Venture capital trusts are the latest product to appear on the FSA’s radar amid concerns that they may be attracting interest from clients who do not fully understand the risks.The temporary increase in income tax relief to 40 per cent from 20 per cent has led to a surge of interest in the sector. Alongside a wave of C share issues and top-ups to existing VCTs, a number of new providers have arrived on the scene. Not only has the tax enhance- ment led to greater competition, bringing down minimum investment levels to within easy reach of the mass market, it is also the driving force behind the dual VCT structure used by several providers. Under the dual structure, two identical VCTs are introduced by a provider and managed as mirrors of each other. Shore Capital, Keydata, Core Growth Capital and Downing Corporate Finance are using this structure as none of these providers has an existing stable of VCTs to make co-investment possible. co-investment is the main reason cited by providers for adopting the dual VCT structure as it circumvents the VCT rules which state that a maximum of 1m can be invested in any one company. If a provider wants to invest more than this, it must invest 1m in one tax year and the rest during subsequent tax years. Using a dual structure, up to 2m can be invested within one company in the same tax year, which may be more cost-effective than making a large number of smaller investments. Downing Corporate Finance is no stranger to the VCT market although mainly as a promoter of other providers’ VCTs. It used a dual structure for the Downing protected VCTs II and III, which focus on asset-backed companies to minimise risk. Marketing director Matthew Brown explains: “Bigger investments mean you are mak- ing fewer deals, so you need less money for due diligence. If the provider already has a stable of existing VCTs, they would not need to use the dual structure. But if it is your first offering, you are Billy No Mates and you have nothing to co-invest with.” One potential problem with the dual structure is that it may be difficult to raise enough money to finance two VCTs at once in a competitive market. Six VCTs were withdrawn in 2004/05 because they did not meet the minimum subscription. According to the Allenbridge’s Tax Shelter Report, a total of 506m was raised for VCTs during 2004/05 – less than half the 1.023bn target. Smith & Williamson head of tax-efficient solutions Martin Sherwood points out that dual structures often need a higher minimum to proceed because the money is divided between two vehicles. However, Brown says failing to raise enough money for two VCTs was never going to be a problem for Downing. “We capitalised the shares of Downing protected II while we had Downing protected III sitting on the shelf. We only took it out of its box and unwrapped the cellophane when we had got the minimum for Downing protected II to proceed. If we had raised less than we did, we would have left Downing protected III in its box,” he says. Brown admits that some investors do not understand the dual structure. He says: “We have had people ringing up saying they are invested in Downing protected II but they wanted to be invested in Downing protected III. We have to explain to them that it really does not matter which one they are invested in because they are mirrors but explaining is part of our job.” If the dual VCT structure seems complicated to investors, it can also bring complications for providers. Keydata’s income VCT I and II invest in renewable energy sources, including wind power. The ability to invest up to 2m in a single company through a dual structure is useful because wind turbines cost around 2m to buy. The company also believes that the financing flexibility of the dual structure benefits investors because the returns can be greater. However, Keydata decided against the route favoured by Downing. It prefers a structure which splits the subscriptions raised equally between the VCTs at outset. Sales director Mark Owen says: “If you have two VCTs running in parallel but get the minimum to finance the first before financing the second, you end up with different shareholders and two very different sets of accounts. If you want to run them as mirrors, is it possible to ensure everything is the same? We looked into this way of doing it but decided it was too complicated.” Owen says Keydata’s investors had no problems in understanding that one investment opportunity is split between two investment vehicles. He says: “VCTs have always been a sensible product, they just got caught up in the vagaries of the stockmarket. We are now seeing mainstream groups with quality offerings such as Artemis, Framlington and First State. “From an investor’s perspective – although not the FSA’s – you can have a good spread of VCTs and some are starting to come down the risk scale. The way we structured the income VCTs was for a long-term income stream and we were not saying it was going to shoot the lights out.”
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