The VCT (venture capital trust) offer season is in full flow and recent launches include Octopus Group’s £35 million fundraise for its Octopus Apollo VCT (OAP3) and Gresham House’s £76 million raise for its generalist product Mobeus Growth & Income VCT (MIX).

The Mobeus offer opened on 17 October and raised £52 million in the first three days, showing the popularity of these types of funds. Mobeus VCTs have topped the generalist performance league tables over the past five and 10 years. This feature explains the ins-and-outs of VCT investing and highlights the main advantages and drawbacks.

WHAT ARE VCTS?

Investors are allowed to put up to £200,000 a year into a VCT which attracts 30% tax relief. The money needs to remain invested for at least five years, but the advantage is that dividend income and capital gains are tax free.

The reason behind the generous tax treatment is that some of the funds will be invested into early-stage companies which carry higher risks.

VCTs have evolved over recent years and the industry is now a mainstay of the investment landscape with around £6 billion of money invested in the sector.

WHO ARE VCTS FOR?

While the maximum investment limit might suggest the products are the exclusive domain of high-net-worth investors many products have minimum investments of as little as £3,000.

That said, investors on higher-rate or additional rate tax bands are naturally drawn to VCTs because of their tax benefits. Individuals who have maxed-out on their ISA and SIPP tax wrappers or are close to the £1.03 million pension lifetime allowance may find VCTs an attractive alternative.

Investors with exceptional one-off tax bills might consider the VCT route to reduce their tax liabilities. It is worth pointing out that investing for tax benefits alone is rarely a good strategy.

VCTs are not suitable for individuals who might need access to the cash within five years. If cash is withdrawn from a VCT within five years, the 30% tax relief must be paid back to the taxman. The nature of the product means taking on more investment risk which rules out VCT’s for risk averse investors or those close to retirement.

HOW HIGH ARE THE FEES?

Typically, VCTs charge an entry fee of around 3% which is usually discounted for existing investors while annual management fees are between 2% and 2.5% a year. Performance fees can also be levied subject to minimum annual returns or ‘hurdles’ in the region of 5% or 6%. VCT fees are higher than those charged by plain vanilla actively managed funds, reflecting the complexity of the products and the work undertaken by managers to grow portfolio businesses.

Managers can take six months or more to conduct in-depth due diligence. They also spend a lot of time helping entrepreneurs to develop their businesses and opening doors to useful contacts.

At the end of the day the proof of the pudding is in the eating and many successful VCTs have delivered double-digit returns for shareholders.

WHAT ARE GENERALIST VCTS?

Generalist VCT’s invest in early-stage unquoted companies which can be pre-revenue generating businesses. Managers are looking to ‘get in on the ground floor’ and benefit from strong anticipated growth and multiply their capital many times over.

The strategy will often result in a few failures because the reality is that most new businesses fail. ‘A venture capital manager should expect half of their investee companies to fail,’ says Hugi Clarke at specialist asset manager Foresight.

VCT managers investing in unquoted companies must deploy at least 30% of money raised within the first 12 months and 80% within three years to continue to qualify for VCT status. This means having a good idea of the amount ‘follow-on’ capital required to add to existing positions as well as brand new investments.

Chief investment officer at Mobeus Trevor Hope told Shares the team usually targets putting around 40% on new money into existing positions and the rest into new investments.

A good example of follow-up investment is My-Tutor which is an online platform for students and schools which Mobeus first invested in four years ago. The Mobeus team are interested in investing in businesses that can scale such as business-to-business technology and services companies.

Other areas of focus for Mobeus are healthcare services, consumer brands and e-commerce enablers. Hope said the team knew the consumer brands space very well and had previously invested in high-end furniture and lighting business Buster and Punch.

The Mobeus portfolio is invested across 42 companies. The team look at 30-to-40 companies per month and take around six into extensive due diligence from which it invests in one or two. The fund has a good track record delivering double digit returns over the last decade. Taking a £100,000 investment to illustrate the return profile, it has produced £112,000 of dividends and £75,000 of capital gains in addition to the £30,000 of tax relief.

Conscious of investor’s need to access their money after the five-year lock-up, Mobeus offers an annual buyback facility at around a 5% discount to net asset value.

WHAT ABOUT AIM VCTS?

Many individuals are drawn to AIM VCT because they are already familiar with stocks on London’s junior market. Unlike Generalist VCTs which are full of unquoted companies, AIM VCTs feature stocks which are more transparent in terms of corporate updates and their latest valuation.

VCT managers are only allowed to invest in AIM companies when they raise capital either via IPO (initial public offering) or a share offer. In other words, they are not allowed to purchase shares in the secondary market.

The largest player in this segment is Octopus Group and its September fundraising offers investors the opportunity to invest into both Octopus AIM VCT (OOA:AIM) and Octopus AIM VCT 2 (OSEC:AIM), which both target a 5% tax free dividend yield every year.

Kate Tidbury, senior fund manager at Octopus Investments, commented: ‘We believe there is room for valuations to recover when the market outlook improves, and we’re continuing to focus
on finding companies and management teams that we think can deliver significant growth over the long-term.

‘We expect to have opportunities to invest the funds raised at attractive valuations.’ Octopus’ AIM VCT portfolios contain companies across various sectors which offer what the manager believes to have significant growth potential.

One example is Clean Power Hydrogen (CPH2:AIM) which has developed a technology able to generate pure hydrogen and oxygen as separate gases to accelerate progress towards a zero-carbon future. Octopus invested in the company when it floated on AIM in February 2022.

Some companies have been held for over a decade, such as Scottish-based software company Craneware (CRW:AIM) which provides software to gather operational, financial, and clinical data that gives healthcare providers valuable insights.

LIMITED LIFE VCTs

The essential goal of these types of VCT is to ensure an investor gets his money back after five years, so he can reap the 30% tax benefit.

The investment manager’s role is to increase the value of the portfolio to cover the fees, typically an upfront 4% and 2% annual management fee as well as administration fees of around 0.35%. Should the VCT manager manage to exceed that goal investors should expect to pay a performance fee in the region of 20% on the gains above the original entry price.

As an example, Jane invests £10,000 and gets £3,000 back from the tax man, leaving her with an initial investment of £7,000. Turning £7,000 into £10,000 requires the fund to grow around 43% over five years which is just over 7% a year.

Limited life VCTs will adopt a conservative investment approach to reflect the relatively short-term investment time horizon. They typically hold sizeable cash and short dated loans, and qualifying deals are asset backed, primarily through loan notes.

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