When Beauty Tech Group made its debut on the stock exchange earlier this month, it was a welcome boost for the UK market, which has struggled to attract new issues in recent times. The £300 million listing was also a big win for venture-capital trusts (VCTs) – three VCTs run by Mercia Fund Management were among the first investors to recognise Beauty Tech’s potential, taking stakes in the company in 2018 when it had annual sales of less than £1 million and was still losing money. Beauty Tech follows in the footsteps of other VCT success stories, including Zoopla, Gousto and Virgin Wines.
VCTs were launched 30 years ago this year by the then chancellor Ken Clarke with a mandate to encourage investment in early-stage British businesses. Clarke’s view was that investors needed encouragement to risk their money in these small and immature companies, where the danger of failure is a very real one. He therefore legislated for the launch of VCTs – collective funds that build portfolios of such companies, but offer a series of generous tax reliefs to compensate for the additional risk, providing some downside protection in the event of losses. Successive chancellors have fiddled with the reliefs along the way, but the basic premise has been maintained. Today, investors who buy new VCT shares get 30% upfront income tax relief – so a £10,000 investment, say, costs only £7,000 – and enjoy tax-free dividends with no capital-gains tax to pay on profits. In addition, you can put up to £200,000 a year into VCT shares – far more than you’re allowed to invest in other tax-efficient wrappers, such as private pensions and individual savings accounts (ISAs).
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The Budget reference is a significant one. In recent years, VCTs have captured investors’ attention in an environment where other tax-advantageous savings schemes have been squeezed. Reduced private-pension contribution allowances for wealthier savers, for example, appear to have boosted the sector. The move to make unused pension assets subject to inheritance tax is also piquing interest in VCTs; although they offer no inheritance-tax benefits of their own, the funds are subject to fewer withdrawal restrictions than pension products and are hence useful for financial planning. Demand has boomed accordingly. “Despite a difficult economic background, the 2024/2025 tax year was the third-best year for VCT fundraising,” says Annabel Brodie-Smith, communications director of the Association of Investment Companies. “In the current environment, dominated by daily headlines about the need to raise taxes, it’s not surprising that VCTs remain a favoured investment for those who want to back growing UK companies while reducing their tax bill.”
Are VCTs right for you?
Last year’s VCT fund-raisings totalled £845 million, some way behind the £1.13 billion and £1.08 billion achieved by the sector in 2021-2022 and 2022-2023 respectively. Nonetheless, Chris Lewis, chair of the VCT Association, says the scale of the figure reflects widespread support for the sector. “More than ever, we see entrepreneurs, investors and policymakers aligned on the need to support the high-growth, high-potential firms backed by VCTs.” Clearly, this year’s VCT managers spy an opportunity given speculation about more tax rises to come in next month’s Budget. Several are even offering discounted fees to early birds. But while it’s true that the most popular VCTs tend to sell out relatively quickly – funds limit the amount they raise so that managers aren’t left scrambling to find enough attractive small businesses in which to invest – advisers urge investors to be cautious. VCTs aren’t suitable for everyone. They’re generally a better fit for those who have already made good use of private pension and ISA reliefs – and you’ll need to be comfortable with risk and volatility.
Even if you’re relaxed about risk, a question mark remains. The average fund has delivered a 53% total share-price return over the past decade. While the effective value of that return is boosted by the upfront tax relief, it’s worth putting it into context. The average investment trust investing in UK-listed companies rose 112% over the same period; the average investment trust with exposure to global shares delivered 280%. Choosing the right vehicle is critical. Over those 10 years, shareholders in the best-performing VCT enjoyed total share-price returns of 168%; those in the worst performer lost almost 80% of their money.
