Annual Financial Report

Sustainable Investing

The company is required, by company law, to provide details of environmental (including the impact of the company's business on the environment), employee, human rights, social and community issues, including  information about any policies it has in relation to these matters and the effectiveness of these policies. Since the company does not have any employees and it has no direct impact on the community or the environment due to its status as a VCT, the company does not maintain specific policies in relation to these matters.

However, the board is conscious of the potential impact of its investments on the environment as well as its social and corporate governance responsibilities. The board and the manager believe that sustainable  investment involves the integration of ESG factors within the investment process and that these factors should be considered alongside financial and strategic issues. The company therefore complies indirectly with ESG requirements through its monitoring of the ESG impact of its investee companies.

Environmental, Social, and Governance update from the Manager

The Manager is committed to sustainable investment as an integral part of its business strategy. During 2021, The Manager has taken further steps to formalise its approach to sustainability and has put in place several policies and processes to ensure environmental, social and governance ("ESG") factors and stewardship responsibilities are built into asset management across all funds and strategies, including venture capital trusts.

The Manager published its inaugural Sustainable Investment Report in 2021, that along with existing asset specific policies, including the Public Equity Policy and the Private Equity Policy, can be found on the Gresham House website. These reports and policies cover the Manager's sustainable investment commitments, how the investment processes meet these commitments and the application of the sustainable investment framework. The Gresham House Board and Management Committee assess adherence to the commitments in the Sustainable Investment Policies on an annual basis.

Sustainable Investing Committee

The Manager formed a Sustainable Investing Committee (SIC) at the start of 2020. It meets monthly and drives sustainability related deliverables, whilst providing a forum to share best practice, ideas and education. The Committee is chaired by the Director of Sustainable Investment and has representation from the Gresham House Management Committee, each asset division, sales and marketing.

Embedding ESG analysis

A framework based on ten key ESG themes is used to structure analysis, monitor and report on ESG risks and opportunities across the lifecycle of investments.

The ten themes are the basis of the ESG Decision Tool which supports the investment team in implementing the commitments made in the sustainable investment policies. The ESG Decision Tool is completed as part of the due diligence process prior to investment for all VCT investments.

The Tool will not tell the Manager whether to invest or not, instead it aims to provide a rational and replicable assessment of key ESG risks which should be considered prior to investment, and to help rank the significance of each risk. It is up to the Manager to decide whether it is sufficiently comfortable with these risks to proceed with an investment.

The Manager believes the "G" (Governance) of ESG is the most important factor in its investment processes for public and private equity. Board composition, governance, control, company culture, alignment of interests, shareholder ownership structure, remuneration policy etc. are important elements that will feed into the Manager's analysis and the company valuation.

The "E" and "S" (Environmental and Social) are assessed as risk factors during due diligence to eliminate companies that face environmental and social risks that cannot be mitigated through engagement and governance changes.

Where material ESG risks are identified, these are reviewed by the Manager and a decision on how to proceed is documented. The Manager will then proactively follow up with the investee company management team and ensure appropriate corrective and preventative action is taken and any material issues or incidents are recorded by the Manager.

Sustainable investing - Baseline ESG survey

The Manager has been working over the last year to better understand how well portfolio companies understand relevant ESG risks and how they are addressing them as part of their operations.

Earlier in 2021, the Manager conducted an ESG survey on the unquoted investments to identify a baseline understanding of how portfolio companies think about ESG, and which ESG data is already being reported and monitored.

The results were analysed by the Manager's Sustainable Investment team and overlayed with a well-known sustainability materiality assessment to understand if companies were aware of the most significant ESG risks to their business types.

This is the first time the Manager has issued the ESG survey. The findings have been extremely insightful and will inform the actions the Manager takes to better manage ESG risks and opportunities across the portfolio over the next year. The Manager will then issue the survey again in 2022 to assess improvements in disclosure, understanding and action across the portfolio.

Results

Some of the core findings, how they compare with the Sustainable Investment Team's best practice recommendations, and consequently the actions the investment teams will take to address any material areas of divergence are set out in the full Annual Report.

