It’s been a stressful week for fund managers at venture capital trusts.
As vehicles that invest in start-ups and tech companies, VCTs were shaken by the sudden collapse of Silicon Valley Bank. HSBC’s rescue deal came as a welcome relief, at the end of a weekend of ruling over which of its portfolio companies it may have banked with its UK subsidiary.
Still, it underscores the risky nature of investing in early-stage businesses and why tax breaks are offered to those who do. But the week’s drama wasn’t over.
Days later, the chancellor handed out some unexpected big bucks to the wealthy in the Budget by increasing the annual tax-free allowance on pension contributions to £60,000 and scrapping the lifetime allowance altogether.
The political fallout continues, but if pensions expand their role as a tax-efficient investment vehicle for the wealthiest, what might the future hold for risky VCTs?
With just weeks to go until the end of the current tax year, VCTs have raised an impressive £821mn according to figures compiled by the Wealth Club, the second-best year on record after breaking the £1bn barrier last year.
But what will the next tax year look like?
Venture capital trusts typically invest in young, privately owned companies with assets of £15mn or less and fewer than 250 employees.
Some may come off as wet squibs, but the real attraction for investors is the very fast successes that become household names, such as Zoopla, Grey’s and Five Guys.
One of the most successful exits last year was Pembroke VCT’s sale of fashion brand ME+EM to private equity firm Highland Europe, where investors received a return of 16 times their original investment.
VCT’s new share issues come with a 30 per cent income tax credit if the stock is held for at least five years, while dividends and gains are tax-free – all the more attractive considering April’s upcoming squeeze on dividends and capital allowances.
For those “capped out” of pension savings, VCTs and EIS (Enterprise Investment Schemes) offered the “next best thing” in terms of tax benefits – but at significantly higher risk.
While the chancellor tried to play down the risk of a recession in this week’s budget, investors are increasingly nervous about stretched valuations of start-ups and growth companies in general.
For those with smaller sums to invest, saving more into a pension may be a less risky option when the annual allowance is increased by £20,000 next month.
As former pensions minister Sir Steve Webb told the FT this week:
“If I were in this position as an individual and I thought the next government could put this limit back, I would fill my boots in the next two years, do a little gold rush and then crystallize on the eve. of the General Election.”
FT Money’s latest bonus survey showed a cautious climate among investors, with 5 per cent of readers saying they would invest some of their annual bonus money in VCT and EIS structures, down from 7 per cent last year.
More than half of respondents said tax limits restrict what they can invest in their pension, with 28 per cent restricted outright and a further 23 per cent restricted due to reduced annual allowances.
From April, for the highest earners, this will reduce potential pension contributions from £60,000 to £10,000 a year. Thar is higher than the current £4,000 floor, but survey respondents I contacted this week said this was not enough to put them off investing in tax-efficient options such as VCTs, EIS and SEIS (Seed Enterprise Investment Schemes).
“If you’re affected by pension cuts, the tax breaks on these plans are still great,” said one reader in his 40s. “Labour have announced they will reverse the pension changes, so it is impossible to plan. But what attracts me more is the huge upside potential on exit.”
Older readers who have invested in VCTs for many years said that it is the tax-free dividend stream from their portfolios that they value most.
“The majority of our VCT investors – 73 percent – are retirees,” says Alex Davies, founder and chief executive of Wealth Club.
“The reality is that most retirees live on their pensions, investments, property income and interest. This does not qualify as ‘earned income’ so for these investors, the increased pension allowance is meaningless as they can only use the non-earner pension allowance of £3,600. So VCT remains a logical option.”
Davies acknowledges that the net asset value of most VCTs has fallen between 10 and 20 percent over the past year, noting that it is more difficult for early-stage businesses to raise money now than it was 18 months ago.
I’ve written here before about the high fees rife in this sector and the need for investors to do careful research before committing their cash.
Although there are no official figures to measure the money invested in EIS schemes this tax year, Davies says the capital raised is “significantly down”. As these are structured as investments in one or a small handful of companies, this is a very different risk profile to most VCT funds that diversify between 60 to 100 companies of different ages and stages.
But there was one small tantalizing line in the budget that might have caught the ears of VCT and EIS investors.
We won’t get full details until the autumn statement, but the chancellor said The lifts were preparing to lift off — a new type of fund called long-term investment for technology and science initiatives.
The government wants to make it possible for members of DC pension schemes to invest in innovative, high-growth companies – those that have moved beyond the risky start-up stage to more sustainable scale-up.
An interesting future prospect for those of us putting more money into pensions – and potentially a boon if the wall of institutional capital pans out naturally for patient VCT and EIS investors.
The author is the FT’s consumer editor and writer.What they don’t teach you about money‘ firstname.lastname@example.org