Trusting VCTs

Assets under management of venture capital trusts (VCTs) dropped roughly a fifth to £2.3bn in the tax year 2008/09. AIM-listed VCTs fared much worse, plunging at more than twice that rate, from £664m to just £372m. This drop for AIM-listed funds reflects the decline in the alternative exchange itself, which has seen total market capital of listed companies fall from almost £100bn in December 2007 to approximately £40bn in December 2008. This is accounted for by a stark drop off in value, since the number of listed companies has shrunk only modestly.

According to Mark Wignall, managing director at Matrix Private Equity Partners, many of the companies on AIM floated over the past three to four years, at the height of the market. "These companies have less fat and there might even be companies on AIM that should not have been floated," says Bernard Fairman, managing partner of Foresight Group. Wignall agrees: "AIM VCTs are constrained by having to invest in a currently very difficult segment of the market. In addition, they have to deal with all the regulations that come with being a VCT in the UK." These include investing in companies with gross assets not exceeding £7m (previously £15m) among other things.

Make or break

As attractive as the 30% tax break and tax-free dividends might sound, this used to be 40%. In 2004, the market had reduced considerably, (from its peak in 2001 of over £400m to a paltry £50m in 2004) so the government increased the tax break from 20% to 40% for a two-year period. On the back of that, more than £500m was raised in 2005, and more than £700 in 2006. "Tax breaks really make or break the VCT model," Fairman says, pointing out that only £45m has been raised in the current tax year.

With only a few weeks left until the tax year comes to an end, some are hoping for a last-minute feeding frenzy - as was the case in the heady days of 2006. But it is not guaranteed in today's market, and so Fairman and Wignall are urging the government to continue its support for the industry. "The tax break needs to go up to 50% and the enterprise value limit of £7m needs to go back up to £15m," says Fairman.

He envisages fundraising for 2009/10 to reach just £70m, and speculates that if that low level continues, hundreds if not thousands of small companies could fail due to lack of support. Additionally, VCTs have to make up for the lack of banking, and according to Fairman, they have to put in 2-2.5x more money than before. Together with low fundraising levels, this means that a significantly smaller number of small businesses can be supported.

Looking ahead

In terms of the future, 2009 and beyond, clear trends become visible. AIM VCTs will struggle to the extent AIM itself will struggle. "AIM needs revamping and that will take longer than a year," says Fairman. Wignall adds: "The London Stock Exchange is already lobbying to broaden the strict investment regulations VCTs are bound to." Generalist VCTs, which still returned 77% in 2008 and almost 113% over the past five years, are expected to do fairly well. "We are expecting a shakeout, but many generalists are in good shape with plenty of liquidity," says Wignall.

Limited-life VCTs, a type of VCT established in 2004, aim at taking advantage of the VCT tax relief and invest in specific fields such as asset-based companies or structured products. By funds under management, they only make up 10-12% of the total VCT market today. "It is difficult to say where the limited-life funds will be in one or two years," Wignall says. "They still have to prove themselves."

Another trend will be an increase in fund consolidation. Currently 39 VCT managers oversee 124 funds - but not all are active. "There are only five to seven funds out there who regularly manage to raise funds", says Fairman. "These will be the firms who will survive in the long run. The rest will gradually fade away," he believes. Wignall is less pessimistic. "I don't think the market will go down to a small number of VCTs controlling all assets. But the top 10 managers will definitely get more market share," he says. According to Matrix, 50% of all assets were under management by the top 10 VCT managers in 2007/08. Now, it is already at 63% and Wignall sees that number rising to 70% in the future.

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