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Venture forth

The market for venture capital trust fund-raising has seen yet another record year.

In the season to April 5, 2001, nearly £400m has been raised from private investors compared with £270m for the 1999/2000 season and £160m for the season before that.

Press coverage has been broader than ever before, with the personal finance sections of most newspapers including VCTs as a core part of personal financial tax planning.

There are now a total of 61 separate VCTs in issue. Since the first launch in autumn 1995, a total of £1.3bn has been raised.

Not bad for a product that, at its conception six years ago, was seen by many critics as being a fringe, high-risk product suitable only for the very wealthy.

Even so, some of the record number of 20 new funds launched over the last six months have been unable to reach their minimum fund-raising levels and have consequently been cancelled.

The first among these was the independently managed Harvest VCT, whose issue was pulled in mid March. Many other VCTs have also failed to reach their maximum target.

Meanwhile, the stockmarket is showing a steady but remorseless decline and investor sentiment is subdued. Is this the first sign of the end of the holiday season for venture capital trusts?

The answer is a simple no. With their unique spread of tax breaks combined with the strong investment performance of many of the funds, VCTs are now a recognised ingredient of a private investor&#39s portfolio.

What we are seeing is the natural inclination of investors to shy away from risk. This perceived risk rises from two sources, neither of which, ironically, is necessarily linked to the natural risks involved in investing in smaller, unquoted companies.

First, investors have undoubtedly been affected by the depressing news from the stockmarket, even though the markets only have any direct relationship to Aim-related funds. Indeed, with valuations down substantially from their peak last year, now could be arguably a better time to invest.

Second, investors are tending to avoid the higher-risk investment profiles implicit in smaller, specialist funds of funds from managers with a less obvious track record.

Put quite simply, investors like to be able to point to a previous, clearly demonstrable record of success before parting with their money. It is interesting to note that, out of the 25 VCT managers, the top five managers account for 55 per cent of the market.

Having said all this, investing in small, often young, unquoted businesses is risky. These companies are of a size not to be able to afford the depth of management and financial expertise that you see in bigger businesses and are consequently considerably more fragile. A downturn in the general trading climate or even a temporary setback such as the loss of senior staff, or the delay in a contract, can provide a serious set back to the business.

That, however, is where the experience of the manager plays an essential role. Many of the top VCT managers have been through two or more recessions and they fully realise the importance of risk control in a way that would have seemed quite alien to many of the dotcom investors of last year.

Other than during the intoxicating atmosphere of the last stages of a bull market, private investors by and large seem to prefer steady, predicable growth in their investments, to the intense volatility and excitement of the high-technology funds. Despite the higher-risk nature of their underlying investments, VCTs can and do achieve this in a variety of ways.

First, the breadth of a VCT&#39s portfolio, with typically more than 20 different companies, plays a considerable role in balancing out the risk.

This portfolio effect is furthered by an investment spread across a variety of different sectors, some of which may be contra-cyclical.

Companies selling products and services into the health and education sectors, for instance, may find greater resilience in a slowdown than businesses involved in advertising or capital goods.

Other ways of lowering the risk include a conservative investment structure and a concentration on keeping external bank borrowings down to a low level. While this can reduce returns in the good times, a low-risk structure helps to preserve the key aim of providing a steady return to investors year in, year out.

The very fact that VCTs themselves are quoted helps to reduce the risk profile further. If an investor really needs the cash or simply feels nervous, he can sell his holding (always bearing in mind that he may forfeit some of his tax breaks in doing so).

Many VCT managers play an active role in supporting the market for their company&#39s shares by buying them in for cancellation.

This ensures that a seller will always find a buyer for his shares at a price which, if managed correctly, should be at a tighter discount to net asset value than is typically the case for investment trusts.

On top of this, risks are reduced further by the extensive tax breaks. They not only reduce the up-front cost of investment in a VCT but also provide considerable ongoing benefits.

Most investors now know of the 20 per cent income tax relief and 40 per cent capital gains tax deferral provisions for investments in new shares.

Less commented upon, however, are the additional tax breaks available to investors in both new and in secondhand shares bought in the market. These include tax-free growth, tax-free revenue dividends and tax-free dividends paid out of capital profits. The first two are identical to the tax breaks available to investors in Isas but instead of the £7,000 a year limit, you can invest up to £100,000 a year in a VCT.

These dividends are important, particularly for those who see their investment as a longer-term proposition, providing a steady income stream year on year.

Many VCT managers are treating their funds as a machine for realising and distributing capital profits on their underlying investments, which means investors can get their money back over a relatively short period of time while still retaining the benefit of their original investment.

Interestingly, the Treas-ury sees VCTs as self-financing, in that the up-front tax rebates to private investors are more than offset by the future corporation tax tak-ings from the underlying investee companies.

Certainly, the Labour Government has built on and enhanced the provisions created by the Conservatives in 1995. Indeed, overall, VCTs seem set to continue to form both an essential investment tool for the private investor while at the same time forming a key plank to the Government&#39s strategy for helping smaller businesses.


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