The first thing to consider before investing in VCTs or EISs is that they are restricted to investing in the earlier stages of potentially higher-risk small companies. As such, investors should first consider making full use of their pension and ISA entitlements before considering VCTs or EISs. However, if an adviser thinks a VCT is suitable for a client, then the first step to selecting a VCT is to assess the manager.
VCT managers are courted by hundreds of companies that seek funding every year, and must be skilled at picking future winners. They must also be good at providing strategic advice, since they play an advisory role to the investee companies, sitting on their boards and helping to increase a company’s value by means of an ultimate exit after a number of years.
Another consideration for advisers is whether their clients are looking for capital growth or income. The income tax exemption on dividends means that VCTs are an excellent method of establishing a long-term tax-free revenue stream. EISs are usually focused on short-term capital growth, making them less suited to long-term savings. The long-term nature of VCTs can make them a highly complementary component in a retirement portfolio. For example, someone in his 50s supplementing his pension provision might wish to allocate a part of their savings to a VCT. The income from a pension pot is taxable, but dividends from a VCT are usually exempt.
VCTs and EISs are not suitable for everybody. Many cautious investors will prefer to avoid backing smaller, often privately owned and inherently riskier companies. However, they can be suitable for high net-worth investors due to their tax efficiency and, in the case of VCTs, their proven ability to deliver regular income. VCTs are particularly attractive to three types of investor:
• Young high-flyers, who are likely to have high salaries and pension contributions and be heavily taxed. Time is on their side, so the long-term nature of investing in VCTs can be appropriate for them, and the opportunity to benefit from the initial 30 per cent income tax relief is especially attractive.
• Senior managers who are ready to retire with substantial pension pots close to the lifetime allowance. Investing part of their tax-free lump sum into a VCT could provide a good tax-free supplement to their pension pot as it falls outside the lifetime limit. The reduction of the annual pension contribution limit to £40,000 is also likely to be a consideration.
• The comfortably retired, who are financially savvy and seeking income in a low interest rate environment. The high tax-free income available from generalist VCTs is highly attractive to them as part of a broader savings strategy.
