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When comparing VCTs for a client, advisers will naturally look at areas such as performance, charges, dividends and the composition of the portfolio. But it is also worth looking at how the companies within that portfolio were selected in the first place.
VCT managers invest in smaller, growing businesses, where the potential for growth comes with a higher level of risk. Shares in smaller, unlisted companies can be more volatile than those of larger, established companies, with greater potential for significant falls in value and a higher risk of business failure. The manager therefore has an important job to do, finding enough promising opportunities to be selective, assessing those businesses thoroughly and continuing to work with them once an investment has been made.
Every manager will approach this differently, but there are several areas worth understanding when considering how a VCT puts investors' capital to work.
Finding enough opportunities to be selective
Before deciding which companies to back, a VCT manager needs a strong pipeline of potential investments.
Opportunities can come through direct approaches from companies, introductions from founders, investors and corporate finance advisers, as well as the manager's wider network. Investment teams may also carry out their own research, identifying sectors or markets they find attractive and approaching companies directly.
For advisers, the important question is not simply how many opportunities a manager sees, but whether it has access to a sufficiently broad pool from which it can be selective.
Looking beyond a strong growth story
A promising company may attract a manager's attention, but deciding whether to invest requires a much deeper understanding of the business.
Financial performance and forecasts are part of that assessment, alongside questions about the size of the market, competition, customer demand and the experience of the management team. Managers also need to understand what differentiates the business and whether that advantage is likely to remain defensible as the company and its market develop.
Some managers use structured assessment frameworks to evaluate potential investments consistently, looking at areas such as product-market fit, market opportunity, competitive advantage, the strength of the management team and alignment with the VCT's investment strategy.
As an opportunity progresses, the investment team reviews more detailed financial and commercial information and spends time with the company's management. Customer and industry feedback can provide another perspective, helping the team test the assumptions behind the company's plans rather than relying solely on information provided by management.
Putting the investment case under scrutiny
The closer a company gets to receiving investment, the more detailed the assessment becomes.
For advisers comparing VCT managers, it is worth understanding who is involved in making the final decision and how an investment case is challenged before shareholders' capital is committed.
As part of this process, investment teams may prepare detailed investment papers covering financial modelling, the market and competitive landscape, feedback from customers and industry experts, and the potential risks and returns. These may then be reviewed by an investment committee or through another internal approval process, allowing the investment case to be scrutinised before a final decision is made.
Further legal and financial due diligence may also be carried out by third-party specialists before an investment completes, with technology due diligence undertaken where appropriate.
None of this removes the risks associated with investing in smaller companies, but understanding the level of scrutiny applied before an investment is made can help advisers compare how different managers approach those risks.
The terms of the investment matter too
Finding an attractive company is only part of the equation. The price a manager pays and the terms it negotiates can also have an important bearing on the investment.
This means considering the company's valuation, how much capital to commit and the rights the VCT will have as a shareholder. Depending on the investment, terms may also cover governance, board representation and rights relating to future funding or an eventual sale.
For advisers, this is another area worth exploring when comparing managers. Two VCTs could invest in similar types of companies but take quite different approaches to valuation, deal structure and their involvement as shareholders.
Managers may also consider the potential return alongside the risks involved and how the investment might eventually be realised. Understanding these considerations can help advisers assess the investment discipline behind a VCT's portfolio.
What happens once the investment has been made?
The investment process does not necessarily end when the money reaches the company.
VCT managers can differ in how closely they work with businesses once they enter the portfolio. Some take a more active role, working alongside management on the challenges that come with growing a company, while others may take a less involved approach.
Understanding what happens after investment can therefore give advisers a better sense of how closely a manager works with portfolio companies during the holding period.
For managers taking a more active approach, this may involve joining company boards or working closely with management throughout the investment period.
The support provided will vary depending on the manager and the needs of each business. It may include guidance on commercial strategy, recruitment and leadership development, international expansion, introductions to potential customers and partners, future fundraising and preparation for an eventual exit.
Some managers also provide access to wider networks, specialist expertise or structured programmes designed to help portfolio companies address common challenges as they grow.
VCTs may also make follow-on investments in existing holdings, providing additional capital to selected companies as they develop. For advisers, understanding a manager's approach to follow-on funding can offer further insight into how it supports its portfolio over time.
Thinking about the exit from the beginning
However promising a company may be, a VCT manager also needs to consider how an investment could eventually be realised.
There is no single route to an exit. A business might be acquired by another company, receive investment from a private equity firm or provide an opportunity for existing shareholders to sell through another secondary transaction. The right route and timing will depend on the company and the market at the time.
Potential exit routes may be assessed from the outset and reviewed throughout the investment period as the business develops and market conditions change.
The timing of an exit can be difficult to predict, particularly for smaller, unlisted businesses. Market conditions, buyer appetite and the company's financial performance can all influence when and how an investment is realised.
Many VCTs operate as evergreen vehicles, meaning they have no fixed fund-end date requiring their underlying investments to be sold by a particular point. However, managers still need to consider how and when capital might be returned from individual investments.
Why the investment process is worth understanding
Tax relief is an important feature of VCT investing, but ultimately a client's money is being invested in a portfolio of smaller companies. The nature of these businesses means investments in them can be more volatile than investments in larger, more established companies. How those businesses are found, assessed and managed therefore deserves attention alongside areas such as performance, dividends, charges and the wider investment strategy.
Looking at the breadth of a manager's deal flow, how it conducts due diligence, who makes the investment decisions, the terms on which it invests and how it works with companies afterwards can give advisers a better understanding of the approach behind the portfolio.
For an introduction to how VCTs work, their tax benefits and the risks to consider, read our guide to VCTs.
Risk warnings
Please note that an investment in a VCT involves risk and is not suitable for everyone. Key risks are outlined below:
- Capital at risk, investors may lose part or all of their investment.
- VCT tax reliefs are subject to change, possibly retrospectively. Income tax relief is only available to UK taxpayers, on amounts invested up to a maximum of £200,000 per person, per tax year, and is restricted to the amount which reduces the investor’s income tax liability to nil.
- VCTs should be considered as a long‐term investment, if an investor sells their investment within 5 years they may have to repay the initial income tax relief.
- VCTs invest in smaller companies which can fall or rise in value much more sharply than shares in larger, more established companies. They can also be harder to sell.
Important Notice
For professional advisers only.
This article is for information purposes only and does not constitute investment, tax, financial or legal advice. It does not constitute an offer to buy or sell an investment or solicit any such invitation.
The information is believed to be accurate at the date of publication, but no representation or warranty, stated or implied, is made or given by any person as to its accuracy or completeness and no responsibility or liability is accepted for any such information or opinion. Tax treatment depends on individual circumstances, and tax rules may change.
Issued by Beringea LLP of Charter House, 55 Drury Lane, London, England WC2B 5SQ. Registered in England and Wales under number OC342919. Authorised and regulated by the Financial Conduct Authority under number 496358.
