In his November 1993 budget, the chancellor unveiled a proposal to set up a new type of investment vehicle called a venture capital trust.This aims to encourage the channelling of savings into small, unlisted trading companies.

It is also designed to promote the venture capital industry, which has performed strongly over the past decade.A venture capital trust will be a new type of investment vehicle which the government proposes should have certain characteristics.

The shares will be listed and the venture capital trust will be subject to the same tax rules as investment trusts - in particular they will be exempt from corporation tax on capital gains.A substantial proportion of the ir assets, perhaps 90%, will be in unlisted trading companies; not more than 15% of their assets at the time of making an investment will be in any one company or group of companies.The proportion of the venture capital trust's assets invested in unlisted trading companies may include both equity and debt, but at least half of these assets must be equity.Individual investors will have tax relief on personal equity plan (PEP) lines, that is tax exemption on dividends when they are received and on capital gains from shares in the trusts when they are made (but no relief for any capital losses).In March 1994, the Inland Revenue issued a consultative document on venture capital trusts, inviting submissions by the end of May.

A consultation process has been going on and, subject to an acceptable outcome to this consultation, the chancellor intends that legislation for the scheme will be included in the next Finance Bill.On 10 May 1994, the Inland Revenue took the unusual, but welcome, step of co-sponsoring a seminar with the British Venture Capital Association to debate the merits of the proposed venture capital trust.These include: what is the most appropriate investment vehicle for the scheme? What kind of finance do unlisted companies need? Which unlisted companies should the scheme target? What should be the limits for tax relief? How viable would the venture capital trust be? How should the scheme be administered?Many at the seminar came away feeling the proposals in their present form would not work.

The fundamental reason for this is that the tax incentives on offer are insufficient to persuade investors to move into the famous 'funding gap' - the provision of equity of under £1 million.The funding gap exists for good reasons: venture capitalists have found that approximately one third of all investments of under £1 million fail.

It is also inefficient for venture capitalists to have to monitor a large portfolio of relatively small investments.

For these reasons, most venture capitalists have moved to medium-sized and large management buy-outs and buy-ins of established businesses.The feeling of the seminar was that for the venture capital trust to work, it must be made more attractive by allowing front-end relief, particularly by permitting an investor going into a venture capital trust to roll over his or her gain into the trust.A number of other observations on the chancellor's proposals can be made.-- It may be that the cost of obtaining a listing will make the structure unworkable.-- The requirement to invest 80% of the venture capital trusts assets in new capital in unlisted companies within two years may cause the trusts to make over-hasty investments leading to poor performance and the discrediting of the scheme.

Three or four years would be a more realistic period.-- The proposal that only individuals should be able to invest in the venture capital trust and that the maximum amount that each individual investor could invest each year to qualify for tax relief should be £100,000 would mean that a venture capital trust would need so many investors that it could be uneconomic to administer.-- The proposal that venture capital trusts be permitted to make their investments in long-term (over ten-year) loans, provided that such loans do not exceed 50% of the trust's assets overall, sits uncomfortably with the trusts' principal aim of plugging the equity funding gap.

There is not thought to be any particular difficulty in small companies obtaining long-term debt.-- The suggestion that 'qualifying com panies' should be defined as companies trading wholly or mainly in the UK would make it impossible to invest in many high-technology companies.-- It is arguable that it is too restrictive that certain categories of investment are outside the scope of the scheme.

The categories excluded are property related investments, investments in financial services, oil extraction, leasing and dealing in goods otherwise than in wholesale or retail distribution.

However, there would seem to be good arguments for allowing hotels and nursing homes, in particular, to be within the scope of the scheme.-- It is proposed that there should be a limit in any one year for investment in a company of £1 million and a limit on the gross assets of a target company of £10 million prior to the injection of new capital.

If the £1 million limit were raised to £2 million this would enable the venture capital trust to invest in the safer territory of small/medium-sized management buy-outs and buy-ins.Paradoxically, it may only be by permitting the venture capital trust to invest in areas other than where the funding gap exists, thereby providing some protection against a high failure rate of investments, that the whole scheme may succeed and that the funding gap may be plugged.-- There is a concern that, as is frequently the case with investment trusts, the venture capital trust may, at least initially, trade at a discount.

Investment trusts often do this, partly because it can be difficult for the market to value the underlying shares in which the investment trust invests and partly because its dividend yields are often lower than the yields of those underlying shares.

The problem about venture capital trusts routinely going to an initial discount would be that investors will be reluctant to participate in the offer to the public.

It may be that the venture capital trust would be less likely to go to an initial discount if it is allowed to distribute all or part of its realised gains.