Stewardship Responsibilities

As an active investor, the Manager acts as a long-term steward of the assets in which it invests. Active ownership responsibilities include engagement and voting, which are used to protect and create value. The Manager will almost always take a board seat or become a board observer, which ensures sufficiently frequent levels of communication with the management team.

The Manager has published its Engagement and Voting Policy on its website, which sets out its approach and explains how integrated these activities are to its business practices and investment processes.

Engagement

The Manager's investment philosophy means that it is an actively engaged shareholder. The Manager's assessments of management, board and governance form a critical part of the investment case, which necessitates that it works with companies on strategy, M&A, remuneration and related matters, from the outset of the holding period onwards. The Manager encourages an open and honest dialogue with the companies as this is an essential part of effective stewardship.

The Manager will meet face-to-face with the management team of a publicly listed company at least twice a year, and more frequently when it owns a material stake in a company. The Manager will generally work more closely with the management teams of private equity investments and meet on a more frequent basis. These meetings form the basis for the ongoing monitoring of a company's strategy, financial performance and ESG considerations.

Defining engagement objectives

The Manager will usually identify and agree strategic milestones that it expects a company to deliver on over the holding period. The Manager will typically identify three or four key strategic milestones that are bespoke to the organisation and its business development, aiming to keep the directors focused and ensure continued progress.

Objectives may change over time depending on several factors, including business priorities, market forces and stakeholder considerations. Example of engagement objectives include:

·      Board composition

·      Improvements to governance arrangements

·      Product or geographic expansion or variance, including due to ESG related market forces

·      Staff retention and reduction of absence rates

·      Implementing compliance programmes with forthcoming ESG legislation

·      Improvements to reporting, including ESG factors

The identified objectives provide a framework which forms the basis of the Manager's discussions with companies during regularly scheduled engagements.

Voting

Voting is an important part of the Manager's investment strategy and Gresham House is a signatory to the UK Stewardship Code and the Principles of Responsible Investment ('PRI').

The Manager's voting decisions are based on the course of action that will be in the best interest of the investee company and are informed by various sources including; procedures, research, engagement with the company, discussions with other stakeholders and advisers, internal discussions and consultations, and other relevant information.

For the twelve months to 30 September 2021, the Manager was subject to votes on 2,211 issues. Of these, the Manager voted for 91.1 per cent of resolutions, against 3.3 per cent, abstained on 0.4 per cent and did not vote on 5.2 per cent.

In Q3 2021, the Manager voted on all 521 resolutions, voting for on 93.9 per cent of occasions, against on 4.6 per cent and abstaining on 1.5 per cent. Of the 24 votes against, nine were because the resolutions conflicted with the Manager's house policy, notably to vote against political donations, while the others were on M&A and liquidation issues that went against the investment teams' philosophy.

Voting decisions

The Manager does not have a set policy defining how voting decisions should be made on specific items, but has set the following guidelines:

1.   Authority to allot shares - policy to vote against anything over 33 per cent.

2.   Disapplication of pre-emption rights - policy to vote against anything over 10 per cent.

3.   Authorise Company to purchase own shares - policy to vote against anything over 10 per cent.

4.   Political donations - policy to vote against all political donations.

Proxy voting providers

The Manager does not use any proxy voting advisory services, but will usually use proxy voting services to deliver voting decisions to the companies it invests in.

Voting against management 

If the Manager plans to vote against the company decision, it will engage with the company in advance, explain the reasons for voting against management and look for ways to avoid that if possible. If a satisfactory outcome is not reached through this active dialogue with the company, the Manager will typically tell the company in advance of its intention to abstain or vote against management and clarify the reasons grounding such intention.

Other matters

Applying the business model

This section of the Strategic Report sets out the practical steps that the Board has taken in order to apply the business model, achieve the investment objective and adhere to the investment policy. The investment policy, which is set out in the full Annual Report, is designed to ensure that the Company continues to qualify, and is approved, as a VCT by HM Revenue and Customs.

