Venture Capital Trusts: Opportunity for investors and SMEs
Bill Nixon, Managing Partner at Maven Capital Partners writes that there has probably never been a better time to invest in VCTs.
With GDP rising again in the second quarter of 2021, this time by 4.8 per cent, the economic recovery is gathering pace and investor optimism remains strong. The type of high growth, early-stage businesses that VCTs back, many with disruptive business models and pioneering products and services, should do well against such a backdrop. Certainly, the robust post-pandemic performance of the UK’s biotech and life sciences sectors supports the notion that early-stage companies born of economic crises can be among the best businesses to back.
VCTs remain one of the most attractive ways investors can gain exposure to well researched, actively managed and diversified portfolios of early-stage companies. In addition to the 30 per cent income tax relief available on investment in new VCT shares, dividend tax hikes announced earlier this month will likely drive further demand for VCTs as dividends paid to VCT shareholders are also tax-free, and shareholders are also exempt from capital gains tax on selling their VCT shares.
Indeed, investors seem to appreciate the value that VCTs can add to a portfolio, with VCTs raising GBP685 million in the 2020-21 tax year, up 11 per cent on 2019-20. This was the third highest amount raised in the past 10 years, despite the impact of Covid-19, and it maintains the trend of growing popularity for VCTs, underpinned by the sector’s 25-year track record of delivering robust, resilient, and tax-free returns.
VCTs can certainly deliver superior returns for investors compared to the UK main market, with the 20 largest VCTs making an average return of 8.4pc last year – that is 18 percentage points better off than the FTSE All Share. Moreover, according to the Association of Investment Companies (AIC), the last decade has seen the top 20 VCTs at least double investors’ money on a net asset value total return basis.
A 2015 rule change requiring VCTs to make any new private company investments in earlier stage businesses prompted experienced and well-resourced VCT managers to boost their investment capabilities in order to identify young companies with high potential. For the leading mangers, a winning combination of existing SME market knowledge and early stage company expertise has already translated into strong returns from these earlier stage portfolios. One of Maven’s most recent realisations, for instance, involved exiting a post 2015 investment in Edinburgh based Symphonic Software through a sale to an NYSE listed US tech firm, achieving a 2.9x money multiple return and 90 per cent IRR for investors less than two years after Maven’s investment.
A recent survey by the AIC found that VCTs displayed reassuring resilience in 2020 in the face of the challenges caused by Covid-19. Two thirds of managers reported that trading conditions for most of their investee companies had either improved or been unchanged.
Moreover, according to a study of the constituents of 10 randomly selected VCT portfolios, 45.7 per cent of invested assets are in companies which have grown revenues by an average exceeding 25 per cent year-on-year, while only 4.6 per cent of the invested assets of FTSE 350 companies achieved this. Similarly, whereas 23 per cent of VCT constituents have grown revenues by more than 50 per cent, just 2 per cent on the UK main market can claim to have done likewise.
Previous global economic crises also provide indicators that VCTs will play a key role in future recovery. VCT activity resurged remarkably quickly from the 2008 financial crisis, with a fall from GBP230m in 2007-08 to GBP150m in 2008-09 swiftly followed by a jump to GBP340m in the following financial year. Activity has since continued on a general upward trend right up to the GBP685m raised in 2020-21. This impressive track record bodes well both for VCTs and for those who invest in them.
Indeed, some of today’s highest profile GBP1bn+ companies grew out of the 2008 financial crisis and continue to grow thanks to the resilience of their innovative technologies, business models, and areas of expertise. However, also crucial to their success was the capital they received to facilitate growth from an early stage. Investors in this year’s fundraising could potentially be backing the next Uber, Airbnb, or Slack...
VCTs provide essential support for SMEs, which account for 61 per cent of employment and 52 per cent of turnover in the private sector. With more than 70 VCTs, the industry has raised more than GBP9bn of funding for SMEs, supporting approximately 1,000 companies, and creating 27,000+ jobs.
And VCT managers have been busy despite the wider economic impact of COVID-19, backing new businesses as well as protecting value in their VCT portfolios. Maven’s four VCTs, for example, have made 17 new private company investments since the beginning of the pandemic.
Identifying high potential businesses in regional markets is key to ensuring that the most effective funding reaches SMEs throughout the UK, according to a recent ScaleUp Institute and Innovate Finance report. Equally, regional investment opportunities can also often be sourced on more competitive terms than is available in the South East, providing the opportunity to generate superior return for investors.
However, not all VCT managers have the resources required to operate a regional investment model. A key differentiator for Maven is our national network of experienced investment teams, operating out of the key economic centres, where we manage multiple regional development funds, including parts of the Northern Powerhouse Investment Fund and the Midlands Engine Investment Fund on behalf of the British Business Bank.
Taking all of the above into account, it is clear that VCTs are a well-established and valuable part of the UK’s investment ecosystem. Not only do they deliver robust returns to investors, they provide vital support for early stage businesses and help to drive innovation while creating jobs and increasing exports.
Indeed, in the wake of the Budget, it appears that the Government appreciates the value that investment in SMEs can bring to the UK economy. The Chancellor reiterated his aim of enhancing the UK’s status as a global leader in innovation, and private capital will have a key role to play in helping the nation’s most innovative growth businesses to develop. VCTs are an ideal vehicle for this investment which will benefit the UK as a whole.