Venture capital trust (VCT) sales are booming ahead of feared rule changes in the Autumn Budget but buyers had better beware that if they let the tax tail wag the investment dog, they might get bitten.
Eight years into the second-longest stock market bull run on record, with interest rates stuck at an historic low and only 18 months left to go before Britain leaves the biggest trading bloc in the world might not be the ideal time to top up with unlisted tiddlers.
Smaller companies eligible to be held in the VCT wrapper tend to be riskier than bigger ones because they are less likely to have diversified businesses or substantial contingency reserves to help them cope with setbacks – such as a cliff edge, ‘no deal is better than a bad deal’ Brexit.
Even in the good times – such as we might see if Brexit proves a soaraway success – most start-up firms fail within five years of launch. So, as the City cynics say, you don’t need to be brave to buy VCTs – but it helps.
That is even more the case today with fixed-term investments during fast-moving times. The five-year minimum holding period for VCT shares to earn generous tax breaks, which include 30% initial income tax relief and tax-free dividends and gains, could prove problematic for buyers now, because that lock-in period will certainly carry them through to the other side of the next general election.
While few things are as uncertain as politics – how many political ‘experts’ predicted Britain would vote to leave the European Union or that Donald Trump would be elected president of America? – it is a daunting fact that the Conservatives will be seeking their fourth victory in a row, if you count the coalition government they led in 2010.
Anyone who thinks Jeremy Corbyn and his Marxist pal John McDonnell are unelectable should not underestimate the tendency for disgruntled voters to say: 'let’s give the other lot a go.'
Many young adults, including some entering middle age, now feel they have nothing to conserve but their student debts. Let’s hope Conservative chancellor Philip Hammond can galvanise voters aged less than 35 with his conference speech next week but past form suggests that would not be the way to bet.
However, I think it unlikely he will further restrict VCTs as they were made riskier as recently as November, 2015, when they were forced to focus more on start-ups. The recent Association of Investment Companies review of how VCTs are raising capital for smaller companies claimed they have created 27,000 jobs and nearly half of them are outside London or the South East. So, despite the pre-budget marketing drive, Hammond may well decide: 'If it ain’t broke don’t fix it.'
Never mind the macro, though, because personal finance is personal first and financial second. This would be a good time to declare an interest in the form of two five-figure investments I hold in Northern VCTs 2 (NTV) and 3 (NTN). Taking account of the initial 30% tax relief, both sets of dividends received this year produced eye-stretching yields of 17.26% and 14% respectively.
If that looks too good to be true, then consider that both VCTs trade at substantial discounts to their nominal or par value. Northern VCT 2 shares are currently priced 26% below the grossed up value of my investment and Northern VCT 3 are 14% under water.
As it is four years now since I bought these shares to avoid a hefty tax bill on a bit of a windfall in 2013, I won’t really know what the capital position is to compare with income inflows until next year. Only after the shares can be sold without having to pay back tax reliefs already received will their real value become clear, assuming there are willing buyers for second-hand stock.
No wonder it is sometimes said that VCTs are like lobster pots; it’s easy to get in but difficult to get out.
Here is a complete list of Ian Cowie’s stock market investments. It is not financial advice nor is any recommendation implied.