Nothing ventured...

by Sarah Modlock

23 March 2005

It is a truth universally acknowledged that if you want to make money you need to invest in the stock market. In the finance fashion stakes, Venture Capital Trusts - or VCTs - would be gracing the cover of Vogue right now. But like the slinkiest supermodels, they require time, money and effort and are not for the faint-hearted. If you prefer to stash all your cash safely in a building society then these beauties are not for you.

If you are prepared to take on the risk and commit your cash then VCTs provide the chance to become an entrepreneur and perhaps reap financial rewards. Created by the government in 1995 as a way to encourage investment in growing companies, they are collective funds, run by professional managers. And if you thought ISAs had decent tax-breaks then wait until you see how attractive Gordon Brown has made VCTs. In his 2004 Budget, the Chancellor doubled the tax relief on VCTs to a massive 40% providing you invest before April 2006. This means that investing £1,000 only costs you £600. Plus sales of VCT shares are free from capital gains tax and there is no income tax to pay on dividends. You can usually invest from as little as £1,000 and as much as £200,000 in any tax year.

But you must look before you leap. 'The danger is that people might invest for the tax advantages and not consider the risk to their money,' says Patrick Connolly, of independent financial adviser John Scott & Partners. 'Many of our clients are high net worth with large, diversified portfolios but VCTs are only right for a small proportion of them. It's essential to only invest if it is right for you,' he says.

So before you get dizzy at the prospect of great tax relief, there are some essential things to understand about VCTs. For starters, they are a definitely not a short term option. Be prepared to leave your money in for a minimum of three years. Trying to cash-in earlier will result in all that lovely tax relief being grabbed back by the tax man. Any real gains are likely to be made over five years or more. This 'aint no Christmas Club.

Size matters

As with all stock market investments, VCTs carry risk; there are no guarantees of whether your money will grow or by how much. You may not even get back everything you put in. To qualify for a VCT, a company must have assets of less than £15 million. 'But this does not mean that every VCT invests in a brand new firm at the smaller end of this scale,' explains Simon Rogerson of Octopus Asset Management (no jokes about making a few squid, please). 'Many funds put money into well-established, long-running companies which are looking for further investment to develop and are far less likely to fail. Bigger VCTs are likely to bring added security and will also be able to attract the best managers,' he adds. So if you're interested in investing then an independent financial adviser can find a VCT to suit your risk preference.

Again, in common with all investments, you need to ask questions, read the paperwork and have a good understanding of what will happen to your money. Make sure your VCT has a strong management team. These are not just money men. They deliver specialist expertise to advise and guide the company, enabling it to expand more quickly and increase in value to provide investors with a chance of better returns. Before you hand over your cash, find out what their track record is and ask how much of their own money the managers have put into the VCT.

In a world where transparency is not a strong point, Octopus has a refreshing approach: 'We pride ourselves on clear and open communication with clients,' says Rogerson. 'We're not talking about faceless institutional investors here, we are entrusted with the hard-earned savings of real people and that must be respected. We provide regular updates in clear language and have a freephone line so that investors can get through to the team at any stage if they have questions.'

Of course, there is a price to paid for the launch of the VCT manager's expertise. Expect an up-front fee of around 5% and then between 2% and 3.5% per year afterwards in addition to a performance-related fee which will vary between funds. Make sure you find out the fee and charging structure before you sign up.

So there is plenty of homework to be done before you get into VCTs and part of it involves making sure you can get out. Some fund managers offer buyback services and will take your shares off your hands. But be prepared for the price to be lower than the market value, possibly by as much as 10 or 15%. 'Even if you have an exit route lined up, you may find it closes on you if everyone wants out at the same time,' warns Connolly.

As the tax year draws to a close and we are lining the Inland Revenue's pockets with nearly £6 billion more tax than we need to, it's not surprising that the private investment cash pouring into VCTs is expected to reach £500 million. It's easy to get excited about VCTs. But cool-headed investors need to think long and hard before they take the plunge. They are not one-size-fits-all and this is not a look that suits everyone.