Since legislative changes in September 2004, merging venture capital trusts (VCTs) has become a more practical option and a way out for too-small and underperforming trusts. But what are the issues VCTs have faced in merging and are we likely to see a growth in such deals?
Last September, new legislation enabled VCTs to merge without losing tax concessions for investors and since then mergers have been done at Chrysalis, Quester and Pennine Aim. The Murray VCTs are also planning to merge, although this appears to have been over-shadowed by the campaign to unseat directors (see news this issue), and the three Singer & Friedlander AIM VCTs are also thought to be considering a union.
Typically it is small and under-performing VCTs within the same ‘family’ that have opted to merge. At technology-oriented Quester, the merger creates a single fund with over £50m of net assets and therefore increased economies of scale. Quester manager John Spooner says it more makes sense to have one fund with a single board and administrative structure than three quoted companies each with their own administration and directors. It also means an increase in the range and diversity of the investment portfolio and improved spread of risk. “But merging three quoted companies is a complicated business and should not be undertaken lightly,” he says, noting that the merger took five to six months.
The Chrysalis VCTs (formerly Downing) were the first funds to merge. VCT chairman Robert Drummond says there are a number of obstacles to any VCT merger, which include getting the VCTs to agree to merger in the first place. “This can be difficult if there are different boards with different ideas or different fund managers or even different valuation methods,” he says.
Issues such as agreeing on how to value the funds, who will stay on or leave the new board and how to get the required shareholder support are all issues that need to be tackled, says Drummond: “At Chrysalis it was made easier by the fact that there had already been a shake-up at the VCTs and a replacement of the fund manager. We had the same directors on each fund, which made getting agreement more straightforward, although they had to agree to take a combined pay cut.”
Bob Barry, partner at law firm Travers Smith, which advised Quester, says there are different legal models for mergers. Deals such as Chrysalis used an ordinary takeover offer by the largest fund of the other funds. While this is relatively simple, says Barry, it does ultimately require 90% of shareholders to approve the deal and it also incurs stamp duty at 0.5%.
Quester used a scheme of arrangement model, which only requires a 75% acceptance rate among shareholders but also requires a court process that can add to the time period and complexity. The actual advisory process can be expensive, says Drummond, as the stock exchange directed that each of the funds be independently advised: “That meant we were dealing with four merchant banks, legal advisers and so on.”
This sort of advice can prove costly, especially compared to the size of some of the funds, as it will not cost much less to merge two funds of, say, £3m each, than two funds of £10m each. At Quester, for example, total costs of the merger were £600,000. At Chrysalis costs were £300,000 plus stamp duty and irrecoverable VAT. “I think our advisers lowered their rate a little because it was a new area they wanted to gain experience in,” he says.
But for Roger Lawson, communications director of pressure group the UK Shareholders Association (UKSA), it is not primarily the costs of merger that are the main obstacle but the interests of the various parties involved. UKSA has been campaigning for more mergers, as a means to improve performance at VCTs.
He says: “If a fund has £3m to £5m the costs associated with being a listed company are excessively high, especially as many use top-flight auditors, expensive offices and so on.” The main obstacles, he says, is are directors who do not want to lose their job and fund managers, who face a lot of work organising the merger and may end up having to negotiate a lower fee with the new entity. “Probably the main barrier is the fear among directors and fund managers of recommending a merger that is rejected by shareholders because then they’ve put themselves out on a limb for nothing,” says Lawson.
Among the larger funds there is less incentive to merge, partly because funds are limited to investing £1m in each portfolio company. Nick Ross, manager of the Electra Kingsway VCTs, says: “We’re launching our third fund and the idea is to go forward with three or four funds, which will allow us to invest up to £4m in one deal with four separate investments.”
Among the smaller and under-performing funds there is likely to be more merger activity, although Bob Barry of Travers Smith believes that in the long term there could be more amalgamation among mature funds. “In the early days the £1m limit means it makes sense to have several funds, so that you can invest more in a particular company, but as the funds mature there could be more incentive to merge,” he says.
It also looks likely that mergers will continue to be focused on funds that have a common management structure. “Hostile takeovers seem unlikely because VCT investment selection and management is such a personal business,” says John Spooner of Quester.
But UKSA’s Roger Lawson, while acknowledging the difficulties, argues that hostile mergers would benefit investors in some funds. “There are some underperforming VCTs where there is no obvious merger candidate within the same manager, so they would need to merge with an outside fund.”