Investing in the right companies

Investments are primarily made in companies which are substantially based in the UK, although many of these investees may have some trade overseas. Investments are selected in the expectation that the application of private equity disciplines, including an active management style for unquoted companies, will enhance value and enable profits to be realised from planned exits.

The Board has delegated the management of the investment portfolio to Gresham House. The Manager has adopted a 'top-down, macro economic and sector-driven' approach to identifying and evaluating potential investment opportunities, by assessing a forward view of firstly the broader business environment, then the sector and finally the specific potential investment opportunity.

Based on its research, the Manager has selected a number of sectors that it believes will offer attractive growth prospects and investment opportunities. Diversification is also achieved by spreading investments across different asset classes and making investments for a variety of different periods.

The Manager's policy is not to invest in any of the following areas: human cloning; arms/munitions or adult content.

The Manager's Review above provides a review of the investment portfolio and of market conditions during the year, including the main trends and factors likely to affect the future development, performance and position of the business.

Risk is spread by investing in a number of different businesses within different qualifying industry sectors using a mixture of securities. The maximum the Company will invest in a single company (including a collective investment vehicle) is 15 per cent of its investments by value of its investments calculated in accordance with Section 278 of the Income Tax Act 2007 (as amended) ("VCT Value"). The value of an individual investment is expected to increase over time as a result of trading progress and a continuous assessment is made of its suitability for sale.

The Company invests in a range of securities including, but not limited to, ordinary and preference shares, loan stocks, convertible securities and permitted non qualifying investments as well as cash. Unquoted investments are usually structured as a combination of ordinary shares and loan stocks or preferred shares, while AIM-traded investments are primarily held in ordinary shares. Pending investment in VCT qualifying investments, the Company's cash and liquid funds are held in permitted non-qualifying investments.

VCT status

Compliance with the required VCT rules and regulations is considered when all investment decisions are made. Internally, this is monitored on a continuous basis and it is also reviewed by PricewaterhouseCooper LLP ("PwC") every six months to ensure ongoing compliance. PwC have been appointed by the Company to advise on compliance with VCT requirements, including evaluation of investment opportunities as well as appropriate and regular review of the portfolio. Although PwC works closely with the Manager, they report directly to the Board.

The principal tests are summarised below. Throughout the year ended 30 September 2021 and at the date of this report, the Company continued to meet these tests.

1)   To ensure that the VCT's income in the period has been derived wholly or mainly (70 per cent plus) from shares or securities;

2)   To ensure that the VCT has not retained more than 15 per cent of its income from shares and securities;

3)   To ensure that the VCT has not made a prohibited payment to shareholders derived from an issue of shares since 6 April 2014;

4)   To ensure that at least 80 per cent by value of the VCT's investments has been represented throughout the period by shares or securities comprised in qualifying holdings of the VCT;

5)   To ensure that at least 70 per cent by value of the VCT's qualifying holdings has been represented throughout the period by holdings of eligible shares;

6)   To ensure that no investment in any company has represented more than 15 per cent by value of the VCT's investments at the time of investment;

7)   To ensure that the VCT's ordinary capital has throughout the period been listed on a regulated European market;

8)   To ensure that the VCT has not made an investment in a company which causes it to receive more than the permitted investment from State Aid sources;

9)   To ensure that since 17 November 2015, the VCT has not made an investment in a company which exceeds the maximum permitted age requirement;

10)  To ensure that since 17 November 2015, funds invested by the VCT in another company have not been used to make a prohibited acquisition; and

11)  To ensure that since 6 April 2016, the VCT has not made a prohibited non-qualifying investment.

Appointment of the Manager

The Board expects the Manager to deliver a performance which meets the objective of achieving long-term investment returns, including tax free dividends. A review of the Company's performance during the financial year, the position of the Company at the year end and the outlook for the coming year is contained within the Chairman's Statement above. The Board assesses the performance of the Manager in meeting the Company's objective against the KPIs highlighted in the full Annual Report.

