Does the board of a VCT have a role? Richard Hargreaves, chief executive of Classic Fund Management, investigates
A venture capital trust (VCT) is a public company and, like all public companies, is governed by stock exchange and corporate governance rules.
VCTs are similar to investment trusts in many respects and, just like them, usually have a separate manager responsible for making and monitoring investments. Stock exchange rules also require a VCT to have a board with a majority of directors who are independent of that manager, as with any investment trust. In the City's good old days, this was not the case and investment houses used to stuff investment trust boards with 'friends' to reduce the risk of the trust being taken over. This sometimes led to behaviour that was in the interests of the manager rather than the shareholders.
There are two areas where the independence of the board is crucial. First, while the manager will probably initiate the launch of a new VCT, it is the board that controls the manager's contract. If the board is unhappy with performance, it has the power to terminate the contract and appoint a new manager. It therefore has hire and fire responsibility and power.
There is only one case of a real change at this point in VCT history and that is Gartmore VCT. In the five years since that VCT was launched, the ownership of Gartmore changed twice and the VCT became of less and less interest to the house.
Last year, the Gartmore VCT also had the dubious privilege of being the worst performing VCT of all. Officially, Gartmore decided to resign as manager and the board sought a replacement. In due course, Elderstreet Investments was appointed and the VCT was renamed Elderstreet Millennium VCT. The second area where independence of the board is crucial is because most VCTs have a fee structure whereby the manager receives, say, 2% per annum of the value of the underlying assets.
In most VCTs, the majority of their investments are unquoted companies that are valued according to British Venture Capital Association Guidelines.
These are guidelines not rules and the central tenets are consistency of valuation and disclosure. As a result, there remains plenty of room for subjective judgement and managers have a clear conflict of interest as their income depends on the valuation of the investments. In a number of VCTs, the board formally makes the investment decisions following a recommendation from the manager.
In these cases, the board's input on the merits of an investment is of great importance and the skills of the board need to reflect that. In other cases, the board does not make such decisions and the manager has complete discretion unless there is a conflict of interest.
By now, it will be clear that the board of a VCT has an important role. So who chooses the board and what skills are required?
The initial board will be blessed by the VCT sponsor and the stock exchange but the reality is that the nominees probably come from the manager or the promoter.
It is not uncommon for one or two members of the manager's team to be on the board and this is generally seen as acceptable as long as the majority are independent.
The approach to proposing directors that we adopted at Classic Fund Management is that at least one member should already be familiar with the issues of running VCTs or investment trusts. At least one member should also be familiar with making, managing and valuing unquoted investments.
Others need to bring something of value such as their experience of particular investment sectors.
Last but not least, the board needs to be able to work together as a unit despite the members having the right to express independent views.
To illustrate our approach I will describe the thinking behind the appointment of each of the independent directors of I-NET VCT, a technology VCT that we manage.
l Clive Parritt (Chairman) is formerly chairman of Baker Tilly and a very experienced director of investment trusts (Herald) and VCTs (Baronsmead 2, Downing Classic, Downing Classic 2 and Downing Classic 3).
l Chris Kay is an ex-31 executive and runs the Elderstreet VCTs, so he has a great deal of experience of unquoted companies and their valuations.
l Henry Beker is the founder and former chairman of Baltimore Technologies, a highly successful technology company. He now invests in young technology companies on a personal basis and so has closely relevant experience.
l Julie Baddeley was, until the takeover by Barclays, the executive director of the Woolwich in charge of e-commerce and information technology and so has experience of the big company perspective on the sectors of interest to the VCT.
In our view, this has given I-NET invaluable experience additional to that of the management team, which is of particular value as the whole board is involved with investment decisions.
Finally, a healthy feature of most VCTs is that the independent directors do invest their own money on the same terms as other shareholders so that the interests of the two parties are aligned.
This contrasts with the BT non-executives, some of whom have been the subject of recent criticism for not investing in that company and 'sharing the pain' of the shareholders as the shares have fallen over the last twelve months.
Careful choice of independent directors does not guarantee success any more that the manager's past track record. But it is very helpful in ensuring that the VCT is well run in the interest of the shareholders. It also demonstrates that the people behind the VCT, namely the manager, promoter and sponsor, are serious about performance and not just earning fees for themselves.
For these reasons, when investment in a VCT is being considered, the board should get more than just the cursory glance most advisers and investors give it.
In my view, an important part of the assessment of a new VCT is to ask questions about the board and why each member has been chosen.
The board of a VCT has a high level of responsibility and its members need to be clearly capable of fulfiling that responsibility of behalf of the shareholders.
Stock exchange rules require a majority of VCT directors to be independent of managers.
In many VCTs, board formally makes investment decisions on recommendation of manager.
In most VCTs, independent directors invest own money on same terms as shareholders.
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