What it means
The trust itself is run by professional fund managers, who select the small companies, monitor them and eventually sell the holdings. Investors buy shares in the trust, not in the underlying businesses, and the trust shares can be traded on the stock exchange like other listed shares.
The tax reliefs are the main attraction. Typically they include a reduction in income tax for new shares held for a minimum period, and tax-free dividends, although the exact rates, limits and holding periods are set by the government and can change.
Anyone considering an investment should read the current rules rather than rely on a general description. The reliefs exist because the underlying companies are risky.
Small unlisted businesses can fail, can take years to produce returns, and are hard to sell quickly, so the government offers a tax incentive to encourage capital to flow towards them. Trust shares often trade at a discount to the value of the assets they hold, and selling can be difficult because trading volumes are thin.
Charges are also higher than for a typical index fund, with annual management fees and sometimes performance fees reducing the return. For a non-finance reader, the key idea is that tax relief should never be the only reason to invest.
The reliefs reduce the cost of taking the risk, but they do not remove it, and a poor investment with generous tax relief is still a poor investment. Because the trust is listed, its price moves with market sentiment as well as with the value of its underlying holdings.
Investors should therefore look at both the share price and the net asset value (the value of what the trust owns, less what it owes) when judging performance. A gap between the two is common and can persist for years.
In practice
Real-world examples.
Example
A senior manager who has already filled her pension allowance puts $20,000 into a trust to claim tax relief. She understands that she must hold the shares for the minimum period, or the relief may be withdrawn. She also accepts that the investment is for the long term, because the money may be tied up for years.
Example
A retired business owner buys trust shares for the tax-free dividend stream. His adviser reminds him that the dividends are paid from the trust's gains and income, and they may be irregular rather than guaranteed. He balances the income against the fact that the underlying companies are risky and hard to value.
Example
A financial adviser compares a trust charging 2.5% a year with a global index fund charging 0.2%. She explains that the trust must earn considerably more before fees to match the index fund's after-tax return for her client. The comparison shows that fees can erode the benefit of tax relief if returns are modest.
Formula
Calculation
Net cost of investment = amount invested x (1 - income tax relief rate)
The relief rate is set by the government, so this example uses an assumed rate of 30% purely for illustration. An investor puts $50,000 into new trust shares. The relief is 50,000 x 0.30 = $15,000, so the net cost = 50,000 - 15,000 = $35,000. If the shares later fall in value by 20%, the holding is worth 50,000 x 0.80 = $40,000, which is still above the net cost of $35,000. If they fall by 40%, the holding is worth $30,000, which is a loss of $5,000 against the net cost.Case study
Seen in the real world.
Foxglove Growth VCT is an illustrative, fictional trust that raised $40,000,000 from about 2,000 investors. It invested in 18 small companies, including a software developer, a craft brewery and a medical device start-up.
Within five years, four of the companies had failed, ten were growing slowly, and four had been sold for gains well above their cost. The manager sold the winning holdings and paid out part of the proceeds as a tax-free dividend.
The illustrative lesson is that results were uneven, as expected for early-stage investing. Investors who had spread their money across several different investments, and not only this trust, were better placed to absorb the failures.
Watch out
Common mistakes.
- Investing mainly for the tax relief and ignoring the risk that the underlying small companies may fail.
- Selling the shares before the minimum holding period ends, which can mean the income tax relief is repaid.
- Assuming the shares can be sold at their stated asset value, when they often trade at a discount and can be hard to sell.
Questions
People also ask.
Who can invest in a Venture Capital Trust?
Generally UK taxpayers over the age of 18 can, but the tax reliefs only help people who pay enough UK income tax to benefit.
Is a Venture Capital Trust the same as a venture capital fund?
No, a trust is a listed company with specific tax rules, while a typical venture capital fund is a private partnership open to professional investors.
Can I lose all my money?
Yes, because the underlying companies are small and risky, so you could lose some or all of what you invest.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related