VCT Report 2011

According to the findings of the latest research report from our sister publication Business XL, proposed rule changes for venture capital trusts (VCTs) should be good news for small, growing companies and investors alike. Andrew Hore reports.

VCTs have been around for 16 years, and they offer investors the chance to claim 30 per cent of their investment against their income tax bill, as well as tax-free dividends and tax-free capital gains on disposal of VCT shares if they are held for at least five years. Up to £200,000 can be invested by an individual in VCTs each tax year.

In 2006, the Treasury reduced the range of investments that could be made by changing the VCT rules, including cutting the maximum number of employees in a qualifying company and reducing the maximum amount of gross assets that a qualifying company could have in its balance sheet. 

The older funds were still able to invest their original funds under the old rules but newly raised cash had to be invested under the tighter rules. That is why some companies that raise cash via VCTs can issue two tranches of shares on consecutive days. The first is under the current rules and the other relates to pre-2006 VCT funds which are invested when the company is no longer qualifying for newer funds – normally because gross assets have gone over £7 million. Diagnostics firm EKF Diagnostics and interactive telecoms software supplier Netcall both raised money this way last year.

Another AIM company that has tapped VCTs to help it raise cash to expand is Green Compliance. Its shareholder base includes VCT fund managers ISIS (Baronsmead), Artemis, Unicorn and Amati. In the past year Green Compliance raised £9.1 million in two separate fundraisings to finance acquisitions in the water, pest control and fire protection compliance sectors. So far, 11 acquisitions have been made in around one year. This has enabled Green Compliance to become the number two in the water hygiene compliance market in the UK. A business that generated revenues of less than £1 million 15 months ago is now making annualised revenues of £24 million and is highly profitable.

Ringing the changes
In the 2011 Budget, chancellor of the exchequer George Osborne tabled proposals that make VCTs and EIS as attractive as they have ever been.
There are three key changes in the Budget proposals:

• The maximum number of people that a qualifying company can employ has been increased from 50 to 250 – back to where it was previously.
• The maximum gross assets figure, below which companies qualify for VCT investment, has been increased from £7 million to £15 million – also back to the old levels. This gross assets limit is measured prior to the raising of new money.
• The amount any single company can receive in a 12-month period is rising from £2 million to £10 million.

These rule changes are due to come into force at the beginning of the next tax year, in April 2012. This is not quite a done deal, though. The EU still has to approve these proposals under the EU State Aid regulations. This has taken a long time to achieve in the past but Chilton Taylor of accountant Baker Tilly believes that it will be different this time. ‘It did take three years to get previous approvals,’ he admits, but he puts that down to the Treasury ‘not dealing with it in the most expedient manner’. He says that the government is already doing a lot of work with Brussels and he thinks that it has learnt its lesson and deliberately given itself a year to sort everything out.  

‘I was not surprised by the rule changes because the case for making them was so compelling,’ says Dr Paul Jourdan, chief executive of Amati Global Investors, which runs three AIM VCTs.

Trevor Hope, chief investment officer of Beringea, the manager of the ProVen VCTs, says that the ‘change in the rules is a step in the right direction’.

Andrew Garside of ISIS, which manages the Baronsmead VCTs, says that the change to employee numbers is ‘the most critical change’. One of the main points of the VCT scheme is to help businesses to grow and employ more people. Yet the rules meant that the companies were penalised if they did take on more employees because it was more difficult to raise additional cash to expand further. If a company runs restaurants or provides cleaning services then they will have a lot of employees and be blocked from obtaining VCT investment under the current rules.

A previously agreed rule change that could shift the focus of VCT investment covers where the company generates its revenue. In the past, a company had to be headquartered in the UK and be deemed to be doing a majority of its business in the country. ‘Companies can now invest VCT money anywhere in the world,’ says Chilton Taylor. ‘This is good for UK companies expanding internationally,’ he adds

There are mixed feelings among VCT managers about this change. They recognise that it provides additional investment opportunities but some are cautious about making full use of this new rule because they believe it is against the spirit of the scheme and believe they have an obligation to the UK taxpayer to develop UK businesses with the cash raised by VCTs.

