the real attraction for investors is getting in early on soaraway successes that go on to become household names, such as Zoopla, Graze and Five Guys.
One of the most successful exits last year was Pembroke VCT’s sale of fashion brand ME+EM to private equity firm Highland Europe, where investors bagged a return of 16 times their original investment.
New share issues from VCTs come with a 30 per cent income tax credit if the stock is held for at least five years, while dividends and gains are tax-free — even more attractive considering April’s coming squeeze on dividend and capital allowances.
For those who have been “capped out” of pension saving, VCTs and EIS (Enterprise Investment Schemes) have offered the “next best thing” in terms of tax benefits — but at considerably more risk.
While the chancellor tried to downplay the risk of recession at this week’s Budget, investors have been increasingly nervous about start-ups and the stretched valuations of growth companies in general.
For those with smaller sums to invest, saving more into a pension when the annual allowance is raised by £20,000 next month could be a less risky option.
As former pensions minister Sir Steve Webb told the FT this week:
“If I was in this position as an individual and I thought that the next government might put the limit back in, I’d fill my boots in the next two years, have a bit of a gold rush, and then crystallise on the eve of the general election.”
FT Money’s recent Bonus Survey showed a cautious air among investors, with 5 per cent of readers saying they would invest some of their annual bonus money into VCT and EIS structures, down from 7 per cent last year.
Over half of respondents said tax limits were restricting what they could invest into their pension, with 28 per cent capped out entirely and a further 23 per cent restricted by the annual allowance taper.
From April, for the very highest earners, this will taper down potential pension contributions from £60,000 to £10,000 per year. Thar’s higher than the current floor of £4,000, but survey respondents I contacted this week said this wouldn’t be enough to sway them from investing in tax-efficient alternatives like VCTs, EIS and SEIS (Seed Enterprise Investment Schemes).
“If you are affected by the pensions taper, then the tax breaks on these schemes are still superior,” said one reader in his 40s. “Labour have announced they will reverse the pension changes, so it’s impossible to plan. But what attracts me more than anything is the potential for big upside on exit.”
Older readers who have invested in VCTs for many years said it was the tax-free dividend stream from their portfolio that they most valued.
“The majority of our VCT investors — 73 per cent — are retired,” says Alex Davies, founder and chief executive of Wealth Club.
“The reality is most retired people live off their pension, investment, property income and interest. These do not qualify as ‘earned income’ so for these investors, the increased pensions allowance is pointless as they can only use the non-earners’ pension allowance of £3,600. VCTs therefore remain the logical alternative.”
Davies accepts that net asset values of most VCTs have fallen by between 10 and 20 per cent in the past year, noting that it’s much tougher now for early-stage businesses to raise money than 18 months ago.
I’ve written here before about the high fees that abound in this sector and the need for investors to do careful research before committing their cash.
Although there are no official figures measuring money invested into EIS schemes in this tax year, Davies says capital raised is “significantly down”. As these tend to be structured as investments into one, or a small handful, of companies, this is a very different risk profile to most VCT funds which diversify between 60 to 100 companies of different ages and stages.
But there was one, small tantalising line in the Budget that will have caused the ears of VCT and EIS investors to prick up.
We won’t get the full details until the Autumn Statement, but the chancellor said that Lifts were preparing for lift off — a new type of fund known as the Long Term Investment for Technology and Science initiative.
The government wants to make it possible for members of DC pension schemes to invest in innovative, high-growth companies — those that have moved beyond the risky start-up stage to a more sustainable scale-up.
An interesting future prospect for those of us set to shovel more money inside our pensions — and potentially a bonanza ahead if a wall of institutional capital provides natural exits for patient VCT and EIS investors.
The writer is the FT’s consumer editor and the author of ‘What They Don’t Teach You About Money’. [email protected]