Do VCTs make sense as an investment?

Although VCTs have attractive tax advantages, this shouldn't be the sole justification for investing

The age of venture capital trusts (VCTs) is approaching thirty. Although they have endured, should you think about making an investment in VCTs?

VCTs do not have a significant presence in the top stocks and funds for investors because they are vehicles that invest in private companies. They are erratic investments, and small companies frequently face difficulties when the economy is unstable.

Nonetheless, it might be worthwhile to think about investing in VCTs given the declining interest rates, the potential for a peace agreement between Russia and Ukraine, and the growing demand for private assets by investors.

Robert Whitby-Smith, a partner at Albion Capital, stated at a recent media roundtable commemorating 30 years of VCTs, "There's a lot of activity in private markets." It has developed into an extremely fascinating and rapidly expanding asset class. Enterprise in the UK is very robust.

"Our founders are incredible entrepreneurs who started businesses, and the UK's universities are producing amazing innovation. The UK venture capital ecosystem is now bigger than France and Germany combined.

A type of investment trust called a VCT is specifically made to promote investment in small businesses that need outside funding to expand.

They therefore have a number of tax benefits, which we will go over in more detail.

According to Chris Lewis, chair of the Venture Capital Trust Association, "VCTs have steadily provided capital to the most ambitious, high-growth companies that drive productivity, job creation, and technological advancement over the last three decades, making them a fundamental pillar of the UK's innovation economy."

VCTs: What are they?

Investment trusts that make investments in venture-funded businesses are known as VCTs. Their introduction in 1995 aimed to encourage investment in private companies, which is why they offer tax benefits.

The Association of Investment Companies' (AIC) chief executive, Richard Stone, stated, "VCTs are celebrating 30 years of supporting the UK's most ambitious smaller companies'." They have increased economic growth and created thousands of jobs in cutting-edge industries like technology and healthcare.

Because they give regular investors access to private companies, they are a unique asset class. Although some may be listed on Aim, these companies typically do not trade on public stock markets; therefore, you are not permitted to hold them in an ISA for stocks and shares.

Nonetheless, VCTs allow regular investors to access venture-funded companies.

A company's owner is making a venture capital funding pitch.

Venture-funded companies have traditionally found great value in VCTs as a source of funding.

(Image courtesy of Cravetiger via Getty Images) The funds have very stringent guidelines regarding what constitutes a qualifying VCT investment. Typically, VCTs are only allowed to invest in companies with fewer than 250 employees and less than £15 million in value.

These companies must be under seven years old, and some economic sectorsmost notably the financial services sectorare prohibited.

The risks of investing in small, early-stage businesses like these are somewhat reduced by the fact that VCTs distribute their funds among several businesses.

Investors should not be deceived, however, as these are young, delicate companies that have a high chance of failing.

VCTs are listed businesses that trade on stock exchanges, just like all other investment trusts. When it comes to VCTs, which are venture-funded businesses, their sole responsibility is to invest in assets.

It is possible for investment trusts to trade below their net asset value (NAV), and they typically do. The value of the shares you purchase or own in a VCT may become considerably separated from the assessments of their assets due to the inherent difficulty in valuing private companies.

What benefits can investing in VCTs offer?

VCTs provide investors with a number of tax breaks in addition to access to businesses that would not otherwise be available.

As long as the new VCT shares are held for a minimum of five years, this includes a thirty percent upfront income tax relief. Therefore, you can deduct 3,000 from your income tax calculation for every £10,000 you spend up to £200,000.

This is only applicable to investments in newly issued shares that are issued at the time of the trust's formation or when it raises additional funds. Income tax relief is not available for VCT shares purchased on public markets.

Any tax relief you received will have to be repaid if you sell shares on which you claimed income tax relief within five years.

All VCT shares are eligible for tax-free dividends, though, and you won't have to pay capital gains tax (CGT) if you sell any of your VCT shares for a profit.

"VCTs' popularity has grown over time as a result of financial advisers and wealth managers recommending them as a tax-efficient investment strategy," said James Hendry, investment director at Gresham House Ventures.

According to Joshua Gerstler, owner of The Orchard Practice, the tax relief offered should only be considered in part when deciding whether to invest in a VCT.

"The investments are high risk because they are in start-up companies, and even though the tax incentives are substantial, there is a chance that you could lose all of your money. He advises investing in a VCT for reasons other than tax savings, such as personal preference.

Why would it be a good idea to invest in VCTs now?

First and foremost, it's critical to keep in mind that all investing entails risk. Because of the nature of the businesses they invest in, VCTs in particular ought to be considered long-term investments.

Investing in smaller, growth-oriented businesses is usually riskier. Many would contend that this type of investing is not supported by the state of the economy at the moment.

Interest rates are comparatively high, making borrowing more expensive for smaller businesses, and ongoing inflation, which might worsen if President Donald Trump's tariff policies disrupt international trade, can discourage investment in them. These businesses frequently rely on this outside funding to expand.

This is evident in the way VCTs have performed over the last three years; according to data from the AIC, they have decreased by an average of 4 to 6 percent over the last year and 16 to 1 percent over the last three (to January 31, 2025).

Nonetheless, hardships frequently give rise to triumphs.

According to Whitby-Smith, "if you look at the most successful companies in the world"Apple, Microsoft, Amazon, Nvidia, and Uberthey were frequently founded during challenging economic times, but that did not affect their overall success. It might even have played a role in it, he continues.

VCTs have done better over the long run, rising 57.7% in the ten years ending January 31 and 218.9% in the twenty years prior.

"The demand for VCTs continues to reflect their role as a stable and established investment vehicle, even within the context of broader economic uncertainty," says Lewis.

"The combination of growth potential, diversification, and government-backed tax incentives continues to attract investors, thereby solidifying VCTs as a crucial mechanism for financing innovation in the United Kingdom.

Do VCTs have a lower price?

At the moment, the average discount rate used to trade VCTs is 9%. The trading price of AIM Quoted VCTs is 6%.

Discounts, however, aren't always a very helpful metric to use with VCTs.

According to AIC research and content director Nick Britton, "VCT shares are not normally bought and sold in the secondary market."

Although "buying VCTs in the secondary market can occasionally result in interesting trades, the issue is that you don't get the 30 percent upfront income tax relief if they are heavily discounted."

Consequently, trading VCTs on the secondary market is a minority activity.

"Whereby shares are bought back by the VCT at regular intervals at a set target discount (say 5 percent)" is another clause he adds that individual investors would be better off looking at.

Three VCTs with the best performance.

The majority of investing involves taking a long-term perspective. When it comes to investment trusts, this is especially true; with VCTs, it is even more so.

Any investment in a VCT should take into account a minimum of five years due to the tax incentives; we have extended that period even further by taking into account the performance of the VCT over a ten-year period ending on December 31, 2024. All information comes from Wealth Club via Morningstar.

Morningstar via Wealth Club is the source.

Keep in mind that past performance does not necessarily predict future outcomes.

In the case of MIX, British Smaller Companies (LON:BSV) and Mobeus Income and Growth (LON:MIX) both make investments in unlisted and emerging UK businesses.

With an emphasis on B2B software, Albion Enterprise VCT (LON:AAEV) was the first institutional investor in Booking.com. "The focus we have chosen and the knowledge, abilities, and experience we have gained within those sectors are what set us apart," Whitby-Smith said at the media roundtable.