An investment for the more adventurous

I appreciate that the topic of this particular blog may only apply to a few of you but I trust that everyone will find it of some interest. My aim is to cover all aspects of investing and financial planning in my blog and website.

There will be a lot of different views in the investment community and the public at large as to what might constitute a favourite investment. Many will invest in gold for its ability to keep its value in the bad times. Others, particularly those living in the UK, will boast of the benefits of residential property. A lucky few would be quick to point out the tax free £50,000, £100,000 or even £1m they obtained from their Premium Bonds. Younger investors might cite Bitcoin, or some other form of digital currency, for its wild gyrations and the possibility of untold riches.

I suspect that a large percentage of votes would be cast for ISAs and particularly Stocks & Shares ISAs and their ability to outperform inflation over the long term. After all that is surely what most people want from an investment. Not only that but all growth and income from an ISA is completely free of tax apart from Inheritance Tax and AIM ISAs can even address that problem.

I think Stocks & Shares ISAs are great and I try and use them as much as I can, but I am also a keen user of an investment that I view as a Super ISA. It has many similarities to a Stocks & Shares ISA but, if you ignore inheritance tax, it is even more tax efficient. I am referring to Venture Capital Trusts or VCTs as they are known. These are at the top end of the risk scale because of their investment in unlisted or AIM (Alternative Investment Market) listed companies. However, by investing relatively small amounts of around £3,000 to £5,000 in different years into different VCTs you can build up a diversified portfolio which tends to take the edge off the risk of loss.

Why do I like VCTs so much?

Reason (1) A VCT invests into a selection of small to medium sized unquoted trading companies in the UK. As a group these companies have high growth potential and are the very companies that will drive future growth in our country.

In June 2021, the UK crossed a new milestone. It is now home to 100 tech unicorns – private tech companies valued above $1 billion – only the third country to achieve this, after the US and China. Seven of the UK’s 100 unicorns were originally backed by VCTs and I have included these at the end of this blog.

Reason (2) A VCT will take equity stakes in businesses across the UK and across a wide-range of sectors unless it is a specialist VCT investing, say, in healthcare or energy. The VCT managers will seek to make a return on their investment by growing and improving the company, using not only finance but also their own commercial expertise and business acumen.

Reason (3) Income tax relief at 30% is provided on each investment into new ordinary shares in a VCT. I simply work out how much tax I have paid in a tax year and decide how much I would like to claim back. If I were to invest £10,000 in a VCT, therefore, I would receive a tax rebate of £3,000 provided I have actually paid at least that amount of tax in a year. This is an ideal investment for those who have already maxed out their pension funding.

Reason (4) A really nice feature is that all dividends are free of tax and so don’t need to be included in a tax return. By investing relatively small amounts into VCTs each year you can build a good tax free income over time. The income at present from many VCTs is around 4.0%. However, this can increase over time as profits from the sale of an underlying investment by the VCT manager is also paid out as a tax free dividend. I have been investing in VCTs for 16 years and I typically receive an income of around 7.0% a year which is equivalent to 8.75% for a basic rate tax payer or 11.67% for a higher rate tax payer.

Reason (5) VCTs can provide a measure of capital growth over time although this is not something I rely on. This is because the growth tends to be diluted by being paid out as dividend income. Any growth that there is will be free of capital gains tax so again there is no need to report gains on a tax return.

Reason (6) This may not seem to be a positive reason but VCTs need to be held for the long term. They have to be held for at least 5 years so as not to lose the initial tax relief. However, you should generally not invest in a VCT unless you happy to invest your money for at least 7 to 10 years. This is the best way to build up wealth as easy access short term savings and investments have a tendency to get spent.

The issue of risk

Before considering an investment into a VCT there are a number of areas to do with risk that you need to consider as follows:

To invest in VCTs you need to be a ‘High Net Worth or Sophisticated Investor’. In simple terms you have to be earning at least £100,000 a year or have net assets (excluding your property and pension rights) of at least £250,000.

VCTs are considered to be a high risk investment.  They will, therefore, only be suitable for you if you have an adventurous attitude to risk, or you have a moderate or moderately adventurous attitude to risk but are happy to invest at least part of your capital in a high risk investment.

There are many different types of investment.  Are you clear as to why you wish to invest in a VCT?  It is possible that there is another, lower risk, investment that would also meet your objectives.

Are you comfortable with the fact that VCTs are an illiquid investment?  A VCT has to be held for 5 years to qualify for the associated tax breaks.  However, even after 5 years there will not always be a ready secondary market in your VCT shares. Many VCT managers promise to buy your shares from you but a promise is not a guarantee and it will usually be at a discount of around 10% to the net asset value at the time. Because of this you should generally not invest in a VCT unless you happy to invest your money for at least 7 to 10 years. 

Property website Zoopla was the first company backed by a VCT to achieve unicorn status. It is now a household name.

Cazoo was set up using VCT backing to make the experience of buying a used car quick and hassle-free.

It became the UK’s fastest ever unicorn just 18 months after the company was founded.

Bought by Many started out as an insurance broker in 2012 but using VCT backing and expertise it was named Best Pet Insurance Provider in 2020. Today, the business insures over half a million pets globally and is valued at $2 billion.

Depop is the social marketplace where people buy, sell and discover unique fashion. It was founded in 2011 and now has over 24 million users globally, 90% of whom are below the age of 26. Depop was purchased by Etsy in June 2021 for $1.625 billion.

Gousto was one of the first subscription-based meal-kit providers and is now the UK market leader in recipe box delivery with

25 million meals sold in the first three months of this year. It has a valuation in excess of $1 billion.

Graphcore was founded in 2016 using VCT backing and has created a new generation of microchips, designed specifically for machine learning and artificial intelligence. It now partners with Microsoft and Dell and is valued at $2.8 billion.

Every day Wejo collects and analyses data from 66 million journeys across a network of 10.7 million live vehicles. Wejo received its first VCT backing in 2016 and in 2019 General Motors invested

€91 million for a 35% stake, valuing the company at €244 million.

Please note that past performance is not a guide to future performance

For a fuller look at VCTs please go to  https://usefulmoneyguide.uk/vcts-venture-capital-trusts/

Arthur Childs

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