Something ventured, everything lost?

Venture Capital Trusts (VCTs) have the potential to join that, seemingly, ever burgeoning pantheon of mis-sold financial products, ranging from pensions and endowment mortgages through to split-capital trust and precipice bonds.

If this does happen, and the Financial Services Authority (FSA) has already gone on record earlier this year saying, "We're keen to make sure this doesn't turn into the next mis-selling scandal," then the Chancellor surely will have to take some of the flak.

It was he who dramatically boosted the appeal of VCTs in the Budget of 2004. He doubled the tax relief to 40% and doubled the amount that could be invested to £200,000 in a given tax year, at least until 5 April 2006.

The result was a significant reversal in the fortunes of the Venture Capital Trust market with, apparently, everyone's grandma scrambling to get a slice of the action. Nearly £500 million had been invested before the end of the last financial year, compared to a feeble £70 million in 2003/04. The previous high point of VCT attraction was in 2000/01 (around £450 million) during the technology/dot com boom.

What are Venture Capital Trusts for?

Launched in the mid-90s, VCTs were designed as a way of encouraging investment in young, small companies and entrepreneurial endeavours, such as private equity opportunities, qualifying businesses on the Alternative Investment Market (AIM) and high risk capital ventures. VCTs, which are listed companies quoted on the London Stock Exchange, must invest 70% of their funds in qualifying companies within three years of raising the money.

The individual investor benefits from 40% tax relief on share investment up to £200,000 within the tax year, provided the shares are held for at least three years. There is no tax on dividends, whether income or capital, and no capital gains tax payable on the sale of the shares.

Spouses can each invest up to £200,000 (minimum £1,000) and get the 40% tax relief. Shares are deemed part of the estate for IHT purposes, but if death occurs within the initial three year period the upfront tax relief is not withdrawn.

Why there could be tears before bedtime

The FSA's concern is that many individuals attracted are unaware of the risks entailed. Venture Capital Trusts are for the sophisticated, risk-aware investor; they are not a mass-market blag inspired by a good tax break and shouldn't be viewed as such.

The tax allowance is generous but the more naive investor has perhaps not considered the implications of money tied up for three years and the difficulty of selling on after that period. There are likely to be few takers as there is no tax advantage to buying in a secondary market.

The experts say that, realistically, investors need to tie up their capital for at least seven years, maybe ten. Overall, performance in the market hasn't been wonderful. It has been reported that of 75 Venture Capital Trusts launched in the past nine years, investors in 22 of them are facing losses; on the other hand it is said that 80% of those launched between 1995 and 2003 have produced a positive annual return when tax breaks and dividends are taken into account.

The key, as with other forms of investment, is to choose the right one. A bad choice could mean being stuck in an investment for three years with high charges but funding so low that it is uneconomic to manage. The companies it invests in could also go bust.

There are currently some 40 Venture Capital Trusts on offer, including the top-drawer Close Income & Growth which has raised £45 million. But others have withdrawn from the market unable to raise sufficient funding. MTM China, for instance, returned cheques to investors earlier this year because it had raised less than £2 million and concern has been expressed about Arc Growth Company proceeding with just £1 million investment.

03 June 2005 © Moneyextra.com

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