Taking exposure to venture capital in your portfolio
Enterprise Investment Schemes and Venture Capital Trusts
While the UK is globally renowned as a home for early-stage technology companies to pursue rapid growth, what’s less well known are the personal tax incentives offered to UK high-net-worth investors in those businesses.
This is surprising when these tax incentives are among the most generous reliefs of their kind worldwide, and have now existed in one form or another for well over two decades.
How high-risk investments can pay off
There are two core products that allow for investment in such early-stage, high-growth companies while facilitating such tax reliefs – Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT). We’ve been a leading supporter of these investment products in recent years, and we continue to offer clients access to a small number of EIS/VCT managers each year. We offer access only to those of the highest quality, all of which have undergone our extensive, in-house operational and investment due diligence.
Both EIS and VCTs are UK government-backed initiatives, designed to mitigate some of the risk of investing in early-stage businesses, while maintaining the upside (or reward) of successful investments. The reasoning behind this is simple – because the risks associated with investing in early-stage businesses are high, nascent companies (even those with high potential) can struggle to attract capital in their early years.
The UK government therefore incentivises investors by bearing a significant amount of the risk through tax reliefs. A more substantial list of these reliefs and features is shown below (which differ between EIS and VCTs), but the most generous relief common to both is 30% income tax relief on invested capital. Investors can opt to use this relief in the current tax year or, for EISs, investors can carry back reliefs to the previous tax year, meaning that their effective exposure to the investment is 70p per £1 of capital. Any gains on successful, eligible companies aren’t subject to capital gains tax or income tax.
Institutional quality investments more widely available
The investment universe for EIS and VCT has undergone significant change over recent years. Rule changes about what types of companies qualify mean the space now exclusively focuses on high-growth, early-stage investments with substantial risk.
What makes this space particularly interesting for investors currently is that, in our view, there are now a small number of high-quality EIS and VCT managers who are offering access to institutional quality investments. These have formerly been the preserve of institutional venture capital funds, which are typically only available to institutional investors.
EIS/VCT managers typically choose to allocate investor capital to companies that are focused on the technology sector, with a goal of disrupting a well-established industry or sector. A number of companies funded by managers we work with have gone on to become household names – for example, you may well have heard of Zoopla, one of the earliest disruptors of the traditional estate agent sector, or Secret Escapes, which successfully disrupted the traditional travel agent model.
The differences between EIS and VCT
While EIS and VCT structures have certain features in common, there are important differences between both.
Crucially, VCTs are UK closed-end collective investment schemes. This means an investor owns shares in the VCT, rather than the underlying companies (an established VCT will typically hold over 30 companies within its portfolio – and the investor has exposure to all of them).
EIS managers, in contrast, facilitate investments for their clients directly into the companies themselves, so a client directly holds shares in private businesses. A manager will typically facilitate these investments in around 10 companies over the course of roughly one to two years, though these parameters can vary by manager. Managers then facilitate divestments, or ‘exits’ for investors in subsequent years on an individual company basis. The VCTs are companies themselves, which are generally listed entities on the London Stock Exchange. As a result, VCTs trade in a secondary market on the London Stock Exchange, offering investors an element of liquidity.
|Venture Capital Trusts||Enterprise Investment Schemes|
|Available to||Any individual over 18 years old||Any individual|
|Investment||Shares in a company listed on the London Stock Exchange which invests in qualifying unquoted trading companies||Qualifying unquoted trading company shares|
|Maximum size of underlying investee company||Gross asset value not to exceed £15m before VCT invests and £16m immediately afterwards||Gross asset value not to exceed £15m before individual invests and £16m immediately afterwards|
|Maximum number of full-time employees of underlying investee company at the time of subscription||Fewer than 250 (fewer than 500 for knowledge intensive companies (KICs))||Fewer than 250 (fewer than 500 for knowledge intensive companies (KICs))|
|Maximum amount of investment obtained by investee company through EIS and VCT financing in the 12 months before share issue||£5m (£10m for KICs)||£5m (£10m for KICs)|
|Rate of income tax relief||30%||30%|
|Investment limit for income tax relief||£200,000 per tax year||£2m per tax year (provided any excess over £1m is invested in KICs)|
|Minimum holding period for key reliefs||Five years||Three years from issue of shares or commencing trade, whichever is later|
|Tax-free dividends||Yes – on first £200,000 of shares acquired in a tax year||No – taxed at dividend tax rates|
|Ability to carry back investment to previous tax year to obtain income tax relief in previous year||No||Yes – up to investment limit in the previous tax year (£2m in 2018/19)|
|Tax-free capital gains||Yes – even where not held for five years, assuming approval not withdrawn||Only if held for three years and income tax relief not withdrawn|
|Potential to defer capital gains into scheme shares||No||Yes|
|Inheritance tax relief (‘business relief’)||No||Yes – if qualifying investments held for at least two years prior to and at time of death|
|Ability to offset loss at exit against income (‘share loss relief’)||No||Yes – on loss net of income tax relief|
EIS and VCT investing comes with a number of risks and issues that investors need to consider before investing. For example, smaller companies have higher failure rates than more established companies and it’s possible for an investor to lose the whole of their capital. But the impact of the loss may be mitigated in part (but not all) by tax reliefs where applicable.
Your Wealth Planner can help you understand the effect of tax on your wealth and offer tax-efficient wrappers for your investments. They’ll be able to guide you towards making the right decision for your financial planning needs. Your planner can't offer tax advice – you should seek that independently. Please bear in mind that tax rules can change in future and their effects on you will depend on your individual circumstances.
Things to consider
The value of investments can fall as well as rise. You may get back less than what you originally invested.
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