Should venture-capital trusts attract investors as well?

James Mackreides warns that investors may need to act fast if they want to purchase venture-capital trusts before the end of the tax year

Investors may have to act fast if they want to fund venture-capital trusts (VCTs) before the end of the tax year. Following changes announced in the Budget that will reduce tax relief on VCTs starting on April 6, 2026, a number of well-known funds seem to be in danger of selling out well before then.

The up-front income tax relief available on investments in new VCT shares will drop from 30% to 20% starting with the 2026 - 2027 tax year, according to a November announcement by chancellor Rachel Reeves. Although advisers say investors are scrambling to get the higher rate while it's still available, venture-capital trusts will continue to be generous, providing tax-free income and capital gains in addition to the upfront relief.

For instance, of the 90 million in VCT funding that Albion hopes to raise this year, 68 million has already been secured. Out of the target of 80 million, Northern has raised 64 million. With a target of 30 million, Baronsmead is at 22 million. Even though the tax year is still more than two months away, other funds have attained comparable funding levels.

Wealth Club CEO Alex Davies confirms, "We've seen 140m of VCT sales over the past three weeks compared to 79million in the same period last year." This has been done before. When a former chancellor cut income-tax relief from 40 percent to 30 percent in 2006, sales jumped ahead of the change before plummeting 65 percent in the subsequent fiscal year.

Since the government is eager to encourage investment in small, early-stage companies that frequently have difficulty raising capital, VCTs provide tax benefits. The funds diversify risk by building portfolios of these companies, but investors also benefit from tax breaks. According to a recent survey, 42% of VCT investors intended to withdraw their investments after the tax break in April.

Only new VCT shares are eligible for upfront income-tax relief, so the rush to invest in this year's new issues may pick up speed in the upcoming weeks. Importantly, VCT managers impose fundraising limits. Managers attempt to avoid having more money to invest than their probable flow of high-quality deals can justify because venture-capital trusts are required to invest 80% of their assets in qualifying companies within three years.

A number of funds have already declared "overallotment" allocations, in which they raise a bit more than they had anticipated. However, funds must be cautious not to raise too much for fear of having to invest in less appealing opportunities just to meet VCT regulations.

The VCT industry has criticized the budget announcement. As investors seek to maximize current tax relief, James Livingston, a partner at Foresight Group, cautions: "This year's VCT investment will likely be rushed, but the long-term impact is probably going to be less capital available for creative UK businesses.

However, the Budget also contained additional positive changes to the VCT system. The chancellor increased VCTs' permitted investment amounts in individual businesses from 10 million to 20 million, and in "knowledge-intensive" businesses, to up to 40 million. Additionally, she increased from 15 million to 30 million the maximum size of businesses that could receive VCT investment. According to Rupert West, fund manager of Puma VCT 13, "the investible universe expands and the quality of opportunities improves by allowing VCTs to back larger, later-stage rounds." "In order to give investors exposure to a more developed, better-diversified portfolio over time, we can support our winners for longer and be a more valuable partner to the most alluring scale-ups.

The portfolios of venture-capital trusts are maturing.

The changes may, at least in theory, allow VCTs to acquire larger shares in portfolio companies that have demonstrated their viability and potential for commercial success. This ought to lower the risk profile of VCT portfolios and support improved long-term financial results.

VCT managers, however, believe that any benefit from the more favorable adjustments will be outweighed by the bad press surrounding the tax deduction cut. According to Pembroke Investment Managers CEO Andrew Wolfson, "there is a very real risk of reduced cash inflows into the VCT sector." "VCTs react very strongly to incentives offered to investors.

The Gresham House VCTs, which are trying to raise up to 95 million, will be one of the most watched new issues. Having previously stated that it would not hold a fundraising event in 2025 - 2026, Gresham House has now made the offer, which opened this week. The funds, which were formerly known as the Mobeus VCTs, have shown popularity in prior years.

Investors will need to carefully select their funds in addition to making timely investments. The fact that so much money was raised this year will lead to a large pool of capital chasing a small number of investment opportunities. A VCT with a solid track record of gaining exposure to the top underlying companies should therefore be preferred.

Some outstanding companies have previously been found by VCTs. The clothing marketplace Depop, the food delivery service Gousto, and the real estate website Zoopla are well-known businesses that were established with the help of VCT funds. However, there have also been numerous failures due to the nature of investing in small businesses.

In actuality, VCTs' track record over the long run isn't very impressive. With both capital growth and dividends reinvested, the average fund has produced a return of 49% over the last ten years, according to data from the Association of Investment Companies. Over the same time period, the average investment company has generated a return of 206%. It serves as a reminder to exercise caution and refrain from purchasing VCTs merely to receive a tax benefit.