Buy, sell or hold? Optimist, pessimist or realist? The coronavirus pandemic has certainly lit up the ‘re-set’ button. Sifting through existing venture capital trust (VCT) holdings and assessing the impact on future prospects for the SME economy is where most VCT investors are right now.
The natural default to opt for longer-standing VCTs with decent dividend records has traditionally been a well-trodden path, but the dynamics may be shifting. There is rather more for VCT investors to contemplate this year and good reason to check the compass again.
The full impact of Covid-19 on many businesses, however, may not yet be fully known. For investors, making sense of the true value of their investments is difficult as things are changing so quickly. While AIM-quoted investments are likely to speak for themselves through public information and daily share prices, it is a different picture when assessing the value of private company investment holdings.
VCTs are themselves quoted vehicles and their PLC boards will be accountable for published valuations that are validated by auditors. The International Private Equity and Venture Capital Valuation (IPEV) guides best practice in terms of valuing private companies, but investors would gain far more from knowing that PLC boards are holding their managers to account, even to the extent of challenging existing valuation methodologies.
Critical information
In these extraordinary times, the accuracy of carrying values is critical information for investors. The truth is that these valuations must be under constant review and, however unpalatable, if an impairment is needed that triggers the announcement of a net asset value (NAV) reduction then so be it. Otherwise, the risk is that investors are allotted or buying in at false value. Spending a little time digesting recent VCT announcements and updates is worthwhile.
A common question is ‘How do VCTs decide on their distribution policies?’. In the context of the current economic landscape, the answer will provide a number of clues that can help investors make their investment decisions.
Essentially, though, it boils down to two things – the availability of distributable reserves and how much cash is held. Both will be directly influenced by portfolio gains and losses. Considering the above comments, it is easy to see that, if losses are not accurately provided for, then the level of reserves available from which to make these distributions will be impacted.
The question of cash has different connotations. If cash is tight, then distributions are inherently unlikely. If there is cash held on account, investors have another issue to factor into their assessment. Longstanding VCTs are likely to contain portfolios of investee companies that have suffered during the pandemic.
Those that have taken on debt or made use of government support will have to deal with this liability at some future point. Against this backdrop, the ability for large VCTs to generate the scale of profits required to support previous distribution levels is questionable.
Conundrum for VCTs
The conundrum for VCTs going forward may be a decision either to use cash on account to maintain distributions or to support existing investee companies financially. Furthermore, if these companies are not financially supported, there may be a host of portfolio failures around the corner, which in any event will adversely impact NAVs.
The trade-off here is whether investors would be better served with a modest distribution per share – which might at VCT level amount to several million pounds – or see the cash retained to try and ensure there is sufficient firepower available to protect existing investments.
There is, however, another side to this coin. While existing VCT portfolios are dealing with the impact of the pandemic on their investees, the newer and more agile VCTs will be raising funds through this year’s open offers.
These newer VCTs will be taking advantage of the opportunities that exist, fully informed of the post-Covid economics, and unfettered by historic legacy positions. There is a now a good deal more visibility on the likely winners and the probable losers than there was a few short months ago.
Investment decisions will not necessarily be easier, but making them now with the knowledge of how businesses have performed throughout the pandemic and with learnings predicting how resilient they might be going forward, is a significant advantage.
Those investors who are prepared to look carefully through the open offers this year and ask the relevant questions are most likely to benefit from the post-pandemic recovery. These are far from usual times and a different approach to normal is well worth considering.
John Davies is investment director at Seneca Partners and manager of the Seneca Growth Capital VCT