Many VCT managers are focused on income rather than capital gains. The average VCT yields 6.9%, with managers often structuring their funds so the proceeds from successful exits from portfolio companies can be used to pay dividends. That 6.9%, remember, is tax-free, making the yield look even more attractive given current low interest rates. Still, Ben Yearsley, director of adviser Fairview Investing, worries VCTs may have become victims of their own success. “Too much money has been raised in the past few years and it is chasing too few high-quality companies,” he warns. “I think investors will need to get used to returns in the region of 5% each year and not the 7%-8% seen previously. Is this enough for the risk? You’ll need to make your own mind up, but without the tax breaks, the answer would definitely be no.”
Yearsley also points out that the challenges – and risks – involved with managing VCTs have grown due to recent tweaks in the rules. Most significantly, the funds are usually now banned from investing in any business that has been trading for more than seven years – limiting them to less-mature enterprises at an earlier stage of growth. That’s in addition to restrictions such as investee companies having to be worth less than £15 million and with fewer than 250 employees. VCTs must also invest 80% of funds raised in qualifying assets within three years.
“I’m still not convinced that VCT managers have transitioned totally successfully to the new, more restrictive rules that mean only younger high-growth companies can receive investment,” Yearsley adds. Brodie-Smith is more optimistic. “In a challenging landscape, VCTs are helping to get ambitious businesses off the ground, and many of these will go on to fuel growth in the UK economy,” she argues.
VCT options
It’s also worth pointing out that VCTs come in several different shapes and sizes, with different risk profiles in each case. The largest section of the market is accounted for by generalist VCTs that invest in privately owned qualifying companies in a wide range of sectors, providing some diversification benefits. There are also specialist VCTs, which focus on one sector of the market – technology or healthcare, for example – and are therefore more exposed to the fortunes of a narrow band of businesses. In the third category, Aim VCTs invest in shares issues by companies listed on the junior market. Although Aim constituents are listed companies, rather than privately owned businesses, some still qualify as VCT investments because of their size and age. These Aim VCTs have performed less well, on average, than other VCTs, delivering only 20% over the past 10 years – but with much less variability.
These variations on the theme at least present investors with plenty of options – and the potential to build a portfolio of VCTs over time. It’s a good idea to begin with a base of generalist VCTs, only adding exposure to more specialist vehicles later on. The key is to do plenty of homework first – or to consult an independent financial adviser with expertise in this area. As Budget speculation continues and some VCTs start to fill up, it may be tempting to rush into a decision for fear of losing out at the hands of the chancellor or other investors. But don’t part with your money unless you can build an investment case for doing so that makes sense in the context of your existing portfolio, your financial goals and your attitude to risk. Tax incentives alone aren’t a good enough reason, in isolation, to embrace VCTs.
Three VCTs to consider now
For investors ready to take the plunge into the VCT market, choosing the right vehicle from the 20 or so funds raising money is vital. We asked Alex Davies of Wealth Club to pick his favoured funds for 2025-2026. Here are his three top picks.
Northern VCTs: “These long-standing VCTs [manager Mercia is raising money for Northern Venture Trust, Northern 2 VCT and Northern 3 VCT] target more established companies with growth potential. Mercia’s sweet spot is regional businesses – more than half the portfolio is outside London and the southeast – in the healthcare and technology sectors. This is an area where Mercia is getting success after success. The latest example is beauty technology firm Beauty Tech Group, which floated at the start of October at a £300 million valuation.”
British Smaller Companies VCTs: “The British Smaller Companies VCTs [British Smaller Companies VCT and British Smaller Companies VCT 2] target business-services companies – a pretty large pond to fish in. The current catch includes some cracking companies, such as financial adviser review platform Unbiased, which is expanding rapidly in the US, and digital special-effects studio Outpost VFX, which has worked on Captain America and Rings of Power.”
Triple Point Venture VCT: “Triple Point aims to invest earlier in a company’s life than many VCTs. At this stage there’s less competition, resulting in lower valuations and potentially higher returns. It is also higher risk, but the VCT mitigates that by making lots of smaller bets before doubling down on the winners. We think this VCT offers investors a distinctive, well thought out approach – with a manager who is starting to develop an appealing record.”
This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
