EIS and VCT Opportunities

Venture capital trusts (VCTs) and enterprise investment schemes (EISs) are often cited as the next port of call after you have used up allowances for pensions and individual savings accounts (ISAs).

But there are some key differences between VCTs’ and EISs’ tax reliefs and investment approaches, so it is important to use the right one for your financial and tax planning needs.

VCTs are listed funds whose shares can be subject to volatility, and trade at premia or discounts to their net asset values (NAV). While this should mean that VCTs are more liquid than EISs, to benefit from the tax reliefs you need to hold VCT shares for five years after you have bought into an issue.

Even then, there is very little secondary trading of VCT shares, so it may not be easy to sell them – and you may get a lower price than you paid for them. EISs are a wrapper within which you directly invest in unquoted companies and are harder to exit.

Although you only need to hold EISs for three years to qualify for all their tax reliefs it is unlikely that you will be able to exit at that point. EIS exits are generally achieved when their managers sell a company, for example via a trade sale. So it could take eight years or longer before an EIS investment is realised.

If you invest in EISs, it is particularly important to have a long-term investment horizon and not to invest money in them that you might need in the short term. VCTs are more diversified than EISs as they typically invest in 30 to 70 companies. Some EISs just hold a single investment and, although some managers offer portfolio EISs enabling you to invest in a number of unquoted companies, typically it is not more than about 10.

VCTs are arguably less risky because the impact of one company failing has less of an effect on their overall returns. But if a holding does well it also contributes less than would be the case with a smaller number of investments.

So EISs have the potential for both bigger losses and gains. VCTs' returns may be more regular, meanwhile, because they can pay a steady stream of dividends and can be considered as more of an income investment.

EISs are very much about growth so, for example, you might receive nothing for years and then a big payout after a successful exit. However, following investment rule changes between 2015 and 2019, the new investments VCTs have been making are more growth-orientated.

EIS investors can claim loss relief at their marginal rate of tax which, with the income tax break, provides some compensation for investment failures. This means that you are less likely to lose all of your initial investment.

VCTs can be a tax-efficient way to save for retirement if you have used up your annual or lifetime pension allowances, and annual Isa allowance. They can be particularly useful for higher earners whose annual pension allowance has been tapered back to between £4,000 and £40,000.

EISs are useful if you have a CGT liability because if you reinvest a gain in an EIS the CGT is deferred. The tax might be incurred, for example, because you have sold a property that is not your primary home, a business, or investments such as shares held outside an Isa or pension.

As ever, this is an area that requires specialist advice.