Choosing a VCT

Over the years the VCT market has expanded and become more diverse. VCTs can now be classified under four main types.

Generalist VCTs invest in a range of companies in different sectors and stages of investment.

AIM VCTs invest in companies that are AIM listed, or about to become listed.

Specialist VCTs tend to invest in just one sector such as technology, healthcare or environmental infrastructure.

Limited Life VCTs also tend to invest in just one area or theme and will look to wind up in the fifth or sixth year. Normally a large percentage of any potential profit from a Limited Life VCT is from the initial tax rebate, so they might appeal to investors looking for a comparatively lower risk VCT.

Getting started

Many investors start with a generalist VCT as this gives them a relatively broad spread of investments rather than targeting a particular area. How should one choose? You have to consider the future, as well as the past. Have the managers got the infrastructure and resources in place to get the best returns? More crucially, are enough companies approaching the managers thereby providing a wide selection of choice?

Good venture capital managers have a wide network of contacts and can gain access to the best deals. It is as much in the company's interests to find a good VCT team as it is for the VCT manager to find a good company. So the track record and reputation of the manager is important to them.

How does a VCT manager choose investments?

Most VCT managers will be approached by hundreds of companies per year, all seeking funding. Of these, the manager may consider between 20 and 40 and will generally only invest in 1 or 2 deals per month - the VCT rules allow up to 3 years to invest the money raised at launch.

The investee companies are normally not quoted on a stock exchange, though some may be listed on the Alternative Investment Market (AIM) and PLUS Markets exchanges. This means that they are higher risk, but they do offer the potential for higher reward.

It is unlikely that VCT investors will have heard of many of the underlying companies. However, every large company has to start somewhere and investing early generally provides higher growth potential. As a private investor you normally wouldn't have access to these companies, but venture capitalists have wide networks of contacts to find these deals. When fully invested, a VCT will typically have 25-35 investments.

The investment process is lengthy and will often take between 3 and 6 months to complete as lawyers, accountants and industry specialists go through the company with a fine tooth comb. This is known as "due diligence" and is an important part of the process. The major reason for this detail is that, unlike investing in a listed company such as BT, an investment in an unquoted company is very difficult to exit if you get it wrong. At least with BT you can always sell your shares through the stock market, regardless of the size of your holding. Additionally, private companies are not required to report publicly as listed firms do, though the VCT managers will insist on receiving regular management accounts.

When structuring a deal the VCT manager will also decide the appropriate balance of equity and loan. Managers have differing policies in this regard but the use of loan stock generally serves to reduce risk as it offers a higher level of protection in the event things go wrong, as well as providing a regular income stream into the VCT. However, by reducing risk in this way it does mean overall returns can be lower compared to taking a higher equity stake.

Limited Life VCTs often operate slightly differently in that they tend to focus on one sector and identify companies to fit around it. There is either a predetermined equity upside with assurances in place (sometimes backed up by physical assets such as property) to partially protect the capital investment, or the investment is primarily a loan to the company. Limited Life VCTs are at the lower risk end of the VCT spectrum, however the loans and assurances are often only backed by relatively small companies.

Depending on the size of investment, the VCT will often be able to nominate at least one director to the board of the company. This gives more influence and access to very detailed management information.

At least 70% of the VCT's money must be invested in qualifying companies. The other 30% can be invested in alternative assets. This may serve to reduce or increase the trust's risk, depending where the manager invests.