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VCT funding for small companies—Will the elections kill a good idea?

Finance Blogger: Anthony Harrington Anthony Harrington

A parliamentary election often generates something of an ideas frenzy and with an incoming government potentially set to either change course on what it was doing before, or to take an axe to the other side’s way of doing things, it is an important time for all kinds of bodies to say, “Hey, look at what we do, and don’t spoil it!” Venture Capital Trusts (VCTs) were a “bright new idea” in the UK back in 1995, providing tax relief for investment finance channeled into “arms length” small companies.

As the Association of Investment Companies (AIC) notes, VCTs raised some £340 million through the tax year, 2009–2010. This was more than double the funding (£158 million) raised for the prior year and was the fourth highest since VCTs were launched.

Ian Sayers, AIC director general, points out that this funding played a vital role in bridging the finance gap for small businesses at a time when the banks were not lending. It demonstrates investors’ continued willingness to support VCTs and should be a clear indication to whatever party wins the UK elections that this is one funding initiative that really does work, he said.

The AIC’s research shows, it claims, that the kind of small but fast-growing companies that attracts funding from VCTs often invest substantially more, relative to their size, in R&D than big companies. That point adds to the general sense that smaller companies have a better track record of innovation.

At the same time, their rapid growth generates new jobs for the economy. According to Sayers, a survey carried out by the AIC [PDF, 220 KB] provides some strong evidence of the capacity of VCT-funded companies to generate jobs. The survey gathered data on employment levels in 303 investee companies which, at the time the investments were made, had a total of 17,219 employees. By the time the survey was carried out, in April 2009, that had grown to 25,402. In other words, the 303 VCT-backed companies had generated 8,000 jobs between them, amounting to an expansion of their workforce of 47%. (Some 88 companies in the survey disclosed dedicated R&D spending totaling £55.4 million, significantly higher than small companies generally allow for R&D.)

Another feature of VCT-backed companies is that since there is a general understanding, a kind of compact, between the VCT and the entrepreneurs involved that growth will be a high priority, these companies tend to be focused on export at a much earlier stage in their development than other start-ups. Some 103 investee companies provided data to the AIC about the level of their turnover resulting from exports. Total exports amounted to £303 million, or almost exactly a third of their total revenues of £909.7 million. This, again, is a very impressive statistic.

VCT rules in the UK allow individuals to invest up to £200,000 per tax year and to get 30% tax relief on that investment, as well as benefiting from tax-free dividends and no capital gains tax, provided the investment is held for a minimum of five years. You have to invest a minimum (usually £3,000 or £5,000) and the managers of a VCT cannot hold the amount in cash for too long. They have to invest at least 70% of the investment within three years (otherwise this would be a simple, no-risk way of not paying tax on interest earned). The only downside of the current VCT tax arrangements is that the government really does want this to be start-up money, and start-ups are the highest risk going. Only companies with assets of less than £7 million before issue are eligible and they can’t have more than 50 employees. They also cannot raise more than £2 million in funding from VCTs in any 12 month period. The requirement to hold the investment for five years means that many investors can expect to see losses. Some VCTs try to minimize the risk by, for example, only investing in small companies with solid assets such as freehold properties (children’s nurseries being a favorite). The general message in the run up to an election from the AIC is: VCTs are a good thing. Keep it so…

Further reading on VCTs and raising finance

Tags: funding , small companies , tax , Venture Capital Trusts
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