After two record years of fundraising for Britain’s venture capital trusts (VCTs), the tax-advantaged, high-risk/high-reward favourites among wealthier private investors face a sharp downturn.
Nearly £1.1 billion was raised by the whole VCT sector in the 2022/23 tax year - the second-highest on record following £1.13 billion raised in 2021/22.
Estimates for the current tax year are between £600 million and £700 million, marking a hefty 35% to 45% year-on-year decline, bringing the sector back in line with pre-pandemic levels.
Why such a drastic year-on-year drop?
A cautious market
One prominent fund manager in the space, Albion Capital Group, has laid out a £60 million fundraising target for the year- a 25% decline from last year’s £80 million fundraising result.
“There’s lots of reasons why people might not be looking to invest in growth assets,” said Albion’s managing partner Will Fraser-Allen, who pointed to ongoing market risk and the potential for better returns in fixed-rate markets.
With base rates at over 5%, investors can lock up their cash in interest-bearing accounts or government bonds and get a guaranteed fixed return.
VCTs obviously aim for higher than this (5% above the base rate, in Albion’s case), not to mention the 30% worth of tax advantages effectively mean VCT investors are paying just 70p on the pound for their investments.
Tax-free capital growth is yet another VCT bonus, but still, the market is cautious.
Exceptional gains on the US stock market have taken further attention away from alternative investments such as VCTs, though as previously discussed, the S&P’s 26% rally in the year just gone was heavily skewed by 'The Magnificent 7' handful of Big Tech megacaps.
Stripping out the gains penned by Microsoft Corp (NASDAQ:MSFT), Apple Inc (NASDAQ:AAPL, ETR:APC) et al paints a less rosy picture of the stock market, even if passive index-tracker fund holders are unlikely to care.
The substantial weighting of these few megacaps has rewarded a passive approach to investing, but has masked the fact that attractive valuations can be found elsewhere.
The valuation rebalancing
Putting Big Tech aside aside, company valuations at the grassroots have returned to more sensible pre-Covid levels following the 2021 silly season, according to Fraser-Allen.
Constituents of the Bessemer Venture Partners Nasdaq Emerging Cloud Index, for instance, have returned to their pre-Covid levels of around six times forward revenues after surging as high as 16 times forward revenues in the red-hot, zero-interest rate world of 2021.
This retraction of valuations is evident in the UK small-cap space too.
“We're sitting at a point where the market valuations are sensible,” said Fraser-Allen. “There’s value to be had, rather than at 16-times revenues when you’re valuing an awful lot of the future performance when you’re paying.”
So while VCT fundraising will definitely be lower this current tax year, new capital will be deployed to more fairly priced ventures.
That means they’ll be able to invest in larger stakes, potentially leading to bumper exit opportunities when valuations start to climb again.
Unfortunately, that says nothing to existing investments on the books that have fallen in value.
But while it is unfortunate that, as Fraser-Allen said, “the market is naturally going to be smaller this year”, it’s not something to be “overly alarmist about”.
There is one other positive twist in the current macroeconomic environment - where major corporations are cutting staff left, right and centre - a lot of entrepreneurs are coming out of these large corporations and setting up their own businesses.
Some of these entrepreneurs will doubtlessly be looking to tap the VCT market.
“I think that’s encouraging,” said Fraser-Allen.