In theory, a company can set up a head office in the UK but have none of its operations in the country and be a VCT-qualifying investment.

In the money
Figures from the Association of Investment Companies (AIC) show that VCTs raised £365 million in the 2010-11 tax year, which was slightly higher than the £344 million raised in the previous tax year. That represents the fourth-highest amount raised in a single tax year, although it is less than half the amount invested in VCTs in 2005-06, when the tax perk was even more generous – 40 per cent of the investment could be set against an income tax bill.

The majority of that cash went into generalist VCTs and many of those VCTs have a limited life. Solar-focused VCTs raised £58 million in 2010-11 even though the government scuppered their plans to raise more by reviewing feed-in tariffs at the time of the tax year when most people are considering VCT investment to offset their tax liabilities.

A total of £29 million was raised by AIM-focused VCTs in 2010-11. That is a small percentage of the total but it was still the most raised by AIM VCTs since 2006-07. Because of the changes in regulations a few years ago, which narrowed the range of potential investments, it has not been worth launching new AIM VCTs, according to Dr Jourdan. The latest proposals may provide an opportunity to launch new AIM VCTs.

 All VCTs can invest in AIM and PLUS-quoted companies, as long as they satisfy the qualifying investment criteria, but the majority of VCT investment is in companies that do not have a quotation of any kind.

There are 17 AIM-focused VCTs – plus an additional class of ‘D’ shares in Downing Distribution VCT 2. After recent fundraisings, these AIM VCTs have total assets of £385 million, including nearly £40 million in cash. That is equivalent to around eight per cent of the £518 million in cash that all VCTs hold, according to Business XL’s latest VCT Report. VCTs have to invest 70 per cent of their assets in qualifying investments so the majority of this cash should be finding its way into AIM-quoted or other qualifying companies.

The performance of the AIM VCTs is mixed to say the least. Some of the better performers are those AIM VCTs that have changed their manager.

The government is consulting on VCTs this summer, while draft legislation is planned for the autumn. ‘Everyone should take note of this,’ says Chilton Taylor. ‘The government has been given a message that these schemes are important’ because they provide capital for a size of company, generally up to £25 million, that finds it difficult to raise cash to expand.

Outstanding opportunity
Dr Paul Jourdan of Amati says that he does not normally invest in pre-IPO businesses but he was impressed by technology business Ubisense. ‘Every now and then we see something outstanding,’ he says. That is why Amati-managed VCTs bought shares in Ubisense’s £5 million fundraising in November 2010, which was a precursor to the AIM flotation in June.

Ubisense already had £15 million of sales in 2009 and the management had a strong track record; there was also a good customer list. The cash was required to increase the company’s sales capability in order to grow faster. Ubisense also wanted finance to help enhance its relationship with Atlas Copco, the global machine tools company, with which it was launching location systems for production lines. This relationship has already borne fruit, helping win orders from GM, Toyota, VW, Fiat and Honda.

Ubisense supplies real-time location systems that enable companies to track people and assets. The systems can be used to analyse data and improve efficiency. The Real-Time Location Systems division can help manufacturers track tools, people and vehicles in factories and other buildings more accurately than satellite-based systems. The system uses wireless tags that transmit positional data to receivers nearby. BMW is installing the technology on its Mini production line and at its Chinese factory.

The geospatial division provides software and systems for the utilities and telecoms sectors, helping customers such as Deutsche Telekom map their network assets and providing network management planning and design services. 
VCT funding was not vital to the pre-IPO funding because it was heavily oversubscribed, but Dr Jourdan says that having a VCT on the shareholder list ‘gives a very stable shareholder base’. Ubisense knows that VCTs will not just sell out at the first opportunity and that they will be long-term holders.

Amati’s initial investment was ‘with a view to add further shares’. Amati bought an additional 410,555 shares in the AIM placing of new shares, which raised £4.2 million, after expenses of £800,000, at 180p a share. This took the stake of Amati’s three VCTs to 3.5 per cent of Ubisense.