Venture capital trusts and EIS funds have been rising in popularity amongst high-income investors looking for tax-efficient strategies. Here’s the guide to understanding them:
What are VCTs?
Venture capital trusts are listed investment vehicles investing in younger companies in pursuit of high returns. VCTs have tax benefits, with the government keen to incentivise investment in companies that might boost the British economy.
These benefits include being able to deduct 30pc of your investment against your income tax bill (up to a maximum investment of £200,000 per annum), as well as tax-free dividends and capital gains. In order to qualify for this, investors must keep their money invested for a minimum of five years.
What are EIS funds?
EIS funds are specialist investments that make use of a similar scheme (the Enterprise Investment Scheme) incentivising investment in high-growth businesses by offering generous tax breaks.
The EIS scheme itself is newer than VCTs, and was originally designed to cover direct investments (e.g. into a single company). The scheme has adapted over the years to include EIS funds, which invest in a small portfolio of eligible companies, similar to a venture capital fund.
What are the main differences between the two?
VCTs are typically more diversified than EIS funds, often backing a portfolio of 30 or more companies. EIS funds rarely invest in more than ten companies (and sometimes only back a single business), thus magnifying the size of the potential gains and losses.
VCTs are generally considered more liquid than EIS funds, in that they are listed on the stock exchange. However, being a specialist investment, secondary trading is rare, and sellers will often receive less than they paid.
With both VCTs and EIS, it’s worth paying careful attention to exit strategies. Many VCTs are set up as time-limited investments, with the intention that managers will buy back the shares at the end of five years, or wind up the trust and pay back capital as a final dividend.
What are the tax differences?
Both VCTs and EIS funds provide income tax relief of 30pc, as well as tax-free capital gains. In the case of VCTs, dividends are also tax-free.
Both investments have an upper-ceiling on the amount that can be used for income tax relief. For EIS funds, the maximum eligible investment is £1m per annum (or £2m for funds focusing on ‘knowledge intensive companies’). The ceiling for VCTs is lower, at £200,000 per annum.
EIS funds have some specific benefits, not available to VCT investors. These include:
- The ability to defer tax on capital gains from elsewhere (an investor can defer paying CGT on the proceeds of a secondary property, for example, if those funds were invested directly into an EIS investment);
- Exemption from inheritance tax (provided the investment has been held for two years prior); and
- The potential to claim additional tax relief (up to the value of 70pc of the original investment) if the investment is sold at an effective loss
All of these advantages depend on the investment being held for the minimum period (five years for VCTs; three years for EIS funds).
How have they performed?
The niche investment strategies pursued by VCTs and EIS funds mean that performance varies wildly across the sector. Some large VCTs have delivered returns of 60-80pc over the past five years (and over 200pc over ten years) whereas others have fallen by more than 10pc.
Of course, these returns don’t take account of the tax relief (both on the initial investment and, potentially, on reinvested dividends) which would have increased investors’ effective returns.
Both VCTs and EIS funds have been rising in popularity in recent years, as high-earning investors seek to maximise their tax relief. According to the AIC, the amount invested in VCTs in the most recent tax year (ending April 2021) was £658m – the third highest in ten years.
What are the most popular choices?
Popular VCTs include Octopus Titan, Baronsmead and Albion.
Tech-focused Octopus Titan has previously backed the likes of Zoopla, travel brand Secret Escapes and healthy snack company Graze. It currently maintains a portfolio of 80 early-stage companies.
Baronsmead launched its second VCT last year, and currently backs logistics specialist Carousel, AI customer service platform Netcall, and Vietnamese restaurant chain Pho.
Albion currently invests in large hydroelectric schemes in Scotland (Chonais and Gharagin), a Harley Street fertility clinic (Evewell), blockchain analytics firm Ellipsis, and AI-enabled digital marketing company Phrasee.
Popular EIS funds include Access, Downing Ventures, and West Hill Capital.
Access looks to invest alongside established angel investors, whose previous investments include geocode service What3Words, energy storage company HighView, and AI keyboard app Swiftkey (acquired by Microsoft in 2016).
Downing Ventures focuses on tech and life sciences, with investments including bionic limb manufacturer OpenBionics, genetics analytics company GENInCode, and make-up brand Trinny.
West Hill Capital’s past investments include diagnostics company Testcard, foreign exchange platform Freemarket, and hospitality app Onvi.