Could pension changes be a problem for VCTs?
It’s been a stressful week for venture capital fund managers.
As vehicles for investing in start-ups and technology companies, VCTs were shaken by the sudden collapse of Silicon Valley Bank. After a grueling weekend of ruling over which of their portfolio companies ended up with their UK subsidiary, HSBC’s bailout was a welcome relief.
However, he emphasized the risky nature of investing in early-stage businesses and why tax breaks are offered to those who do. But the week’s drama isn’t over yet.
Days later, the chancellor delivered a windfall to the rich in the Budget by increasing the annual tax-free pension contribution to £60,000 and scrapping the lifetime allowance altogether.
The political fallout continues, but if pensions expand their role as a tax-efficient investment vehicle for the wealthiest, what might the future hold for riskier VCTs?
With just weeks to go until the end of the current tax year, VCTs have raised an impressive £821m according to Wealth Club statistics, the second best year ever after breaking the £1bn mark last year.
But what will the next tax year be like?
Venture capital trusts typically invest in young, privately held companies with assets of up to £15 million and fewer than 250 employees.
Some of them may turn out to be damp squibs, but the real draw for investors is their early access to the big hits that have made them known like Zoopla, Graze and Five Guys.
One of last year’s most successful exits was Pembroke VCT’s sale of fashion brand ME+EM to private equity firm Highland Europe, where investors made 16 times their original investment.
New share issues in VCTs come with a 30 per cent income tax credit if the shares are held for at least five years, while dividends and profits are tax-free – even more attractive given April’s cuts to dividends and capital allowances.
For those who have ‘restricted’ their pension savings, VCTs and Enterprise Investment Schemes (EIS) have offered the ‘next best’ in terms of tax benefits – but at a much higher risk.
While the chancellor tried to play down the risk of recession in this week’s budget, investors are increasingly nervous about stretched valuations for start-ups and growth companies in general.
For those with smaller investments, saving more for retirement could be a less risky option if you increase your annual allowance by £20,000 next month.
As former pensions minister Sir Steve Webb told the FT this week:
“If I were in this position as a private person and I thought that the next government might roll back the limit, I would fill my boots for the next two years, have a bit of a gold rush and then crystallize on the eve. in the general election.”
FT Money’s latest bonus survey showed a cautious climate among investors, with 5 per cent of readers saying they would invest some of their annual bonus money in VCT and EIS structures, up from 7 per cent last year.
More than half of respondents said that tax caps limit what they can invest in their pension, with 28 percent saying they do not at all, and a further 23 percent due to annual benefit cuts.
From April, this will reduce the potential pension contribution from £60,000 to £10,000 a year for the highest earners. The Thar is higher than the current £4,000 floor, but survey respondents I spoke to this week said it would not be enough to put them off investing in tax-efficient alternatives such as VCT, EIS and SEIS ( Seed Enterprise Investment Schemes).
“If you are affected by pension cuts, the tax benefits of these schemes are still better,” said one reader in his 40s. “Labour has announced that they will reverse the pension changes, so it is impossible to plan. But what appeals to me more than anything else is the huge lift you can get at the exit.”
Older readers who have invested in VCTs for years said they valued tax-free dividends from their portfolios the most.
“The majority of our VCT investors – 73 per cent – are retired,” says Alex Davies, founder and chief executive of Wealth Club.
“The reality is that most retirees live off of their pensions, investments, property income and interest. This is not ‘earned income’ so for these investors the increased pension is meaningless as they can only draw on the non-earner’s pension of £3,600. Therefore, VCT remains the logical alternative.”
Davies accepts that the net asset value of most VCTs has fallen by 10-20 per cent in the past year, noting that it is much more difficult for early-stage businesses to raise money now than it was 18 months ago.
I’ve written here before about the high fees that abound in this sector and how investors should do their research before committing their cash.
While there is no official data to measure the amount invested in EIS schemes this tax year, Davies said capital raising was “significantly down”. As these are typically structured as investments in one or a handful of companies, this is a very different risk profile to most VCT funds, which diversify between 60-100 companies of different ages and stages.
But there was a small, tempting line in the budget that caught the ears of VCT and EIS investors.
We won’t get the details until the Autumn Statement, but this is what the Chancellor has said The elevators are ready for takeoff – a new type of fund known as the Technology and Science Long-Term Investment initiative.
The government wants to enable members of DC pension schemes to invest in innovative, high-growth companies – those that have moved beyond the risky start-up stage to more sustainable growth.
It’s an interesting vision for those shoveling more money into our pensions – and potentially beneficial if the wall of institutional capital provides a natural exit for patient VCT and EIS investors.
The writer is the FT’s consumer editor and “What they don’t teach you about money‘. [email protected]