Investment extra: How to gain from VCTs

Among the less well known are Venture Capitalist Trusts (VCTs) – tax-favoured investment funds that buy stakes in fledgling firms.

VCTs are companies whose shares trade on the London stock market.

They make money by investing time and money in small ventures looking to develop their business.

They typically invest in 25 to 35 companies each with assets less than Ј7m.

They are aimed at investors who can afford to take a long-term view – at least five years – and who are prepared to accept that not every small company will be a winner.

There are three main tax concessions to help attract new investment into these companies of the future – but you must hold your investment for at least five years to benefit from them:

• a 30% refund on your income tax on any money you put in – so invest Ј10,000, and Ј3,000 will come off your bill;

• no liability to higher rate tax on any dividends; and

• no capital gains tax on any gain.

Private investors can get a stake in a VCT with a minimum of between Ј3,000 and Ј10,000.

The trusts are currently yielding around 5% a year. The maximum you can put in under government rules is Ј200,000 a year.

Last tax year 68 of these tax-efficient funds raised Ј340m, says the British Venture Capital Trust Association, while this year they are expected to raise around Ј300m.

The expertise of the VCT manager is crucial. They provide both capital and advice to the company as it grows.

Once the company is established in a few years time, it will float the business on the stock exchange or sell it for a profit and move on – and that's when you make your gain.

Ben Yearsley, head of VCTs at advisers Hargreaves Lansdown says: 'It's the manager's expertise and track record that's important rather than the sectors that the VCT is investing in.'

Adrian Lowcock from Bestinvest, which specialises in VCT advice, agrees: 'You need to pick a trust with a good manager, and good track record and well diversified with at least 20 holdings.'

Matrix and Baronsmead, he says, have proved themselves good managers among general funds which invest in unquoted companies in a wide variety of sectors and stages of development.

A specialised fund will pick companies in just one sector while an AIM fund picks companies listed or about to be listed on the junior Alternative Investment Market.

Some trusts are 'asset-backed' which means they invest in businesses which own property such as hotels and restaurants.

As a result they can be less risky but less rewarding and you can come out with just the tax rebate as a gain.

You can sell your shares on the stock market but they can be illiquid and the funds are not traded every day.

A good manager will run a buy-back policy so you can sell your shares easily.

'This is very important,' says Adrian Lowcock. 'There is no point in having your VCT trading at a 30% discount to the value of its assets when you come to sell. If this happened you would gain nothing from the tax benefits on the scheme.'

Ben Yearsley adds: 'These funds are not suitable for everyone. They are designed to pay out profits only when the stakes are sold, so you must invest for five to ten years plus.

'Consider them only when you've used your Isa allowance and have paid into a pension.'

Charges taken by VCT managers vary but typically there is an annual charge of 3% and initial charge of 5.5%. And there could be performance fees on top.

You can get a discount on the initial charge by buying through some independent financial advisers such as Hargreaves Lansdown, Bestinvest and Chelsea Financial Services.

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