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VCT market set for supply crunch as industry grapples with new EU enforced restrictions

A new survey of managers of Venture Capital Trusts (VCTs), a scheme designed to provide finance to UK smaller companies, by Tilney Bestinvest suggests that the current tax year is set to see a sharp contraction in VCT fund raising. 

This follows one of the highest years on record in 2014/15 when GBP429 million was raised into VCTs.

Tilney Bestinvest found that 90 per cent of the 11 groups who responded to their survey believe fund raising will be less than GBP350 million and 45 per cent below GBP250 million this tax year. The average estimate for new fund raising was GBP273 million, over a third less than raised in the previous tax year.

The scale of the expected contraction will come as a blow to many financial advisers who had been expecting to increase their use of VCTs to support individuals who are set to be impacted by reductions in the pension lifetime allowance and cuts to pension tax relief for high earners.

The supply glut anticipated by managers stems from proposed changes to VCT rules announced in the summer Budget.  These changes arise from the European Commission requiring the UK’s tax efficient venture capital schemes, which include EIS and VCTs, to comply with European state-aid regulations which are currently being debated at the committee stage of the Finance Bill. As VCT managers and Boards have digested the implications of the potential changes, this has led to a virtual freeze on VCT fund raising activity, with only one new offer launched so far this tax year as groups await the final legislation.

Although the VCT and EIS industry is used to adapting to periodic changes, these have typically been minor adjustments. The proposed new rules will have major implications for the types of investment made under these schemes. The effect will be particularly felt by some of the largest and most popular Generalist VCTs who have historically focused on more mature businesses.

Jason Hollands (pictured), Managing Director of Tilney Bestinvest, says: “Since their inception, both Conservative and Labour Governments have been very supportive of VCTs, rightly seeing the scheme as playing an important role in boosting small, UK enterprises whether through the provision of development capital or re-energising business through facilitating a change in ownership. The age of a small business is irrelevant to its funding needs.

“However, it is clear that these latest changes, which emanate from European Commission, are more disruptive in scale than previous incremental adjustments. In the near term this is expected to adversely impact fund raising as VCTs adjust to the potentially narrower investment universe available. Meanwhile, certain businesses will lose access to a potential source of financing which is firmly based in the UK.  Even for qualifying companies, there is risk that if VCT financing is deemed to come with too many hurdles and restrictions attached – such as tying hands over future M&A or limits on further financing – some deals will go elsewhere, such as non-UK venture funds.

“VCT investors need to be mindful that over time there will be a gradual shift in the risk profile of many VCTs as new investments are ploughed into development capital deals in earlier phase companies than those backed in the past. While 5 of the 11 groups responding to our survey have estimated that the vast majority of qualifying investments made over the last 2 years would have satisfied the new rules, 2 estimated that around half would have qualified and 3 that less than 10 per cent would have satisfied these rules. Reduced fund raising also means that investors should take care not to leave their VCT investing until the end of the tax year, when there is no certainty that better quality offers seeking lower amounts of new cash will still be open.”

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