Venture capital is an excellent option for early-stage businesses seeking the funding to grow, introducing working capital into their operations and establishing themselves in the market.
If you are pursuing venture capital, you may face struggles. The rejection rate is high, with only 1 in 2000 reportedly receiving investment. It’s also a notoriously hard source of funding to obtain, with reliance placed on having the right connections and meeting the criteria a venture capitalist asks for.
Due to the limited acceptance rate of venture capital, it’s vital to search around various providers until you find the one most likely to invest in your business. During this search, you may come across a venture capital trust.
We explain what a venture capital trust is and how it can support your business in your funding journey.
- What is a venture capital trust?
- Types of trust
- Who do venture capital trusts work with?
- Things to consider
What is a venture capital trust?
A venture capital trust (VCT) is an investment company that aims to invest in UK SME businesses. They will be listed on the London Stock Exchange.
The main benefit for VCTs when investing in SMEs is that they receive tax benefits. The government offers these to encourage investment while counteracting the high risk associated with the companies the VCT will be funding.
Tax benefits include up to 30% Income Tax credit on investments of up to £200,000 each year for those who choose to invest in a VCT.
While all VCTs will share the aim of investing in SMEs, they may vary in their strategy, depending on the type of trust. Knowing the difference will help you to understand the potential relationship they may seek with your business.
Types of trust
Generalist VCTs. This applies to most VCTs. Typically, these will invest in unquoted businesses across many sectors. The specific category of companies they choose to back will vary between trusts, with some choosing to pursue early-stage enterprises, others focusing on more developed ventures.
Investment from generalist VCTs will come from a mixture of preference shares, loan notes and equity. By using preference shares and loan notes rather than just equity, investors are able to generate greater reward and security as they rank ahead of ordinary shareholders.
These VCTs will often appoint a non-executive director to your company’s board, assuming they are a substantial shareholder. This gives them an active role in tracking their investment and guiding the business, steering them towards a profitable exit through share sales or a stock market listing.
AIM VCTS. AIM VCTs focus exclusively on companies listing on AIM, a sub-market of the London Stock Exchange for smaller, more risky companies with high growth potential. The leaders of such VCTs tend to be experienced in fund management rather than private equity.
Investment tends to be made through ordinary shares, and, unlike generalist trusts, they do not typically seek representation on the company board.
As ordinary shares will shift in value, AIM VCTs carry a higher risk. However, they are also more flexible as ordinary shares can be more easily sold in the market, making for a quicker exit for an investor who wants to move on.
Who do venture capital trusts work with?
If you want to work with a venture capital trust, you must meet the correct criteria.
Firstly, VCTs tend to work with small or early-stage companies looking for funding. These companies must be either unquoted or listed on AIM (depending on which type of VCT you want to work with).
Most VCTs will be unfazed by risk, so it’s an option for businesses that have been rejected for funding elsewhere. However, you must offer a high reward through solid business potential and predicted return on investment. Only this will offset the risk posed to investors and convince them that supporting your venture is a good idea.
Any new investment made by a VCT must go towards companies seven or fewer years away from their first commercial sale. This rises to 10 years for knowledge-intensive companies. This means you have time to mature as a business, but you must be confident that you will be operating successfully and viably in a matter of years.
Specific VCTs will have additional conditions they need a business to meet, but it might be worth pursuing this funding source further if you meet the above.
Things to consider
If you believe you would be a good fit for VCT funding, there are a few things to consider before you progress further.
Firstly, working with a VCT is usually long-term. This means you need to be prepared for a relationship with them over several years, during which time they may influence your business (especially if they appoint someone to your board). They will benefit from any dividends that are paid and by their investment your shareholding will be diluted, so you must be prepared for this.
It’s also worth emphasising that VCTs will only work with companies that offer high growth potential. This means you must be able to convince investors of your value and ability to generate a profit. You will need to have a strong business plan to do this.
Conclusion
While venture capital can offer great added value to high growth businesses through larger funding rounds and helpful guidance, it can be hard to find and close a deal. To stand the best chance, you need to reach out to various providers, which may include VCTs.
There are benefits to using VCTs, especially given the tax rewards that can make investors more open to supporting higher risk businesses, such as yours, and raise your funding substantially. However, you need to be prepared to relinquish shares in the process, alongside accepting the outside influence of VCT representatives on your business decisions.
You also need to ensure you meet the strict criteria requested by the VCT and prove your long-term potential. If you feel you can do this, working with a VCT might be an ideal solution for you.
If you are pursuing venture capital for your business, we can put you in touch with appropriate contacts and support you on your journey, including venture capital trusts and other firms.