Venture Capital Trusts are hardly an asset class to make the headlines but current market conditions suggest there are growing expectations for a strong 2010 vintage. Emanuel Eftimiu reports

Private equity activity in 2009 has been at best subdued as the economic downturn and banking crisis created what can only be called a perfect storm. Dealflow was not only hampered by limited quality assets, but poor trading visibility was also often a deal breaker as banks pulled the rug from under the industry.

One man’s loss is another man’s gain though and VCT managers are adamant about the opportunities provided by current market conditions. "I believe that there are compelling investment opportunities for VCTs in the current market that will offer great returns, so VCTs raised now should prove to be a fine vintage," comments Matt Taylor, partner at Foresight Group.

Given that VCTs don’t rely on external debt funding for their investments, this should at least eliminate the uncertainty of debt financing falling away at the last hurdle before deal completion.

Indeed, the bullish talk about current investment prospects in the VCT deal space is reminiscent of the sentiment felt by larger buyout houses. Similar to their private equity counterparts though, VCT managers are also suffering from a fundraising malaise that seems to juxtapose the often cited investment opportunities in the market. This, though, is as far as the comparison goes.

While fundraising for private equity funds is expected to remain difficult for some time as many LPs are reducing their allocations to the asset class, the higher income tax rate from 6 April, coupled with the reduction in pensions tax relief for higher earners, is expected to renew investors’ interest in VCTs. "For sophisticated investors, the opportunity to get 30% tax relief without the long-term strings attached to a pension contribution looks increasingly attractive," comments Taylor.

Indeed, Mark Wignall of Matrix Private Equity Partners thinks this strong interest is already coming through: "Last tax year saw £150m raised but I’m confident the market this year will get to £250m and next year will be higher still."

The new tax year will, on the other hand, also bring some changes to the VCT investment conditions. While a VCT must still invest 70% of its funds in smaller unquoted companies (so called qualifying holdings), the percentage of these qualifying holdings that must be in shares is about to rise from 30% to 70%.

Some fear that this required higher level of equity investment has the potential to disrupt the VCT investment model, although established managers are expected to be less affected. "New pools of capital raised within existing VCTs benefit because the percentage tests are measured across the whole fund, so investors will be focussing on the new share offerings from existing VCTs," notes Taylor.

Indeed new VCTs will certainly feel the new changes as Wignall points out. "I think the market won’t notice much difference in practice and the established VCTs will press on with little change. However, I do think it’s made it very difficult for any new VCT entrants to emerge."