In times of change and turbulence, the companies that prioritise innovation and entrepreneurship will flourish –and the UK start-up industry has duly boomed during the pandemic. In 2020 alone, 93 new ‘unicorns’ were created, while the British high-growth company sector was valued at $585bn (£424bn), doubling in size since 2017.
For investors looking to capitalise on this appetite for innovation, venture capital trusts (VCTs) – traditionally seen as niche but now increasingly mainstream – deserve consideration. They offer key benefits to investors and, if the associated risks are carefully considered, can be the answer to investors seeking to capitalise on the current economic climate and back high-quality, better-capitalised companies with lower valuations.
Backing innovation
The UK has experienced an explosion of interest in its start-ups, particularly in the tech sector. In the first three months of 2021 alone, the UK tech sector attracted record investment of close to $8bn. VCTs offer the opportunity to invest into these early-stage companies, providing smart start-ups with access to fast and reliable capital at the earliest stages of their lifecycle. In a survey published by the Association of Investment Companies, 84% of VCT investors said they felt they were helping UK entrepreneurs with their investment.
Indeed, during the 2020/21 tax year, the VCT sector has raised a record £685m for investment into innovative businesses, an 11% increase from the previous year. This historic level of VCT fundraising reflects the desire to prioritise businesses looking to adapt and progress as we meet the instability of the post-pandemic world.
Addressing risks head-on
While this appetite for start-ups and VCT investment presents an exciting opportunity, however, addressing the risks when backing promising early-stage companies will be crucial for investors. There are many reasons why start-ups fail, such as cashflow-related difficulties or issues with a remote workforce, but there is one factor that overtakes the rest – no established demand for their product. Industry research published by CB Insights indicates the number-one reason for start-up failure, cited in 42% of cases, is the lack of market need.
Ensuring that market need is established before investment, rather than simply hoping the market will validate investment, is crucial. As an example, Triple Point’s Venture Fund VCT, founded in 2018, typically invests in pre-Series A business-to-business (B2B) technology businesses. This aims to gives a better valuation on entry, which in turn should lead to a better opportunity to deliver returns for shareholders.
There is a larger proportion of high-growth companies with a B2B model than those with business-to-consumer models, and there are typically more exits by B2B companies, accounting for 77% of all exits in 2019. The strategy’s approach aims to mitigate the risk of investing early in B2B companies by selecting those that are actively solving corporate challenges. This ‘challenge-led strategy’ involves investing in B2B technology companies that have established backing for their product or service.
Essential tax relief
As we transition out of the pandemic, VCTs can offer further benefits to investors. Aside from providing them with the opportunity to back innovation, VCTs also remain one of the few tax-efficient investment solutions –especially useful given the news the government is adding a 1.25% tax on dividends and National Insurance contributions.
VCTs provide the ability to claim upfront income tax relief worth 30% of the amount invested, up to an investment of £200,000, and earn tax-free dividends and capital gains. With 72% of VCT investors already citing tax relief as the principal reason for their investment, this could become an even more crucial benefit as we face tax hikes and further financial uncertainty.
With significant economic instability still ahead, the businesses that thrive in these challenging times will be those that adapt and prioritise innovation. And investors seeking to back innovation must prioritise the right investment strategy that takes into consideration the risks associated with investment in smaller companies. In this environment, investors seeking to take advantage of the appetite for entrepreneurship while mitigating the effects of inevitable tax hikes can find an opportunity in VCTs.
Jack Rose is strategic sales director at Triple Point
