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Now VCTs are five

As the first three venture capital trusts from Murray, Northern and Baronsmead celebrate their fifth birthday in the next two months, the place of the VCT in investment planning is coming under the spotlight.

Most original investors have not wanted to sell until at least this anniversary so they can retain the 20 per cent income tax relief on their original subscription. On April 6, 2000, the minimum holding period was reduced to three years. As a result, some shareholders will want to sell their shares for personal or tax planning reasons.

However, the evidence from a questionnaire sent to Baronsmead VCT shareholders in September 1999 suggests that only about 7 per cent of investors will wantto sell their holding and this could well be accommodated within the 15 per cent buyback policy of the VCT itself.

This suggests that the initial supply of listed VCT shares may be limited. But as more VCT shareholders pass their minimum holding period, the supply will inevitably increase. For those watching the development of the market in listed VCT shares, the key questions are:

l What do venture capital trusts have to offer to buyers oflisted shares?

l What are the tax advantages?

l What should you look for when assessing a VCT?

The investment case for buying listed VCT shares

The investment case for buying VCTs is as follows:

VCTs are similar to investment trusts in the way that shareholders benefit from the underlying portfolio of investments.

A venture capital portfolio differs from a quoted investment trust in that performance tends to follow a J-curve shape. Small losses or flat net asset value growth leads to a sharp upswing as the early successes start to balance out and overtake any failures.

It is the ability to generate realised capital prof-its that then enables the VCT to pay out tax-freecapital distributions. The buyer of listed VCT shares therefore has a key advantage over the original subscribers in being able to see if the VCT fund managers have achieved the growth in NAV and the payment of dividends.

Purchasers can examine the VCT portfolio from its twice-yearly statutory accounts. VCTs are fully listed companies in their own right and adhere to the reporting standards of the London Stock Exchange.

Typically, in a portfolio there will be several stars, many solid performers and a few that do not progress. It is important to examine the portfolio to determine its potential investment performance and to distinguish between fund managers.

So what exactly is the tax planning case for buying secondhand VCT shares? Purchasers of listed shares may not claim the two VCT subscription reliefs of income tax reclaim and deferral of capital gains tax (CGT) liability. However, they do not have to pay income tax on dividends and there is no CGT on the increase in value of the VCT shares on subsequent sale. These tax reliefs are available regardless of how long the VCT shares are held.

Investments in listed VCT shares are akin to Peps, Isas and personal pension plans in that they are investments in a tax-free zone. In fact, the VCT shares are more flexible than a personal pension plan as the whole shareholding can be sold without restriction. In addition, whether subscribing or buying, investors will get the favourable VCT tax reliefs on investments of up to £100,000 in any one tax year, compared with the maximum previously of £9,000 for Peps and £7,000currently for Isas.

A VCT that has been established for five years or more will have an established portfolio that can spin off regular dividends and capital distributions.

If the VCT shareholder does not want this return cashflow, most VCTs have a dividend reinvestment scheme. Shares issued via a dividend reinvestment scheme are deemed as being subscribed for and can attract VCT tax reliefs that relate to new subscriptions.

The timing for buying listed shares is also more flexible than subscribing as these trusts can only offer new shares under prescribed Stock Exchange rules and typically will only be available for a limited period. Purchases can be made at any timeof the year.

Who then are the most likely buyers of secondhand VCT shares? To date, a number of transactions have taken place where the VCT in question has no buyback facility and there has been a significant discount between the net asset value and share price. Seasoned private investors have realised that the subsequent closing of the discount gap presents a sound investment opportunity.

Some IFAs forecast that longer-term purchasers will emerge who will understand the benefit of having high levels of dividend payments coupled with capital growth, all within a tax-free environment. Such a buyer would be free to realise their investment at any time, which would not be the case with a pension contribution.

Listed VCT shares might also be attractive to investors who have no capital gains tax liability to defer or who have used up any capital gains made on VCT subscriptions but not invested up to £100,000 of VCT shares once the purchase is made.

Key questionsto ask when purchasing listed venture capital trust shares

l What is the investment strategy of the VCT?

l Which companies will the VCT be investing in – will it be old/new economy, start-ups/early stage/expansion/management buyouts/management buy-ins?

l What net asset value growth has the VCT experienced?

l What is the level of disclosure about the portfolio?

l What is the track record of the trust on investments/realisations/reinvestment?

l What capital distributions have been made out of realisations by the trust?

l Is there a dividend reinvestment scheme?

l What is the buyback policy for the VCT?

Michael ProbinVCT investor relationsmanager, Friends Ivory & Sime Private Equity


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