Last year’s ‘Enterprise’ budget paved the way for increased investment in the UK’s smaller unlisted companies. The higher bank lending targets agreed under Project Merlin along with a relaxation of the rules governing VCTs promised greater flexibility for funding.
VCT managers surveyed by the Association of Investment Companies (AIC) have seen a surge in demand for funding from companies over the last year and they are currently seeing good investment opportunities in a range of sectors, from media to healthcare and education.
As a result of this, managers view the outlook for 2012 as largely positive. Patrick Reeve, Managing Partner, Albion Ventures believes that: “VCTs provide an essential source of finance to SMEs at a time when banks are contracting their balance sheets, and funding is scarce. The Government has recognised this, and has taken measures to broaden the range of companies that VCTs can invest in (by requesting that the EU increase the size of company that VCTs may back) as well as sharpening the investment focus to ensure that only those businesses that genuinely lack alternative sources of finance are backed.”
David Hall, Manager, British Smaller Companies VCTs and Managing Director of YFM Equity Partners said: “The proposed changes to the VCT rules may herald a trend to larger trusts, which is likely to see costs reduce further, which is good news for investors. It may also be that as VCTs get larger this might help in further stimulating the secondary market. VCTs will be able to further diversify their portfolios of investments which can only help in the drive to deliver consistent dividend returns. With the best VCTs now showing tax free dividend yields of 5-6% over 15 years these can only be positive developments.”
In fact, for those VCT providers that are poised to invest, there are some attractive opportunities with less of the pricing pressures present near the top of a market cycle. Bill Nixon, Manager, Maven VCTs added: “Access to finance is one of the key challenges facing SMEs in pursuing their business plans and maximising growth potential. The challenge has been made more acute by the position of major lending institutions, which historically have been the largest providers of debt-based finance to private companies but have had to reduce that lending as they seek to repair their balance sheets.”
David Glick, Manager, Edge Performance VCTs commented: “We have seen a massive increase in the number of deals coming to us. Partly that’s because there are limited options in the current climate for companies to secure growth capital, but partly it is because there is growing awareness in the SME community of the value a VCT can bring, not only in terms of investment, but also particularly with a specialist, as we are, in terms of expert knowledge and input.”
David Hall, Manager, British Smaller Companies VCTs and Managing Director of YFM Equity Partners said: “Demand for funding from companies hit a low in mid-2009 and has been climbing steadily from there. Demand for investment is high – in the first quarter of this year we anticipate over GBP35 million of offers to businesses which equates to an annual rate of nearly GBP150 million. We won’t complete all of those transactions as there are some other VCTs offering the capital – but that rate is a third up on last year, which is itself a third up on the year before.”
Patrick Reeve, Managing Partner, Albion Ventures said: “The advantage of investing at a time of subdued economic growth, verging on recession, is that opportunities are many, finance is scarce, and so pricing is highly attractive. This is proven by the BVCA performance figures, which show that funds raised in an economic downturn greatly outperform those raised in a boom. Thus funds raised in the run up to the dot com boom in 1999 averaged only 8.6% pa across the private equity industry, while funds raised at the end of the resulting recession in 2004 returned a massive 32% pa. We believe that this is the case now, where many sectors of the economy seem to have reached a nadir, from which one can only see recovery, and investment can be made on the back of conservative forecasts without the pricing pressures of competition.”
The sector was notable for its strong performance in 2011, with half of the top ten performing investment companies to the end of December being VCTs. In addition to this positive capital return, investors in some VCTs benefited from yields strong enough to rival conventional income focussed companies.
Tax benefits at launch and tax free dividends compound these gains, as Patrick Reeve, Managing Partner, Albion Ventures explains: “The undoubted considerable attractions of VCTs as tax free income vehicles ensure a core base of dependable demand. This is because a VCT offering a tax free yield of 5% increases to a tax free yield of 7.1% on the net cost of investment after the up-front 30% tax relief. This, in turn, is equivalent to 9.5% gross yield for higher rate (40%) tax payers."