Continuing Appointment of the Manager

The Board keeps the performance of the Manager under continual review. The Management Engagement and Remuneration Committee, comprising all Directors, conducts an annual review of the Manager's performance and makes a recommendation to the Board about its continuing appointment.

It is considered that the Manager has executed the Company's investment strategy according to the Board's expectations. Accordingly, the Directors believe that the continuing appointment of Gresham House Asset Management Limited as the Manager of the Company, on the terms agreed, is in the best interests of the Company and its shareholders as a whole.

The management agreement

Under the management agreement, the Manager receives a fee of 2.5 per cent per annum of the net assets of the Company. In addition, the Manager is responsible for providing all secretarial, administrative and accounting services to the Company for an additional fee. The Manager has appointed Link Alternative Fund Administrators Limited to provide these services to the Company on its behalf. The Company is responsible for paying the fee charged by Link Alternative Fund Administrators Limited to the Manager in relation to the performance of these services.

Annual running costs are capped at 3.5 per cent of the net assets of the Company (excluding any performance fee payable to the Manager and irrecoverable VAT), any excess being refunded by the Manager by way of an adjustment to its management fee. The running cost as at 30 September 2021 was 2.7 per cent.

The management agreement may be terminated at any date by either party giving 12 months' notice of termination and, if terminated, the Manager is only entitled to the management fees paid to it and any interest due on unpaid fees.

Performance fees

A performance fee is payable to the Manager when the total return on net proceeds of the ordinary shares exceeds 8 per cent per annum (simple). To the extent that the total return exceeds the threshold over the relevant period then a performance fee of 10 per cent of the excess will be paid to the Manager. The amount of any performance fee which is paid in an accounting period is capped at 5 per cent of net assets.

Nil performance fee is payable for the year to 30 September 2021 (2020: £nil).

Management retention

The Board is keen to ensure that the Manager continues to have one of the best investment teams in the VCT and private equity sector. A VCT incentive scheme was introduced in November 2004 under which members of the Manager's investment team invest their own money into a proportion of the ordinary shares of each eligible unquoted investment made by the Baronsmead VCTs. The Board regularly monitors the VCT incentive scheme arrangements but considers the scheme to be essential in order to attract, retain and incentivise the best talent. The scheme is in line with current market practice in the private equity industry and the Board believes that it aligns the interests of the Manager with those of the Baronsmead VCTs.

Executives have to invest their own capital in every eligible unquoted transaction and cannot decide selectively which investments to participate in. In addition, the VCT incentive scheme only delivers a return after each VCT has realised a priority return built into the structure. The shares held by the members of the VCT incentive scheme in any portfolio company can only be sold at the same time as the investment held by the Baronsmead VCTs is sold. Any prior ranking financial instruments, such as loan stock, held by the Baronsmead VCTs have to be repaid in full together with the agreed priority annual return before any gain accrues to the ordinary shares. This ensures that the Baronsmead VCTs achieve a good priority return before profits accrue to the VCT incentive scheme.

Prior to January 2017, executives participating in the VCT incentive scheme subscribed jointly for a proportion (12 per cent) of the ordinary shares (but not the prior ranking financial instruments) available to the Baronsmead VCTs in each eligible unquoted investment. The level of participation was increased from 5 per cent in 2007 when the Manager's performance fee was reduced from 20 per cent to its current level of 10 per cent. With effect from January 2017, an additional limb was added to the VCT incentive scheme to accommodate the increasing number of "permanent equity" investments being made by the Baronsmead VCTs. "Permanent equity" investments are those in which the Baronsmead VCTs hold a relatively lower proportion of prior ranking instruments (if any at all) and a higher proportion of permanent equity or ordinary shares. This means that there are fewer prior ranking instruments yielding a priority return for the Baronsmead VCTs before any gain accrues to the ordinary shares, hence this additional limb to create a hurdle described below. The cut off to define a "permanent equity" investment is one where permanent equity is greater than 25 per cent of the total or where permanent equity is greater than £250,000.

