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Sense of venture

Venture capital trust fund-raisings have continued to fall from the heady sums achieved during the bumper years of 2003-06 and investors could be forgiven for thinking that these investment vehicles have had their day.

In 2005-06, VCT managers raised a record £750m as investors took advantage of the tax breaks involved but this year fund-raisings are unlikely to break the £250m mark as changes to VCT legislation seem to have taken the shine off the investment.

Launched in 1995 to increase the flow of capital into small and growing UK companies, VCTs now have more than £2bn under management. This has been achieved in no small part because of the attractive tax breaks offered. Despite the many Budget changes to VCT legislation, many of these tax breaks remain intact.

VCT investors still benefit from income tax relief, which at 30 per cent remains a significant attraction, tax-free dividends and exemption for capital gains made on the investment. No other vehicle can pay out capital gains by way of tax-free dividends.

There are other benefits to be reaped from VCT investing beyond the tax breaks. There are 107 VCTs in existence, with a wide range of investment remits.

Around 55 per cent of funds raised has gone into generalist VCTs which invest in qualifying companies on or off the public markets in any sector, with just under 30 per cent going into VCTs specific to the Alternative Investment Market. These give retail investors access to some of the best fund managers in the Aim-listed and venture capital markets.

However, the recent rule changes and investment restrictions are making things increasingly difficult for VCT managers. This is naturally having an impact on the number of managers raising new funds.

VCT funds could previously be invested in companies with gross assets up to £15m but from April 2006 that figure was halved to £7m.

The new rules stipulate that investee companies should have no more than 50 full-time employees at the date on which shares or securities are issued and must have raised no more than £2m in a 12-month period from VCTs, enterprise investment schemes and corporate venturing schemes.

On the surface, this seems like a drastic reduction in the universe from which VCT managers can select investment opportunities and many would assume that it makes VCT investments a far riskier play but this is not necessarily the case. All VCT money raised before the rules tightened can still be invested in companies complying with the old rules and can therefore maintain the same risk profile as before.

A balanced VCT portfolio will already have contained commitments to companies at either end of the available risk spectrum. In other words, an established VCT portfolio will be exposed to bigger and smaller company stocks and so the discerning manager will use any new funds raised this year to invest in smaller, higher-risk stocks alongside the existing money from previous fund-raisings which can make up the bigger, lower-risk element of the portfolio, ensuring the overall risk profile is unchanged.

What must remain to the fore when considering these investments is that the most significant benefits of VCTs, notably the ability to earn tax-free dividends with no CGT liability on the growth of the fund, remain intact.

A limited number of VCT managers will be raising money this year. Those who entered the market when raising VCT money was simply a case of putting up an “Open for business” sign will be notable by their absence.

Advisers and their clients must look closely at how managers raising funds today will be dealing with the new investment rules. Investors need to be confident that the managers they invest in are able to work within the new restrictions while maintaining the original risk profile of the fund. For those well advised and in a position to take a long-term view on smaller companies, VCTs are worthy of serious consideration.

Bruce McLaren is chief investment officer of Noble Fund Managers

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