Identifying sectors likely to benefit from long-term growth and developing specialisms are seen as key strategic drivers for some VCT managers. David Glick, Manager, Edge Performance VCTs said: “Entertainment and media really is a growth sector with internet and mobile creating major new opportunities. When you’re dealing with a growth sector like this, depth of sector knowledge, your network and experience really count.”
Patrick Reeve, Managing Partner, Albion Ventures commented: “Taking a longer term strategic view, we believe sectors such as the environment, and healthcare / education will always have resonance. So in the period 2010-2011 we invested a total of GBP45 million into around 30 smaller, unquoted UK companies, of which GBP18 million was in the broader healthcare sector, GBP8.7 million in education, and GBP17 million in the environmental sector. These include a GBP3 million investment to construct and operate a waste food-to-energy power station in Scotland, which burns methane from waste household food, recycles the surplus heat and C02 into nearby tomato greenhouses, and distributes the residual slurry as organic fertiliser. In education, we have founded a new fee-paying independent junior and senior school on a freehold property on the Thames at Twickenham. The school opened for business after extensive refurbishment last September and already has 150 pupils, with a 50% increase due later this year, towards capacity of over 400.”
Despite the recent boons to the sector, some VCT managers expect to see a more cautious uptake of fundraising offers this year. Patrick Reeve, Managing Partner, Albion Ventures said: “We’re expecting fund-raising to be a bit lower than last year at GBP200-250 million against GBP350 million. There are three main reasons for this – first, a general investor unease, resulting from the Euro crisis; second, the fact that pension contributions have been made more attractive due to the carry back provisions for the current year combined with tax relief at up to 50%; and thirdly, a reduction in the number of the more artificial, low risk VCT schemes following the recent tightening in legislation.”
David Glick, Manager, Edge Performance VCTs commented on whether it will be a good fundraising season: “Almost certainly not – and the reason seems almost entirely due to uncertainty caused by the various Government reviews and consultations around the VCT sector. That uncertainty has filtered down to advisers and investors with the result that the market is significantly down on where it was this time last year. We have moved quickly to deal with this uncertainty by announcing we will close our Edge Performance VCT (Planned Exit) ‘I’ share offer early this year on March 30 and will conclude our underpinning deals before the new regime comes into force on 6 April. We do think there will be a last minute rally, but the market may well be significantly down by the end of season.”
However, Bill Nixon, Manager, Maven VCTs predicts a good fundraising season, largely driven by investors’ appetite for income: “It is looking like a strong year for fundraising and some offers have closed early after becoming fully subscribed well before the end of the tax year. What is abundantly clear from shareholder comments is that investors are increasingly attracted to high yielding investments, to help combat increased tax burdens and persistently low interest rates, and specifically the benefits of the tax-free income available from mature VCTs to supplement investment and retirement income. This income opportunity has previously been overlooked by both investors and advisers.”
David Hall, Manager, British Smaller Companies VCTs and Managing Director of YFM Equity Partners said: “This year’s fundraising has been good for the generalist VCT; which is showing fundraising 25% up on last year – albeit that the market to date is 20% down. Part of the reduction might be attributed to some product being later and also some product not being released whilst waiting for the consultation on VCTs to conclude – which happened just before Christmas. The generalist might just be beginning to widen its appeal, with the consistency of performance and generally lower volatility, across the advisor network. Our own fundraising is over 60% up on the same week last year; which is extremely encouraging.”
Annabel Brodie-Smith, Communications Director, AIC said: “As the end of the tax year approaches, higher-rate tax payers have many reasons to consider investing in VCTs. Some good performance in the last year and attractive income yields prove that the sector has benefits beyond maximising tax allowances. The strong demand for funding from SMEs should provide some compelling opportunities for managers. However investors should be aware that investing in unlisted companies carries a higher degree of risk and investors should be comfortable with this before investing. It’s always worth researching potential investments carefully and the AIC’s website provides a range of statistics and information to help with this.”
