What are Venture Capital Trusts?

Since their creation in 1995, Venture Capital Trusts have encouraged investment into UK small businesses with the potential for high growth.

As a result, they provide a valuable source of equity funding for small businesses looking to grow, with businesses securing £11 billion since the scheme’s inception.

But what exactly are Venture Capital Trusts, or VCTs for short?

How do they raise their money to invest, what kind of businesses do they invest in, and what are the benefits and drawbacks of seeking funding from them?

In this article we provide an overview of what VCTs are, how they work, and the various advantages and disadvantages of using them to fund your business.

As with all things to do with business finance, it’s a good idea to seek independent, specialist advice to determine if a particular course of action is suitable for you and your business.

What is a Venture Capital Trust?

A Venture Capital Trust (VCT) is a tax-based scheme first introduced in 1995 and is designed to support young businesses with high growth potential.

VCTs are one of three Venture Capital Schemes, alongside the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS).

A VCT is essentially a corporation whose stocks are available for trading on the London Stock Exchange (LSE) and typically provide financing to small, early-stage companies with high growth potential. 

These are typically businesses that are not yet ready for an initial public offering (IPO) or find securing debt finance more difficult due to their limited trading history or the amount of funding they require.

Like other early-stage equity funding (such as Angel investors), VCTs also represent a source of guidance and expertise to companies they invest in, further improving their chances of long-term growth and success.

One of the key differences between VCTs and other equity funding, such as Angel investing, is that individuals invest indirectly via the VCT, rather than directly with the company looking for investment.

To maximise the use of their market expertise, some VCTs focus on distinct sectors or industries, like nursery schools or green energy initiatives whilst others focus on investing in Alternative Investment Market (AIM)-listed companies.

How do Venture Capital Trusts work?

A Venture Capital Trust operates in a manner similar to a traditional investment trust, one of the oldest forms of collective investing. 

As a publicly listed company, a VCT gathers funds from investors and invests in qualifying companies, which are often privately owned. 

When an investor places funds with a VCT, they own shares in the trust itself, rather than directly in the companies it invests in. 

Upon the VCT investing in a business, the investor receives a share certificate representing their investment in the VCT. 

As a company listed on the London Stock Exchange (LSE), a VCT needs to conform to the rules of the LSE and:

• publish its reports and accounts annually
• ensure the interests of its stakeholders are represented by an independent board of directors
• hold an Annual General Meeting (AGM) and other general meetings for shareholders
• meet established corporate governance requirements in the same way as other public companies.

What are the different types of Venture Capital Trust?

A key aspect of VCTs is their diverse investment objectives, which can significantly influence their performance and suitability as a potential investor for a smaller business.

Understanding the investment strategy of a VCT is crucial because it determines the types of companies the trust will invest in. 

For example, some VCTs target early-stage companies that have yet to achieve profitability. 

These investments often come with higher risk to investors but also the potential for substantial returns if the companies succeed. 

Conversely, other VCTs may focus on more established businesses that exhibit a degree of maturity and stability.

Broadly, VCTs fall into three categories:

Generalist VCTs

Generalist VCTs represent a significant portion of the VCT market and adopt a broad investment approach by allocating funds across a variety of industries and sectors. 

The primary objective of generalist VCTs is to build a diversified portfolio, which helps in spreading risk and potentially enhancing returns for its shareholders.

By investing in companies from different sectors, generalist VCTs aim to mitigate the impact of poor performance in any single industry. 

This diversification can provide investors with a more balanced exposure to different economic cycles and trends. 

For instance, if one sector faces challenges, the performance of companies in other thriving sectors can help offset potential losses, thereby stabilising the overall portfolio performance.

AIM VCTs

This type of VCT limits its investments exclusively into smaller businesses that feature on the Alternative Investment Market (AIM).

AIM serves as the junior market for the LSE, specifically designed to facilitate the growth and development of smaller UK companies. 

Established in the same year as VCTs, AIM shares a similar mission of supporting emerging businesses with access to capital and investment opportunities.

AIM-listed companies are distinct from other VCT-qualifying businesses due to their listing on a public exchange, which provides them with a daily market price. 

This public listing requires them to adhere to specific regulatory standards to maintain their status on AIM, ensuring a level of transparency and accountability. 

These regulatory requirements are beneficial for investors, as they provide a degree of protection and oversight.

Learn more about the Alternative Investment Market with our guide.

Specialist VCTs

The last group of VCTs focus on just one or two sectors, such as healthcare or sustainability.

These VCTs seek an edge over the market by applying their in-depth specialist knowledge of their chosen industry to identify businesses with the potential to scale and sustain high growth.

