They’re not for everyone. But, if you’ve already maxed out your pension and ISA allowances for this tax year, a Venture Capital Trust might be an option.

It’s that time again – almost the end of the tax year

April 6 is only a short distance away. These next few months are a critical time for ensuring you’re getting maximum value. Are your savings as tax efficient as they could be? Have you topped up your pension? Have you used your full ISA allowance (£20,000 for the current tax year)?

For those who can afford it and are comfortable with the risk involved – and looking for an additional avenue to reduce the tax burden on their investments – Venture Capital Trusts might be an option.

But I stress, they’re definitely not for everyone, so take advice before you dive in.

Understanding venture capital

Investors are increasingly looking outside the more traditional routes of publicly listed equities and bonds. More and more, they’re exploring private markets that carry more risk, but promise the potential for higher returns.

Venture capital involves investing in the early stages of a company’s lifecycle (see the chart below), when businesses need financing for new ideas, building their distribution networks, or growing their sales and marketing operations.

It can be an exciting area of opportunity, and many investors are attracted to the concept that their money is funding the future, including developing new technology, experimental drugs, or innovations that fight climate change.

There are many aspects to venture capital. In the very early stages, you have seed capital or angel investing looking for funding from a few sources in return for a minority stake in the business (the kinds of business you might see on Dragon’s Den).

Venture Capital Trusts, however, tend to focus a bit further along, targeting existing companies that have gone as far as they can on bank loans and are looking for additional funding rounds that will help expand their business and take it onto greater levels of growth.

How does a Venture Capital Trust work?

Venture Capital Trusts (VCTs) have been around for more than 25 years, one of three programmes set up by the UK government to encourage greater investment in the country’s private sector.[1] With a VCT, rather than investing directly in particular project, you instead buy shares in a listed company that then invests in small and emerging UK businesses. It’s like an investment trust, but involving private equity.

Bluntly, many companies in VCTs will fail, but those that have succeeded have seen huge returns. Zoopla, for example, the online property-search company, was backed by VCT funding, going on to achieve the much-coveted unicorn status (a private start-up valued at over US$1 billion).

Investors are locked in for at least five years, and might not receive their money back, but the trade-off is up to 30% income tax relief, with an allowance of £200,000, and no tax to pay on any dividends you receive.

They can be for higher-earning individuals (Up to 30% income tax relief can be claimed via Self-Assessment). VCTs can also be useful for business owners looking for tax-efficient ways of extracting profits from their companies (If you’ve already paid your £40,000 into your pension and you’ve already taken up your tax-free dividends and Nil Rate Band salary allowance) as the tax relief can be claimed on dividend Income as well as salary. This is also true for landlords who can receive tax relief on rental income.

VCTs can be relevant to responsible investors

Venture capital has a big part to play when we’re talking about ESG.

An important part of making the world a more sustainable place is encouraging new technology and innovation.

For example, projects devoted to clean energy (such as wave or tidal) that are not yet commercially viable, may look for venture funding to build up their business. Venture funding in climate tech has seen a rapid increase. More than US$70 billion was poured into it in 2022. It makes up around as much as one third of total venture investment.

Of course, not all VCTs are devoted to ESG, but just like any other publicly listed companies, it’s possible to research their ESG credentials, to decide whether to invest or not.

Look before you leap

So, investing in a VCT is certainly not for the faint hearted. Putting it simply, while I’ve never had a client lose everything from the more traditional route of diversified investments in the stock market, there’s clearly a higher chance this could happen when branching out. With private equity, particularly those early stages of a company’s lifecycle, then it’s a possibility you can’t ignore.

So why discuss this route at all? As I’ve set out here, there are risks, but also potentially large benefits. VCTs are gaining in popularity because of the potential for tax breaks and an alternative means of accessing capital growth and income. If you’re making your investments tax efficient before the end of the financial year, this is a very real alternative some might like to consider.

But with something as complex and high risk as venture capital, it is of course crucial to take advice before diving in.

For help on this and other areas of getting ready for the new tax year, please get in touch.

[1] The others are Enterprise Investment Schemes and Seed Enterprise Investment Schemes, which focus on very early-stage start-ups, so therefore carrying an even higher potential risk for investors.