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Nothing ventured…

Since venture capital trusts were launched in autumn 1995, they have proved to be a success. By the end of 2000, a total of £1.1bn had been raised by around 50 VCTs.

Estimates for last year show that about one in eight new companies backed by venture capital has a VCT as a corporate shareholder.

VCTs have become mainstream investors in companies with less than £15m gross assets. These companies are often said to be one of the key engines of the UK economy as they create more jobs, grow faster and innovate more effectively than businesses not backed by venture capital.

Yet it was only last winter that demand from private investors began to outstrip the supply of shares issued by VCTs.

New VCT shares attract 20 per cent income tax reclaim and deferral of up to 40 per cent capital gains tax, as well as three other tax reliefs available to qualifying VCT shareholders.

Their increasing popularity is due not only to individuals having greater capital gains to shelter but also to the realisation that VCTs are a good investment. They provide investors with easier access to a selected portfolio of faster-grow-ing unquoted and Alternative Investment Market companies than it would be possible to build up in any other way.

The selectivity is not to be underestimated as typical VCT managers will only invest in a ratio of about two to every 100 proposals that they see.

The venture capital community has played its part in fuelling the growth of VCTs by communicating more effectively with existing and prospective shareholders together with their advisers.

While most VCTs are classed as generalist, focusing on more established unquoted growth companies, the choice now extends to VCTs specialising in technology or Aim companies. The three Baronsmead VCT investee companies highlighted (right and below) illustrate the different types and stages of growth of qualifying companies.

The task of each VCT manager is to build a portfolio of qualifying investments within their stated investment policy and subsequently manage both the risk and return through to the realisation of each investment. The eventual sale of investments will come from flotation or trade sales for the unquoteds or from market sales in the case of Aimor fully listed shares.

Net realised capital profits have already occurred in a number of the earlier VCTs. These profits can be paid out to VCT shareholders by way of tax-free distributions and, in many cases, have provided an unexpected pleasant surprise to recipient shareholders.

There will be a wide choice of VCTs into which shareholders can subscribe between now and the end of the present tax year. Although much of the choice will depend on the IFA&#39s assessment of their client&#39s tolerance for risk, most private investors will want good diversity.

Some key criteria to look out for when making the selection process include:

Investment objectives and policy

The objectives will be a formal statement of how the VCT will generate capital growth for investors and pay out dividends/distribution. The policy will describe both the types of target investee companies and the portfolio mix to give a better understanding of diversity.

Track record of the fund manager

This is the most tangible way in which to form clear judgements, including performance of managing other VCTs in terms of asset growth, dividends paid and share price growth, ability to select winners and sort out problem investments through to realisation, size, depth and experience of the venture capital team, management of compliance, investor relations and, generally, the reputation of the fund management company.

Investment process including deal flow

This may be evident from an analysis of the track record but deal flow – or how a transaction is originated – is important. The more deals a VCT can see, the easier it is for the managers to be selective about their choice.

VCTs can use co-investment, often with other non-VCT funds, so that any tax reliefs are not used to overpay, as a way to back bigger transactions/companies than the present annual investment limit of £1m per company allowed for each VCT.

Investor relations

Evidence to date is that VCT shareholders, once invested, wish to keep their capital in a tax-free environment for the longer term. How does the VCT intend to build good long-term relationships through communication and regular contact?

What helpline facilities are available to answer queries from shareholders or give advice to IFAs?

Although VCTs are growing in popularity and there is a gathering band of IFAs who now include VCTs in their mainstream activities, the number of VCT investors can be measured at much less than 50,000. Generally, however, shareholder experiences have exceeded initial expectations.

From the Government&#39s viewpoint, VCTs are seen to be working by stimulating the way investee companies strive for above-average economic growth.

But the next three months will show whether the VCT is becoming less of a secret and more of a must have for successful private investors reinvesting their capital gains.

FAT FACE

Fat Face is a multi-channel retailer which has shown strong profitable growth since its first shop and direct-mail catalogue were launched in 1993. It supplies active outdoor wear for aprés ski, sailing and other sports.

The firm raised capital from two VCTs and another institutional venture capital in a shareholder restructuring and expansion in February last year.

Sales are continuing to grow at 30 per cent annually. Both gross and net profit margins have also been increased.

AORTECH

Aortech has a range of established and innovative heart valves and, more recently, has launched a range of cardiovascular measuring devices which have been recognised as having high potential.

This company first joined Aim in 1997 but only received its first round of VCT funding as part of a public placing in August 1999 when acquiring its range of measuring devices. The share price has since risen dramatically and stayed high.

Although the company is making a loss at this stage, it has a good portfolio of products, some of which are profitable while others are in their development phase.

CONCLUSIVE LOGIC

Conclusive logic produces integration software for greater e-business security. It raised second-round funding from three VCTs and other institutional funds in June 2000 to fuel the growth in the team and its entry into the US.

This remains an early stage company but it has the opportunity to dominate its market niche.

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