A Venture Capital Trust (VCT) is a company whose shares trade on the London stock market, just like Barclays or Shell. However, rather than banking or energy, a VCT aims to make money by investing in other companies. These are typically very small companies, which are looking for further investment to help develop their business.

This is a vital area of the economy, and without funding from venture capitalists many companies we consider household names would never have been able to grow their businesses.

Who do VCTs invest in?

VCTs invest in small, fledgling companies, typically around 20 such businesses, in need of capital. HMRC rules require that now at least 80% of a VCT's assets are invested in 'qualifying holdings'. There are rules surrounding what constitutes a qualifying holding, but the main ones are that the company must not have net assets of more than £15m, and must have fewer than 250 employees.

Benefits of a VCT investment.

To encourage investment in this crucial area, the government offers generous tax benefits to investors, including tax relief of up to 30% when investing. Tax rules can change and any benefits depend on personal circumstances.

Profits are generally paid to VCT investors as tax-free dividends, which are the primary source of return for VCT investors. The VCT manager will also provide expertise to help their chosen firms expand and provide better returns for their investors. They normally look to sell their share of the business three to seven years after investing and reinvest the capital in the next opportunity.

Investing in this dynamic area makes VCTs an exciting investment proposition, but it also means they are inherently higher risk, as smaller companies can be prone to failure. VCT shares are difficult to buy and sell – the market price may not reflect the value of the underlying investments. The value of the shares will fluctuate, income is not guaranteed and you could get back less than you invest. VCTs are therefore aimed at wealthier, sophisticated investors who can afford to take a long-term view. The prospectus of each VCT will give full details of the risks and should be read thoroughly before making an investment.

Different types of VCT.

Generalist VCTs - the most common, and the most popular with investors. They invest in a broad range of companies in different sectors and at different stages of development.

AIM VCTs -  invest predominantly in companies listed on AIM, or those which are about to list on AIM.

Specialist VCTs - tend to invest in just one sector, such as technology and are becoming less common.

Limited Life VCTs - designed to be lower risk and lower return than other VCTs and aim to wind up and distribute assets to shareholder five to seven years after launch, although there are no guarantees.

If you sell your VCT shares in the first five years you will have to repay any tax relief you have received. Furthermore, because there are very few buyers and sellers of VCT shares in the secondary market, liquidity is poor. This means that the price you can obtain often doesn't reflect the value of the underlying assets.

Please also see our previous article on 'Why consider a VCT investment for an ISA.'

If you would like to find out more about VCTs, or want to discuss the issues raised, please contact your Dentons Wealth Independent Financial Adviser.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.