What do Venture Capital Trusts (VCTs), gorillas and basketballs have in common? Until recently I wouldn’t have been able to tell you either. But if you go onto YouTube and search The Invisible Gorilla Experiment, you’ll find the answer.
Over 45 seconds or so, the video asks you to count the number of times a group of people pass a basketball. How many do you count? Around 14 or 15? You’re then asked how many gorillas you saw. Well, none. Watch again without counting the passes and you’ll notice a huge gorilla walks through the group, beating their chest at the camera.
The video was a psychology experiment from the 1990s. It showed that when people are concentrating on something intently, they can easily miss the other things which are going on around them, even if it seems clear the second time around.
What does this have to do with VCTs? Well, in the tax year just passed VCTs raised £731 million. This was the second-highest amount raised by VCTs ever.
VCTs are collective investment funds which provide finance to some of the UK’s most dynamic small businesses. In exchange for the higher risk of backing small, young companies, investors in VCTs are offered tax benefits.
Investors can receive 30% income tax relief on up to £200,000 of new VCT shares providing the shares are held for five years. They will also receive tax-free capital growth and dividends whatever the holding period. Whilst VCT-backed companies start small, they can grow into household names. Zoopla and Secret Escapes received VCT funding.
The £731 million VCTs raised in 2018-19 is actually the highest amount ever raised whilst the level of tax relief has been at 30%. The only time VCTs raised more was when tax relief was at 40% in 2005-06.
So what does this tell us about gorillas and basketballs? Well, whilst the forecast for the UK has arguably been a gloomy one, with Brexit rumbling on, projections of slowing economic growth and UK equities deeply unloved, VCTs have continued to go about their work, backing some of the UK’s most exciting small companies and offering valuable tax-efficient investments for savers.
But how is Brexit affecting VCTs and the UK’s small, young companies? Interestingly it’s not trade that seems to be the main challenge. At a recent VCT event at the AIC, John Glencross, manager of Calculus VCT says “as I look at our portfolio, however, by and large exporting to the rest of the EU is not an important market. It has always been difficult for small businesses to sell to other European countries. Even pre-Brexit, the US, Asia and Middle East are more important markets.”
David Hall, manager of the British Smaller Companies VCTs, agrees. “The ideal business to invest in is one that doesn’t move goods across borders and has a high proportion of business outside the EU. Generally, this is where many of the growth businesses focus and, in reality, trading within Europe for these businesses also comes with less regulatory hassle,” he says.
Some VCT managers argue that potential trade restrictions have actually presented opportunities for some young companies. Jo Oliver, manager of Octopus Titan VCT, says “uncertainty isn’t good for any business. However, it does create opportunity for companies that are nimble and adaptable such as early-stage businesses. Many of these are deliberately creating companies that can be global from the start, due to enabling technology such as smartphones and cloud computing.”
The area where VCT managers were most worried about Brexit was in being able to access talent. Ian McLennan, manager of Triple Point VCTs says “the main concern we are hearing from portfolio companies is around people. Tech-related companies in particular often have a significant number of EU nationals in their team. One portfolio company has reported that they have already seen a 50% reduction in job applications from EU nationals after the 2016 referendum result.”
Jo Oliver agrees. “Our single greatest concern when it comes to Brexit is the importance of being able to access talent and the UK continuing to be a leader in innovation and entrepreneurship.”
Despite this medium-term challenge, VCTs are finding many entrepreneurial UK companies to back in areas as diverse as healthcare, technology, education and the environment. Ian McLennan explains that “Triple Point has funded several of the fastest growing tech innovators in the UK, including Capital-on-Tap which itself uses cutting-edge technology to arrange finance for thousands of UK SMEs. We have also invested in a digital health company which uses artificial intelligence to assist NHS GPs and dermatologists in the diagnosis of melanoma skin cancer.”
Investing in technology-enabled companies is a theme for Jo Oliver too. “One example is the artificial intelligence-powered language learning app, Memrise, which has grown rapidly to more than 35 million users, while another is Sofar Sounds which hosts intimate music events in cities across the globe every month.”
The support VCTs provide businesses creates powerful economic benefits for the UK. An AIC study showed that every £1 million of VCT funding increased an investee company’s turnover by an average of £2.2 million and that 27,000 jobs had been created since the start of VCT investments, an increase of over 100%.
From speaking to VCT managers, the level of innovation taking place in the UK’s small and medium-sized enterprises makes the outlook for VCTs a very promising one, and VCTs’ investment activity remains strong despite the Brexit uncertainty, as evidenced in the record fundraising.
It just shows – sometimes it’s best to not have your eye on the ball.