For these investors, venture capital trusts (VCTs) are an increasingly attractive option. Last year’s changes in the Autumn Budget have only enhanced their appeal, making them a more compelling choice for those seeking alternatives or next steps beyond pensions and ISAs.
But what exactly are VCTs, who are they suitable for, and how do they contribute to the broader economy?
What are VCTs and who are they for?
VCTs are listed investment vehicles designed to provide funding to early-stage, high-growth businesses. Launched in 1995, they were created to bridge the funding gap for small and medium-sized enterprises (SMEs) that struggle to secure capital from traditional lenders. By investing in a VCT, individuals gain access to a diversified portfolio of promising UK businesses while benefitting from generous tax incentives.
Unlike pensions, which lock in funds until retirement, VCTs allow investors to access dividends tax-free and potentially exit their investment after a five-year holding period without incurring capital gains tax (CGT). However, they come with higher risks than traditional stock market investments, given they focus on early-stage, privately held companies, and stocks listed in the Alternative Investment Market (AIM), which can be more volatile.
The VCT scheme is one of three tax-based venture capital schemes in the UK, the other two being the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS). While EIS and SEIS involve direct investments into individual start-ups, carrying significantly higher risks, VCTs spread investments across multiple companies, reducing exposure to any single failure.
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Enhanced tax efficiency
The Autumn Budget introduced several tax changes that reinforced the appeal of VCTs for investors. One of the most significant changes was the reduction in the higher-rate CGT threshold from £12,300 to £3,000. Investors who had previously relied on CGT allowances to minimise tax liabilities will now find themselves facing higher tax bills when selling shares and other taxable assets. As a result, tax-efficient vehicles like VCTs – where dividends and capital gains are entirely tax-free – have become a more attractive option.
While VCTs were never exempt from inheritance tax (IHT), recent changes in pension exemptions have placed them on a more level playing field. The abolition of the lifetime allowance means pensions remain an attractive option, but those who have already reached their contribution limits may find VCTs a logical next step.
With VCTs offering up to 30% income tax relief on investments up to £200,000 per tax year – provided the shares are held for at least five years – they present an increasingly valuable option for investors looking to mitigate their overall tax liabilities.
The broader economic benefits of VCTs
Beyond their tax efficiency, VCTs play a crucial role in supporting the UK economy by funding high-growth, innovative businesses, having collectively raised £12.5bn for early-stage companies since launch. VCTs currently support more than 1,000 businesses, employing more than 106,000 people, according to recent figures from the Venture Capital Trust Association.
The UK has long been a centre of gravity for innovation, but historically struggled to scale start-ups at the same pace as the US. VCTs help bridge this gap by providing essential funding to early-stage companies and supporting the country’s most promising entrepreneurs.
For instance, the Baronsmead VCTs have backed UK companies like Ozone API, which provides a global banking interface supporting open banking frameworks worldwide, and CitySwift, an AI-driven data platform that enhances public transport efficiency. CitySwift recently announced a partnership with TfL to roll out its platform across all bus operators in London, exemplifying how VCT-backed businesses can drive productivity, create jobs, and contribute to economic growth.
Are VCTs right for you?
While VCTs offer attractive tax benefits, access to fast-growing sectors, and the opportunity to support UK innovation, they are not without risk. These trusts invest in small, early-stage companies, which can be more volatile than established businesses.
Therefore, VCTs are best suited to investors who have already maximised their ISA and pension contributions, understand the risks associated with investing in smaller companies, and want to diversify their portfolio with exposure to high-growth sectors.
It is also essential to consider a VCT’s focus. Most invest in privately held early-stage companies across sectors like fintech, artificial intelligence (AI), healthcare, and consumer markets, while some concentrate exclusively on AIM-listed stocks.
For those looking to optimise their tax position while supporting UK innovation, VCTs present a compelling opportunity. With increasing Government support for early-stage companies and a growing need for alternative funding sources, these investment vehicles are set to play an even greater role in shaping the UK’s economic future.
Please note, the views expressed in this article are Ken and James’ own and should not be taken as investment advice.
Ken Wotton and James Hendry are portfolio managers at Gresham House
