Is it worthwhile to invest in venture-capital trusts?

With the tax breaks, investing in early-stage companies is a risky but potentially lucrative venture

Trusts for venture capital are one entry point. Do they, however, justify the risk?

The UK market has recently had trouble attracting new issues, so Beauty Tech Group's initial listing on the stock exchange earlier this month was a welcome boost. Venture-capital trusts (VCTs) also benefited greatly from the £300 million listing. Three VCTs managed by Mercia Fund Management were among the first to see Beauty Tech's potential and invested in the business in 2018 when it was still losing money and had yearly sales of less than £1 million. Like Virgin Wines, Gousto, and Zoopla, Beauty Tech is another VCT success story.

The then-chancellor, Ken Clarke, established VCTs 30 years ago this year with the goal of promoting investment in British companies in their early stages. In his opinion, investors should be encouraged to put their money into these fledgling businesses because there is a very real chance that they will fail. In order to offset the increased risk and provide some downside protection in the event of losses, he enacted legislation allowing the creation of VCT collective funds, which construct portfolios of such businesses while also offering a number of substantial tax breaks. Over the years, different chancellors have made changes to the reliefs, but the fundamental idea has remained the same. These days, investors who purchase new VCT shares receive a 30% upfront income tax refund, making an investment of £10,000, for example, only 7,000. They also receive tax-free dividends and are exempt from paying capital gains tax on their profits. Furthermore, you are permitted to invest up to £200,000 annually in VCT shares, which is significantly more than you are permitted to do in other tax-efficient vehicles like individual savings accounts (ISAs) and private pensions.

"New VCT shares" is a crucial phrase. The only subscriptions for new shares that qualify for the 30% income-tax break are for shares of VCTs, which are listed on the stock market and offer helpful liquidity for investors who need to sell. Investors must also keep their shares for at least five years or risk being asked to repay the relief. In actuality, this means that VCT managers issue new shares every tax year through the introduction of new funds or through further fund-raisings for already-existing vehicles. About 20 VCTs have issued new shares this tax year or indicated that fund-raisings are about to happen, and Alex Davies, the creator of the investing platform Wealth Club, believes this is only the beginning. According to Davies, "the VCT season has only just begun with the launch of the big name VCTs, such as Northern and British Smaller Companies." In their first few days of operation, these VCTs raised 12 million and 18 million, respectively, suggesting that demand is strong thus far. There should be a robust demand for VCTs this year due to the initial public offering (IPO) markets showing signs of life, which should be favorable for VCT exits, and the likelihood of additional tax increases in the budget.

One important example is the budget reference. In a climate where other tax-advantageous savings plans have been squeezed, VCTs have drawn the interest of investors in recent years. For instance, the sector seems to have benefited from lower private-pension contribution allowances for wealthier savers. Interest in VCTs is also being sparked by the decision to make unused pension assets subject to inheritance tax; while they don't itself provide inheritance-tax advantages, the funds have fewer withdrawal restrictions than pension products, making them helpful for financial planning. As a result, demand has surged. The 2024 - 2025 tax year was the third-best year for VCT fundraising, despite a challenging economic environment, according to Annabel Brodie-Smith, the Association of Investment Companies' director of communications. It is not surprising that VCTs continue to be a popular investment for people looking to support expanding UK businesses while lowering their tax obligations in the current climate, which is dominated by headlines about the need to raise taxes.

Are you a good fit for VCTs?

The sector raised 1.13 billion in 2021 - 2022, and 1.08 billion in 2022 - 2023, respectively, far exceeding last year's 845 million VCT fund-raising total. The scale of the figure, however, indicates broad support for the industry, according to Chris Lewis, chair of the VCT Association. More than ever, we observe that investors, entrepreneurs, and legislators share the same belief that high-growth, high-potential companies supported by VCTs must be supported. Given the rumors that the budget for next month will include additional tax increases, it is obvious that this year's VCT managers see an opportunity. Some are even giving early birds a discount on their fees. Although it is true that the most well-liked VCTs tend to sell out rather quickly, funds restrict the amount they raise to prevent managers from having to scramble to find enough appealing small businesses to invest in. Advisors advise investors to exercise caution. Not all people can use VCTs. In general, they are more appropriate for people who have already effectively utilized private pension and ISA benefits, and you will need to be at ease with risk and volatility.

