BESs were intended to help small and risky ventures raise money, not from banks but by share subscription from private investors. Instead, most were set up to invest into rentable property, including campus accommodation for students.
The regulation of VCTs reflects the lesson learned from the failure of BESs to help high risk, hi-tech enterprises find investment backing. The risk should not be under-estimated: as from June last year, VCTs cannot be "asset backed" or "protected". This makes any VCT investment risky.
In return, you can put as much as pounds 100,000 in a year into one or more funds, and can benefit from four tax breaks, two on income and two on capital gains. All dividend income from VCT shares is tax free. If buying into a new issue, you can claim back 20 per cent income tax at the lower rate of the amount you invest.
All capital gains on VCT shares are also tax exempt, but more than this, you can roll over any liability for capital gains tax (CGT) on shares just sold by re-investing the gain into a VCT.
Moores Marr Bradley (MMB), a firm of independent financial advisers specialising in helping accountants shelter their clients' money from tax, offers the following example of VCTs' tax generosity. Suppose you are a high- rate taxpayer, selling shares which originally cost pounds 100,000 for pounds 206,500. After deducting the original cost, plus an indexation allowance of, say, pounds 10,000, and the annual CGT exemption of pounds 6,500, there would still be a chargeable gain of pounds 90,000, on which the assumed liability would be pounds 36,000.
By investing the whole gain of pounds 90,000 into a VCT, any capital gains liability is deferred until the VCT is sold.
Claiming the 20 per cent income-tax rebate, you have already made pounds 18,000, adding this to your existing share portfolio. You have already sheltered pounds 36,000 from the tax man and, in theory, you have turned pounds 90,000 into pounds 108,000.
The catch is that to qualify for two of these tax breaks - the 20 per cent rebate and CGT roll over - you must hold the VCT shares for at least five years. This would not be much of a catch except for the inherently risky nature of VCT investment.
Gareth Marr, managing director at MMB, says: "VCTs may not be suitable for everyone. The job of any adviser is to look very carefully at the client's needs to determine whether this investment fits. If it does not, you have to be prepared to advise against a VCT, no matter how attractive the tax incentive. If it does fit, you also have to be prepared to research the market extremely carefully to find the right VCT."
Martin Churchill, director of research at stockbroker Allenbridge, adds: "Comparing VCTs to say PEPs is like putting together chalk and cheese. When you buy into a VCT you are lending your money to a team who may only be investing into 15 or 20 small companies, appointing and removing board members, seeing management accounts on a monthly basis."
By comparison to traditional fund management, this is hands-on stuff, with annual investment into any one company by the VCT limited to not more than pounds 1m, and the average running at pounds 733,000. It also calls for particular skills on the part of those running the VCT.
Allenbridge specialise in analysing VCT performance, and Mr Churchill warns: "If you are thinking about investing into one, look closely at the management's track record on deal making. The key factors are that they be consistent, used to doing deals of the right size and frequency, and spread the exposure of investors' funds across both companies and business sectors."
Because VCTs are intended to provide start-up capital, they are not allowed to invest into shares which can be traded on main stock markets. The only exception to this are shares traded on the Alternative Investment Market (AIM), itself set up to provide a market for shares in small firms.
This means that VCT funds may have difficulty finding buyers for shares they hold. At present, there are only some 12,000 VCT holders, by comparison with about 3.3 million PEP owners. Total funds under management have a value of pounds 370m, with new issues this year looking to top this up by at least pounds 150m. This is a lot of new money to flow into a limited market, potentially forcing up the price of good deals,
Past performance might serve as a guide, but for the fact that most existing funds first issued shares in 1997. Although VCT share prices are quoted and tradable, there is no incentive to sell within the five-year term.
For those still tempted, Close Brothers is looking to raise pounds 10m for a fund investing only into AIM-listed shares. The company already manages some pounds 62.8m of VCT funds. Murray Johnstone also runs existing funds of around pounds 55m, and are looking to raise a further pounds 40m for a general VCT.
Size isn't everything, but it implies diversification of risk. Murray Johnstone's existing VCT funds are invested across 12 industry sectors, with average exposure per sector of less than 10 per cent of total fund value.
This new generation of VCTs is packaged to look much like other retail financial products. Don't be deceived. These are not replacement PEPs, but investments of a riskier nature. Invest only what you can afford to lose.
Allenbridge is offering readers of `The Independent' a free guide to VCTs. Call 0171-409 1111. Moores Marr Bradley offers a short pamphlet on the same subject. Fax the company on 01908 690369 to receive a copy.
spotlight on: M&G's index-tracker pep
The product: M&G's Index Tracker personal equity plan (PEP).
The deal: Invest a minimum of pounds 50 a month and M&G's managers will use it to track the fortunes of the FTSE All-Share index.
Plus points: The FTSE All-Share has risen by 19 per cent over the past year, to the end of January. This is much better performance than most active fund managers. None of the money will go to paying "star" fund managers excessive fees to underperform the index.
If used within a PEP, the fund comes with "ISA-bility". This means it can switch without penalty into another vehicle which will replace the PEP in April 1999, the Individual Savings Account (ISA).
Taking up this investment will cost little. There is no initial charge, which elsewhere can come to 3 per cent of the investment. There are also no exit fees, which punish investors for needing their money sooner than they thought they would. There is only a 0.75 per cent annual management fee. This is less, for example, than Virgin's tracker PEP.
Drawbacks and risks: This is an unusual departure for M&G, which has no experience of running tracker funds. But it's "value-driven" approach has been troubled by poor performance until very recently.
It has farmed out the day-to-day management to State Street Global Advisors, which does manage over $140bn of tracker fund money.
Annual management charges could be cheaper. Legal & General charges just 0.5 per cent a year. Buy L&G's identical tracker through a discount broker and you could even end up being paid pounds 60 to set one up.
But the main worry is the "Duke of York" objection to all trackers: when they're up, they're up, and when they're down, they're down. They have no way of mitigating the downside if the market slumps.
Graham Bates, of Leeds-based financial adviser Bates & Partners, criticises M&G for promoting the product to first-time, "unsophisticated" investors. "It's all very well looking at how much a tracker can rise. But you will also get the full whack of any losses."
Verdict: As long as there are cheaper trackers around, why bother with this one?
Marks out of five: Two and a half - because unlike some other trackers, there are no exit fees.