For the right type of individual, an investment into Venture Capital Trusts (VCT) or Enterprise Investment Schemes (EIS) can make sense. These investments offer the following qualities;
Access to a portfolio of young, emerging companies with the potential for significant capital growth.
The ability to claim income tax relief at 30%.
In the case of EIS, the added tax benefits of capital gains tax deferral, Business Property Relief from inheritance tax and the ability to carry the income tax relief back into the previous tax year.
Our view is that a VCT carries less risk than an EIS but, unquestionably, both carry investment risks far in excess of anything available in the mainstream investment market. For starters, the risk of one or more of the young, emerging companies failing is very real and therefore our approach has been to recommend portfolios spread between multiple companies and across multiple sectors. These investments are certainly not for everyone.
Both the VCT and EIS markets have become increasingly competitive over the past decade or so, with a wide range of investment strategies and companies becoming available to invest into. We believe that both markets can generally be split into two headline categories;
1) VCT/EIS portfolios which are looking to generate significant capital growth.
2) VCT/EIS portfolios which are looking to generate more modest returns, but with lower volatility and a more predictable outcome once the tax reliefs have been secured.
There is little question that category 1 fits the spirit of the legislation; the government is prepared to offer private investors tax reliefs in order to make sizeable investments into the youthful end of the UK economy.
Category 2 is a little more opaque; some of the strategies used here in the recent past have included solar energy, hydroelectric power and anaerobic digestion plants. Returns from strategies such as this are very predictable and for them to also receive tax reliefs was deemed to not be in the spirit of the legislation. The government therefore removed such strategies from the qualifying list.
Subsequent to these “renewable energy” linked trades being removed from the scope of the legislation, there have been further clampdowns on the types of trade which will qualify for tax relief.
Management buyout’s, a lucrative trade for some of the VCT giants such as Baronsmead and Mobeus, are no longer allowable. This has proven to be an excellent avenue of generating profit for a number of managers in the market, and will undoubtedly increase the average risk profile going forward.
It will no longer be possible to invest into a company more than seven years after their first commercial sale took place, or ten years after the first commercial sale for “knowledge intensive” companies. This is a rule change which could prove particularly problematic, particularly for AIM Venture Capital Trusts.
Reserve power will also be removed as a qualifying trade from 30th November. This essentially involves a small scale gas and diesel generating station which is connected to a local distribution network to provide energy to the national grid during times of peak power.
Risk warnings associated with VCT/EIS investments
VCTs are high risk investments and there may be no market for the shares should you wish to dispose of them. You may lose your capital.
Enterprise Investment Schemes (EISs) are very high-risk investments. An EIS investment is usually concentrated in one single unquoted trading company. Often there is no market for the shares and it may therefore be very difficult to make a disposal. There is a strong possibility of the chosen company failing.
Our initial reaction to these changes is that they are sensible. If tax relief is going to be given to investors for investing into young companies, it follows that these monies should be making their way into the hands of genuine young companies which are looking to grow, as opposed to companies set up for a specific purpose which are looking to take advantage of the rules in order to provide tax relief to investors.
However, equally this means that the risk profile of those schemes targeting lower volatility and some of those schemes targeting growth is moving upwards considerably in our view. Our view is that these investments will remain suitable for certain types of investor, but the days of finding schemes which were too good to be true are likely to be well and truly in the past.
We wait with interest to see how the VCT and EIS market will react going forward. Our Investment Committee has already met with a range of providers in the marketplace and listened to some interesting new ideas, and we do anticipate shortlisting new schemes in early 2016 once the new legislation has been fully interpreted by providers.
If you are interested in principle in a high risk, potentially high reward solution such as this please let us know, and we will ensure you are contacted once we have shortlisted an appropriate product.