By Shane Elliott, partner and head of investor relations at Beringea
Venture Capital Trusts (VCTs) have been instrumental in fostering entrepreneurship across the UK since their inception in 1995. These funds provide tax-efficient investment opportunities for individuals while channelling essential capital to early-stage innovative businesses.
The past few years, however, have tested the resilience of VCTs and their portfolios. Rising inflation, interest rate hikes, and political instability have created a challenging environment for the growing companies backed by VCTs.
Despite these challenges, the most recent Budget underscored VCTs as a means of revitalising the UK economy. This endorsement by the Labour government could prove to be a pivotal moment for the sector.
Reanimating VCT fundraising
The VCT fundraising landscape has evolved significantly, shaped by both macroeconomic pressures and changing investor expectations.
Investors remain drawn to the tax benefits of VCTs, which include up to 30% income tax relief on investments of up to £200,000 per tax year, provided shares are held for at least five years. Dividends are also tax-free, and any capital gains realised upon selling VCT shares are exempt from capital gains tax.
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These incentives have made VCTs particularly appealing to IFAs advising clients on tax efficiency. But at the same time, uncertainty brought on by high inflation and interest rates has prompted greater scrutiny, with IFAs and individual investors conducting more rigorous due diligence.
This translates to heightened interest in fund performance and the resilience of underlying companies. Investors are not only seeking growth but also assurance that their capital is being deployed into businesses capable of navigating economic turbulence.
Over the last couple of years, the higher interest rates and stagnant economic environment have created new challenges for the growth companies that VCTs look to back. These conditions have required fund managers to refine their approach to identifying and assessing potential investments.
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In today’s climate, VCT managers place an even greater focus on understanding how companies can weather economic challenges and adapt to evolving market conditions.
Restaurant chain Farmer J, which joined the ProVen VCTs’ portfolio in early 2024, exemplifies this. The brand closed all its restaurants during the first lockdown but quickly adapted by reopening its sites to serve home deliveries and continue trading despite an empty city. Since then, the chain has added three new sites and grown revenues – by backing businesses with proven resilience, managers can build portfolios prepared to thrive in uncertain times.
The cautious optimism in the market is reflected in the £882m raised by VCTs in the 2023/24 tax year – the third-highest figure on record – as well as the significant fundraises already delivered in the latest tax year by the likes of the British Smaller Companies VCTs and Mobeus VCTs.
Encouraging signals from the Budget
The Autumn Budget of 2024 reinforced the government’s support for VCTs, with the Chancellor highlighting their role in supporting entrepreneurship.
This followed the earlier extension of the sunset clause for VCT and EIS schemes to April 2035 – a decision that provided much-needed certainty about the future of VCTs for fund managers and investors alike.
It also reaffirmed the government’s commitment to maintaining the tax benefits of VCTs while introducing tax increases in other areas, such as higher capital gains tax rates. These changes have enhanced the tax appeal of VCTs, sparking renewed interest among high-net-worth investors seeking shelter from rising taxes.
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Moreover, the government’s commitment to innovation was evident in the £20.4bn allocated to research and development (R&D) for the year. This investment aligns with the mission of VCTs, creating fertile ground for portfolio companies in high-growth sectors such as healthtech, climatetech, and artificial intelligence.
These policy measures reflect the Government’s recognition of growth companies – including those backed by VCTs – as vital drivers of economic growth.
Yet, fund managers must remain vigilant, ensuring investments contribute meaningfully to this broader agenda while still delivering returns for investors.
Resilience and opportunity
The VCT sector’s 30-year history demonstrates an ability to weather economic downturns and emerge stronger.
From the dot-com crash of the early 2000s to the 2008 financial crisis, periods of upheaval have tested VCTs, but also revealed their potential. Businesses that pivot, embrace technology, or address societal challenges can thrive amid downturns, creating opportunities for bold, innovative companies.
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Today, we find ourselves at a similar inflection point. Rising interest rates and inflation present undeniable challenges, but they also create opportunities for disruptive technologies and resilient business models.
For VCTs, the alignment between government policy and their mission is encouraging. Potential lies in supporting entrepreneurs who are not just navigating adversity but turning it into opportunity.
The journey ahead for VCTs continues to be one of resilience and innovation. With economic headwinds come challenges, but also a renewed sense of purpose. This could be a moment to drive meaningful growth, both for investors and the broader UK economy.