Why the party might be over for venture capital trusts

Is the party coming to an end for venture capital trusts, the tax-advantaged funds launched by the UK government 20 years ago to raise money for UK start-ups? Those in the know are increasingly concerned that VCTs are about to become victims of their own success.

VCTs were launched in the early 1990s amid fears that start-ups with strong growth prospects would struggle to raise the capital they needed to realize their potential. To persuade investors to invest their money in these ventures, VCTs offer a range of generous tax breaks, including an up-front 30% tax break, which reduces the cost of investing, say, £100,000 to just £70,000.

By all accounts, the funds have been a success, raising over £100 billion for immature businesses in need of funding. In line with the risk profile of this type of investment, some of these companies have gone bankrupt. Others have become household names – online real estate agency Zoopla, for example, has received VCT funding. So did travel company Secret Escapes, video game developer Frontier Developments, and internet of things company Simulity.

Now, however, VCTs may be at risk. The Treasury Select Committee has launched an inquiry into the UK venture capital market, including an inquiry into the effectiveness of VCT tax relief. The current VCT scheme is due for government renewal by 2025, but there are growing fears the inquiry could pave the way for ministers not to care - or at least they reduce the tax breaks offered.

"Chances are that April 2025 will see the sun set not only on these popular programs but also on the UK's position as the best place in Europe for start-ups to get funding," warns Alex Davies, CEO of Wealth Club, an adviser who specializes in working with investors in programs such as VCTs.

Why abandon a program that seems to work like a charm? Critics question whether the tax breaks offered by VCTs are too generous - at a time when the government is trying to tighten its belt, could investors be persuaded to pledge their capital without these tax benefits, wonder- they, or at least with a less generous scheme.

It probably doesn't help that VCTs just had a banner year. The industry raised £1.1bn in the 2021-22 tax year, which ended in April; that's more than ever before in a single year. Such a large number seems to have caught the attention of the Treasury, which must be considering whether to fund the program so generously given its popularity.

However, the debate is not simple. One of the reasons VCTs raised so much money last year was because the government made other tax-advantaged savings schemes much less generous, especially for high earners. This has seen savers turning to VCTs in greater numbers.

It's also true that investors need reassurance before investing their money in early-stage companies. VCTs are not sure things - some funds have performed much better than others and investors' money is genuinely at risk. The tax breaks on offer provide a sort of buffer of safety, comforting those who might otherwise balk at the prospect of gambling their money.

Certainly VCT proponents such as Davies believe that many investors would no longer support start-ups in the absence of VCT relief. Wealth Club has published research suggesting that nine out of 10 people would at least reduce their investments in these companies if the tax breaks for CDVs were reduced.

That would be bad news for growing businesses, Davies points out. “Scalable start-ups are the engines driving economic growth and job creation around the world,” he says. "Policymakers should take a longer-term view of these decisions because years of good work could quickly be undone and the UK could lose its status as the start-up capital of Europe."