Annabel Brodie-Smith, Communications Director at the Association of Investment Companies, looks at how VCT managers are standing up to the Brexit problem
As the Brexit negotiations rumble on and on, the only certainty is… yes more uncertainty over Brexit’s outcome.
Despite a tough year for UK markets as Brexit worries and wider economic uncertainties took their toll, the average VCT returned 2.7% in 2018 and is up 42% and 163% over five and 10 years. VCTs’ perspectives on Brexit are thought-provoking as they are at the coalface of the UK economy, investing in small unquoted companies which could grow to become household names, generating economic growth and jobs. Are managers still finding investment opportunities today and what are the prospects for these companies? And how are the VCT rule changes bedding in?
On Brexit, VCTs’ key concern is the status of Europeans working in the UK after Brexit and whether smaller companies will be able to retain and attract talent. Ian McLennan, Manager of the Triple Point VCTs, said: ‘When it comes to Brexit, the main concern we are hearing from portfolio companies is around people. Tech-related companies in particular often have a significant number of EU nationals in their team.
One portfolio company has reported that they have already seen a 50% reduction in job applications from EU nationals after the 2016 referendum result.’
These worries about the future of European working in the UK are reinforced by John Glencross, Chief Executive of Calculus Capital, which manages Calculus VCT: ‘Where uncertainty is biting is in the status of EU nationals who work for UK companies. Their status post-Brexit needs to be settled quickly.’
Jo Oliver, Manager of Octopus Titan VCT, summed it up: ‘Our single greatest concern when it comes to Brexit is the importance of being able to access talent and the UK continuing to be a leader in innovation and entrepreneurship.’
Brexit contingency plans are being made by companies which are exporting to EU markets. David Hall, Managing Director of YFM Equity Partners, which manages the British Smaller Companies VCTs
explained: ‘What we have seen in our portfolio is those businesses who move physical goods across borders step up contingency planning, which in many cases means finding other ways of getting their goods to overseas markets, for example offshore inspections or quality control centres or final assembly outside the UK. These are temporary measures for now but could be made permanent if needs be.’
Many companies are not so worried about exporting to the EU as they believe it has always been fairly difficult to sell to EU countries. Glencross said: ‘As I look at our portfolio, by and large, exporting to the rest of the EU is not an important market. It has always been difficult for small businesses to sell to other European countries. Even pre-Brexit, the US, Asia and Middle East were more important markets.’
Clearly, technology is helping some companies to take a global approach. Oliver said: ‘Uncertainty isn’t good for any business. However, it does create opportunity for companies that are nimble and adaptable such as early-stage businesses. Many of these are deliberately creating companies that can be global from the start, due to enabling technology such as smartphones and cloud computing.’
It’s too early to understand the long-term impact of Brexit but usually the growth companies that attract VCT funding are global in their approach and adaptable. As Hall of YFM Equity Partners
explained: ‘The ideal business to invest in is one that doesn’t move goods across borders and has a high proportion of business outside the EU. Generally, this is where many of the growth businesses focus and, in reality, trading within Europe for these businesses also comes with less regulatory hassle.’
Hall said there’s less impact on services companies. ‘It’s not quite business as usual, but there is less thought about tomorrow and more about the long term,’ he said.
So looking beyond Brexit, are VCT managers finding investment opportunities in these interesting times? The encouraging response from VCT managers is the British entrepreneurial spirit is alive and kicking. In 2017, the UK had 20 home-grown companies worth over $1 billion, whereas there were just 30 in the rest of Europe. VCTs are continuing to find attractive investments and manage diverse portfolios of companies in a wide range of sectors throughout the UK.
Many of the companies VCTs invest in have environmental, health and social benefits and lead the way when it comes to technological innovation. For example, Triple Point VCTs invest in several of the growing tech innovators in the UK, including Capitalon-Tap which itself uses cutting-edge technology to arrange finance for thousands of UK SMEs. It also invests in a digital health company which uses artificial intelligence to assist NHS GPs and dermatologists in the diagnosis of melanoma skin cancer.
Calculus VCT focuses on healthcare and technology, but also has investments within energy, media, consumer and industrials. It has an investment in an environmental company, Weedingtech, in West London. With increasing concerns over the health impacts of chemical herbicide use, Weedingtech has developed herbicide-free, non-toxic weed control foam. The company has grown significantly and doubled its turnover since Calculus Capital’s first investment in 2016. Users of its product include municipal authorities in New York, London, Munich, Barcelona and many others. Calculus VCT also invest biotechnology company, Synpromics, based in Edinburgh, which is a world leader in the technology surrounding cell and gene therapy. Its groundbreaking patentable technology provides the control mechanisms that direct the activity of cell and gene.
Moving with Rule Change
The other interesting theme to emerge from the VCT industry is the absorption of the ‘new rules’ into VCTs’ investment strategies. This includes the 2015 age limit of investing in companies under seven years old and the ban on management buy-outs (MBOs), as well as the 2018 ‘risk to capital’ condition. While it’s true to say that these rules have pushed VCTs up the risk scale in general, many managers – especially those doing large fundraisings – believe that the effects will be minimal, because they’ve always invested in a way that would be compliant with the new rules.
For those that haven’t, perhaps because they did more MBOs or followed strategies more focused on capital preservation, the new rules have had a number of effects. Fundraisings have generally been smaller. New hires have been made to refocus teams on earlier-stage opportunities. And naturally, investment strategies, including the sourcing of deals, have been reassessed.
It’s important to recognise that not all of the rule changes are restrictive. For so-called ‘knowledgeintensive’ companies, the new rules are more liberal, with a looser age limit and the ability to raise more money from VCTs and EIS.
VCTs’ extensive diversification, together with generous tax reliefs and the ability to access an asset class that’s unlikely to be represented otherwise in clients’ portfolios, are among the key attractions of VCTs. These attractions remain, despite the Brexit worries of attracting and retaining new talent, anxiety over the outcome and the challenges of the new VCT rules. Of course, nothing is guaranteed, and VCTs will always be high-risk. But their 23-year record has demonstrated that the evergreen closed-ended structure is absolutely the right one for this kind of investing, giving managers the maximum amount of control and long-term investors the best shot at a positive outcome.