The latest figures from the Association of Investment Companies (AIC) reported the VCT sector raised £457.5m in the 2015/16 tax year, the third highest on record.

Ian Sayers, chief executive of the AIC, said it’s a real “vote of confidence in VCT managers from investors and their advisors” and it was a “testimony to how well managers are coping with recent rule changes”.

Sayers added the VCT sector continues to be an “important driving force” behind the UK’s up and coming businesses, which are the “backbone of the UK economy” and a “catalyst for job creation”.

But what are they and are they right for you?

21 years of VCTs

VCTs were introduced by the government in 1995 to encourage investment into early stage and new companies and in the 2014/15 tax year they paid out a record £240m in dividends.

Essentially, they are tax efficient ways to invest in small and dynamic UK companies but they are not tax avoidance or loophole schemes.

VCTs are run by a fund manager who invests in small companies, which are either unquoted or listed on the Alternative Investment Market (AIM).

The investments may be subject to initial and ongoing fees, including administration fees and an annual management charge.

What are the benefits of VCTs?

Savers receive income tax relief of 30% on investments of up to £200k in any tax year, although investors must hold the VCTs for a minimum of five years. The minimum investment is usually £5,000.

The dividends earned from VCTs are tax-free and do not need to be declared on a tax return and the growth in value of VCT shares is capital gains tax free.

Who are they aimed at?

They are often considered by those looking for investments capable of generating additional income, or to complement existing retirement plans.

And with the fall of the pension Lifetime Allowance and with the introduction of the Annual Allowance Taper to effect higher earners, recent research from HM Revenue & Customs found that two thirds of VCT respondents said the changes would give them the “greatest cause for optimism in 2016”.

Since the 2008 global financial crash, the VCT sector has held up well compared with the wider stock market. While VCT investors included older and retired investors, not just high net worth individuals, there is a strong consensus that “VCTs are a complement to existing financial plans”. Although HMRC adds that it is for those with an “appropriate appetite for risk”.

What should investors look for in VCTs?

Paul Latham, managing director of Octopus Investments, one of the largest providers of VCTs in the UK, provides the following five tips:

• Take financial advice: A financial adviser can provide an assessment of your current financial situation and what it’s likely to look like in the future, and advise on what steps to take to meet your long-term financial goals. If you do use an adviser, you may want to select a VCT that can facilitate paying your fee to it as this is easier and more tax-efficient. The VCT industry is a mature and established sector with a range of VCTs on offer with different mandates, so taking financial advice can help you to make the right choice for your personal goals.
• Consider the risks: VCTs should be regarded as high risk as they invest in early-stage companies so you may not get back the full amount put in. For this reason, the government offers tax reliefs as an incentive. For those products that do well, they have the potential for significant returns. Shares of smaller companies and VCT shares may be more volatile than those listed on the main London Stock Exchange market, and may also be harder to sell.
• Check performance tables: Check performance tables from reputable sources in order to select those managers who have proven, over the long-term, they have a good track record of managing VCT investments. However, past performance is no indication of future success. You may also wish to consider the size of the VCT fund – larger VCTs can mean you are buying into a well-established, diversified portfolio of investments.
• Check liquidity: At some point you’ll want to sell your shares. Does the manager have a stated policy of buying back VCT shares? Some will reduce your proceeds by 10%, or perhaps more.
• Ask around and act quickly: Ask people about the service they receive, whether they are provided with regular and clear communications and whether they would recommend them to you. Also, there may be more demand for VCTs this year than there will be supply. The best products are already raising significant amounts so don’t wait too long.