Which businesses are eligible for Venture Capital Trust investment?

The rules governing which companies are eligible for Venture Capital Trust funding are established by HM Treasury to ensure that VCTs align with the government's policy objectives. 

These regulations are crucial in directing investment towards companies that are most in need of financial support to expand and develop. 

By setting specific criteria, such as company size, growth stage, and industry, HM Treasury aims to prioritise funding for smaller, early-stage businesses that might otherwise struggle to access capital.

These criteria include:

Eligible business activities

To access VCT funds, a company is required to establish a permanent presence within the UK while engaging in activities classified as ‘qualifying trades’ by HM Revenue & Customs. 

This framework offers financial support to a broad spectrum of business operations, though certain sectors are excluded from this initiative as they are deemed sufficiently capable of self-funding by HM Treasury.

Notable examples of these exclusions include financial services like banking or insurance, farming, shipbuilding, and producing coal. 

Business size

To qualify for VCT investment, a company must meet specific criteria related to its financial assets and workforce size. 

At the time of the investment, the company's gross assets should not exceed £15 million or £16 million immediately after investment. 

The company must also employ fewer than 250 people full-time when the investment is made.

Investment amount

A business can only receive up to a maximum of £5 million of VCT or other tax-efficient funding within a rolling twelve-month period.

There is also a lifetime cap of £12 million for each business.

It’s also worth noting that a VCT can only invest up to 15% of its funds into any one company.

Company age

VCTs can only make first investments into smaller businesses aged seven years or younger from the date of first commercial sale.

There are, however, exceptions for so called ‘follow-on’ investments where an established business, already in receipt of funding from a VCT, is looking to secure additional funding to bring a new product to market or to expand into a new market entirely.

Knowledge-intensive companies

Knowledge-intensive companies have a larger proportion of highly skilled employees or meet particular innovation requirements.

These knowledge-intensive companies can benefit from relaxed rules around funding, allowing them to still be eligible for VCT funding if they have 500 employees or fewer (rather than the normal 250 figure) and have a lifetime investment cap of £20 million rather than £12 million in most other cases.

These companies can also take up to twelve years in which to receive their initial VCT funding.

Venture Capital Trust tax relief

VCTs can be attractive to investors due to the generous tax relief they attract.

This includes:

• Income tax relief – shareholders aged 18 or over are eligible to claim 30% Income Tax relief on up to £200,000 annual investment. This is so long as the shares they own are held for at least five years
• Dividends – dividends from ordinary shares in VCTs do not require Income Tax to be paid on them
• Capital Gains Tax – when an individual disposes of ordinary shares in VCTs, they do not need to pay any Capital Gains Tax.

Venture Capital Trust advantages

As with all types of finance, Venture Capital Trusts have particular advantages including:

Proven way to secure a large amount of funding

VCTs are designed to benefit smaller businesses looking to scale and grow who may have difficulty attracting the funding they need in other ways such as debt finance.

It is not uncommon for VCTs to make investments of millions of pounds into a smaller business to help it scale.

Experience and expertise

Investment from a VCT also brings with it a plethora of experience and expertise from the investors themselves.

Since their returns are dependent on the success of your business, they are usually more than willing to share their experience and their contacts to help your business grow.

Innovation-friendly.

Thanks to the expanded rules for knowledge-intensive businesses, a VCT can be an attractive proposition for innovative businesses with the potential for high growth.

Long-term investment

To benefit from the tax relief given to VCTs, investors need to hold their shares for at least five years, therefore business owners can worry less about investor exits in the short and medium term.

Venture Capital Trust disadvantages

Like all types of finance, VCTs also come with potential drawbacks including:

Loss of control

As with all equity products, selling a stake in your business to a VCT isn’t a guarantee of growth but it does mean giving up a part of your business which could mean diminished control.

Lack of diversity

Some VCTs tend to only invest in particular sectors or growth stages of a business, so are unlikely to invest in a business if they don’t fit into the particular niche the VCT specialises in.

Investment limits

Since VCTs are only allowed to invest a maximum of 15% of their funds into any one business, smaller businesses seeking substantial follow-on funding may need to look to other investors which could further impact the businesses cap table.

What other forms of equity investment are available to businesses?

In addition to VCTs and Venture Capital, there are a number of other forms of equity investment available depending on the type of business you operate and the stage of development your business is currently in.

These include:

• Angel investment
• Equity crowdfunding
• Mezzanine finance
• Convertible loan notes
• Initial Public Offering
• Private equity
• Expansion capital.

For more information on what equity finance could be available at each stage of a business’s development, read our guide.