Choosing investments

Over the years the VCT market has expanded. Generalist VCTs will invest in a range of companies in different sectors and stages of investment. AIM VCTs will invest in companies that are AIM listed, or about to become listed. Specialist VCTs will invest in just one sector - such sectors include technology, healthcare and promotion of live music events. Finally Limited Life VCTs also tend to invest in just one sector 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.

Getting started

Many investors start with a generalist VCT as this gives them a broad exposure to investments rather than attempting to target a particular area. How should one choose? You have to consider the future, not the past. Have the managers got the infrastructure and resources in place to get the best returns? More crucially, are enough companies approaching these managers therefore providing a wide selection of choice? Only the best venture capital managers with the best reputations are approached by those with the best ideas. 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. The track record of the manager is important to them, how have they performed in the past, have they successfully sold or floated businesses?

How does a VCT manager choose an investment?

Most VCT managers will usually 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 one or two deals per month - the VCT rules allow up to three years to invest the money that is raised at launch. The investee companies are normally not quoted on the main stock exchange but they may be listed on the Alternative Investment Market and PLUS Markets exchanges. This means that they are higher risk but they do offer the potential for higher reward. It is unlikely that most VCT investors will have heard of many or any 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. However, venture capitalists have wide networks of contacts who find these deals. When fully invested, a VCT will typically have 25-35 investments.

The investment process is lengthy and will often take between three and six 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 company such as BT, if you invest in an unquoted company it 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 in such detail as listed firms.

Limited Life VCTs often operate slightly differently in that they often identify one sector and then form companies to fit around an investment. There is either a pre-determined equity upside with guarantees in place 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 guarantees are often only backed by relatively small fledgling companies.

Depending on the size of investment, the VCT will often be able to nominate a director for 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 different assets. This may serve to reduce or increase the trust's risk, depending where the manager invests.