VCTs for Financial Independence: Part 1- Intro

At the suggestion of some other bloggers I thought that I would write a bit about Venture Capitalist Trusts (VCTs) from a point of view of someone who wants to reach Financial Independence and is thinking about early retirement. Please see the Wealth Warning!

VCTs are a financial product that offers a lot of potential for tax relief and even capital growth. Dividends are tax free. I’ve not seen any posts from other bloggers on VCTs (except this piece which is well worth a read) so I thought that I would do my own. These will be published over the next week or so and will cover the following topics:

1. Intro & Overview
2. How to get started – buying, holding, selling
3. How to use VCTs to FIRE
4. GFF’s experience of VCTs

First of all: Wealth Warning – VCTs are harmful to your wealth. Fees are high, the shares illiuid and you may lose some or all your money. Be grown up and take responsibility for your actions and for heaven’s sake – do your own research!

History & Info.

Introduced in 1995, venture capital trusts or VCT are a tax efficient closed-end collective investment fund which provide venture capital (money) to help UK companies grow, with the capital gains or income being paid to investors.

The main difference between a VCT and other funds (like Marlborough UK Micro cap growth) is that only eligible companies may be held by a VCT and investors get a 30% tax rebate on investments and dividends are tax-free (reinvested dividends are also eligible for the 30% tax relief). Simply put, if you invest £10,000 in a VCT you may claim back £3,000 from the tax man. The VCT invests that money in eligible companies (80% or more) and can’t hold more than 15% in one single company. Consequently, each VCT fund holds a portfolio of companies to not keep all their eggs in one basket.

Shares must be held for 5 years before being sold and you can’t buy back into the same VCT within 6 months of selling. However, many VCT houses have more than one fund meaning you could sell one VCT and buy another with the proceeds. There is a £200,000 limit per tax year, which is not something I have to worry about.

EIS / VCTs?

VCTs and EIS (Enterprise Investment Schemes) and SEIS (Seed Enterprise Investment Schemes) are all government approved investment schemes with 30% tax relief. I’m not going to talk about the differences, pros/cons but suffice to say that they are similar. More info here.

The Good

Mugs like me think that there is something to be said for using your money for good. If you buy shares in saw Unilever, what is your money really doing? I don’t know. But with VCTs, you are funding companies that hopefully will grow and you could be lucky and invest in a unicorn early on and you made a huge profit! Add on the tax back and tax-free dividends and it’s an attractive offer. Also, if you look at the price performance of most VCTs over the last 10 years or so, the price is not that volatile – so despite investing in risky smaller, early-stage companies which are hard to value, you don’t get wild swings in price.

The tax relief and tax-free dividends (plus capital gains relief) are the main reasons for investment and you can use them to reduce your tax bill. You can only claim tax relief for the year you invest in and not for previous tax years.

The Bad

The downside is that the track record of VCTs to offer stellar performance vs. indices is not great. Many funds back losers – although from the marketing of them you’ll only hear about the winners. Many see their NAVs decline over the years and dividends are not covered by growth/income.

The Ugly

Even worse, whilst many of us in the FIRE-brigade are worrying over the decimal points of our ETF fees, VCTs typically charge in the regon of 2%+ a year for assets held. That’s due to a combination of the VCTs being relatively small (most are around £30-£100m so fees are ~£1-3m per annum) and they need to individually assess, monitor and work with companies plus all of the paperwork to ensue that they are VCT eligible.

Buying / Selling

You can buy VCTs on the stock market like any other share or fund, spreads are large and volumes are thin. You don’t however get the 30% tax relief (although dividends are still tax free). The most common way to invest is through a placing / fund raising. For a new VCT you buy the fund less ~3% transaction costs. For an existing fund you buy it at its net asset value (NAV) +~3% transaction costs. This is done through a broker. And since VCTs typically trade at a (sometimes significant) discount to the NAV, a £10,000 investment might only get you £8,500 back if you needed to sell in a hurry.

If you add up 15% buying/selling spread + 5 years of 2%+ fees then not much of your 30% tax relief is left. That’s unfortunately a bit of a problem. The spreads are lower than they were historically though.

Summary

Iwould like to mention that this is not advice and you should do your own research. These are high risk, high fee vehicles and not for the faint-hearted. I believe that they match my own risk tolerance and I’ve used them for 8 years or so now with some successes, some failures and overall, I see that they a valuable tool for me and possibly many other readers. I would not recommend that you invest any money which you either 1) need anytime soon 2) can’t afford to lose and 3) don’t already have your ISAs/LISA filled and an emergency fund in place! As a rule; holding more than maybe 15% of your net worth is too much and too risky.

Further reading:

• Money Advice Service on VCTs,
• Post from Finumus,
• Tax efficient review – good source of info on individual VCTs,
• Lemon Fool Board on VCTs (I don’t post)
• FT.com article (might be behind paywall)
• Wealth Club list of VCTs raising funds

Hopefully that’s given you some useful information – not too much detail or too little. Next how to VCTs can be a tool for financial independence or early retirement.

Thanks, GFF.