You still have a question mark even if you're comfortable taking risks. The average fund has returned 53% of its total share price over the last ten years. Although the upfront tax relief increases the return's effective value, it's important to consider the bigger picture. Over the same period, the average investment trust that invested in UK-listed companies increased by 112%, while the average investment trust that had exposure to global shares saw a return of 280 percent. It's crucial to pick the correct car. While shareholders in the worst-performing VCT lost nearly 80% of their money during those ten years, those in the best-performing VCT saw total share-price returns of 168%.

Income, not capital gains, is the primary concern of many VCT managers. Managers frequently arrange their funds so that dividends can be paid from the proceeds of successful exits from portfolio companies, and the average VCT yield is 6 percent. Because that 6 percent is tax-free, the yield appears even more alluring in light of the current low interest rates. Ben Yearsley, director of adviser Fairview Investing, is concerned that VCTs might have fallen prey to their own success, though. He issues the warning, "Too much money has been raised in the past few years and it is chasing too few high-quality companies." "I believe that instead of the 78% returns that were previously observed, investors will need to adjust to returns of about 5% annually. Without the tax breaks, the answer would undoubtedly be no, but you will have to decide for yourself if this is worth the risk.

According to Yearsley, recent changes to the regulations have increased the risks and difficulties associated with managing VCTs. Most notably, the funds are now not permitted to invest in companies that have been in operation for longer than seven years, which restricts them to startups that are still in their infancy. This is on top of limitations like the requirement that investee companies have fewer than 250 employees and a net worth of less than £15 million. Eighty percent of the money raised by VCTs must be invested in eligible assets within three years.

"I remain unconvinced that VCT managers have made a complete transition to the new, more stringent regulations that limit investment to younger, high-growth firms," Yearsley continues. Brodie-Smith has a more upbeat outlook. She contends, "In a difficult environment, VCTs are assisting in the launch of ambitious businesses, many of which will contribute to the expansion of the UK economy."

Alternatives for VCT.

Additionally, it's important to note that VCTs vary widely in size and shape, and each one has a unique risk profile. Generalist VCTs make up the largest portion of the market by investing in privately held qualifying businesses across a variety of industries, offering some diversification advantages. There are also specialized VCTs that concentrate on a single market segment, such as technology or healthcare, and are thus more susceptible to the success of a small number of companies. Aim VCTs invest in shares issued by junior market companies in the third category. Despite being publicly traded companies rather than privately held enterprises, some Aim constituents are still eligible for VCT investments due to their size and longevity. Compared to other VCTs, these Aim VCTs have generally performed worse, delivering only 20% over the previous ten years with significantly less variability.

These variations on the theme at least give investors a lot of choices and the opportunity to gradually accumulate a portfolio of VCTs. Starting with a foundation of generalist VCTs and introducing more specialized vehicles later is a smart idea. The first step should be to do a lot of research or speak with an independent financial advisor who specializes in this field. It could be tempting to make a snap decision out of concern that the chancellor or other investors will take advantage of you as budget rumors persist and some VCTs begin to fill up. However, don't part with your money until you can present an investment case that makes sense given your current portfolio, your financial objectives, and your risk tolerance. Tax incentives by themselves are insufficient justification for adopting VCTs.

Now, let's look at three VCTs.

Selecting the appropriate vehicle from the 20 or so funds raising capital is crucial for investors prepared to enter the VCT market. We requested that Wealth Club member Alex Davies select his preferred funds for 2025 - 2026. These are his top three selections.

Northern VCTs: "These seasoned VCTs target more established businesses with room to grow, and Mercia is raising funds for Northern Venture Trust, Northern 2 VCT, and Northern 3 VCT." Mercias specializes in regional companies in the healthcare and technology sectors; over half of its portfolio is located outside of London and the southeast. Mercia continues to have success in this area. The most recent example is Beauty Tech Group, a beauty technology company that went public at the beginning of October with a valuation of £300 million.

British Smaller Companies VCTs: "Business-services companies are the target of the British Smaller Companies VCTs, British Smaller Companies VCT, and British Smaller Companies VCT 2a fairly big pond to fish in." Among the cracking companies in the current catch are digital special effects studio Outpost VFX, which has worked on Rings of Power and Captain America, and financial adviser review platform Unbiased, which is growing quickly in the US.

Unlike many VCTs, Triple Point Venture VCT seeks to invest early in a company's life. Because there is less competition now, valuations are lower and returns could be higher. Additionally, it carries a higher risk, but the VCT reduces that by placing numerous smaller wagers before doubling down on the winners. With a manager who is beginning to establish a strong track record, we believe this VCT offers investors a unique, well-considered approach.