Under the terms of the amended VCT incentive scheme, in circumstances where the Baronsmead VCTs hold a sufficient number of prior ranking financial instruments (a "Traditional Structure"), the terms are identical to those set out above. However, in circumstances where the Baronsmead VCTs make a "permanent equity" investment, the executives participating in the incentive scheme are required to co-invest pari passu alongside the Baronsmead VCTs for a proportion (currently 0.75 per cent) of all instruments available to the Baronsmead VCTs and they also receive an option over a further proportion (currently 12 per cent) of the ordinary shares available to the Baronsmead VCTs. The ordinary shares can only be sold and the option can only be exercised by the scheme participants when the investment held by the Baronsmead VCTs is sold. The option exercise price has a built in hurdle rate to ensure that the options are only "in the money" if the Baronsmead VCTs achieve a good return (equivalent to the priority return they would have to achieve prior to any value accruing to the ordinary shares in a Traditional Structure).

Since the formation of the scheme in 2004, 94 executives have invested a total of £1.1 million in 79 companies. At 30 September 2021, 48 of these investments have been realised generating proceeds of £375 million for the Baronsmead VCTs and £20 million for the VCT incentive scheme. For Baronsmead Second Venture Trust the average money multiple on these 45 realisations was 1.8x cost. Had the VCT incentive shares been held instead by the Baronsmead VCTs, the extra return to shareholders would have been the equivalent of 3.6p a share over 17 years (based on the current number of shares in issue). The Board considers this cost to retain quality people to be in the best interests of shareholders.

Advisory and Directors' fees

During the year, Gresham House Asset Management Limited received £254,000 (2020: £204,000) advisory fees, £375,000 (2020: £360,000) directors' fees for services provided to companies in the investment portfolio and incurred abort costs of £8,000 (2020: £11,000) with respect to investments attributable to the Company.

Alternative Investment Fund Manager's Directive ("AIFMD")

The AIFMD regulates the management of alternative investment funds, including VCTs. On 22 July 2014 the Company was registered as a Small UK registered Alternative Investment Fund Manager under the AIFMD.

Viability statement

In accordance with principle 21 of the Association of Investment Companies Code of Corporate Governance ("AIC Code"), the Directors have assessed the prospects of the Company over the three-year period to 30 September 2024.

This period is used by the Board during the strategic planning process and is considered reasonable for a business of our nature and size. The three-year period is considered the most appropriate given the forecasts that the Board require from the Manager and the estimated timeline for finding, assessing and completing investments.

In making this three-year assessment, the Board has taken the following factors into consideration:

·      The nature of the Company's portfolio

·      The Company's investment strategy

·      The potential impact of the principal risks and uncertainties

·      Share buy-backs

·      The liquidity of the Company's portfolio

·      Market falls and gains, with particular reference to the COVID-19 pandemic

·      Maintaining VCT approval status

The Board has carried out a robust assessment of the above factors, as they have the potential to threaten the Company's business model, future performance, solvency, or liquidity. This review has considered the principal risks as outlined above.

The Board also paid particular attention to the impact of the COVID-19 pandemic on the economic, regulatory and political environment as well as its direct impact upon the Company. The Board has also evaluated the ability of third party suppliers to continue to deliver services to the Company.

The Board has considered the ability of the Company to raise funds and deploy capital. Its assessment took account of the availability and likely effectiveness of the mitigating actions that could be taken to avoid or reduce the impact of the underlying risks, and the large listed portfolio that could be liquidated if necessary.

The Company's portfolio currently includes a large position in cash or liquid money market funds. Over the last five years, cash and liquid money market funds have averaged c.16 per cent of the NAV and reflected 16 per cent of the 30 September 2021 NAV. Cash balances can fluctuate over time due to changes in market conditions, but positive cash levels are expected to be maintained over the period. The Company has no debt, and it is expected that the Company will remain ungeared for the foreseeable future.

The Directors have also considered the Company's income and expenditure projections and find these to be realistic and sensible. The Directors have assessed the Company's ability to cover its annual running costs under several liquidity scenarios in which the value of liquid assets (included AIM-traded investments and OEICs) has been subject to sensitivity analysis. The Directors noted that under none of these scenarios was the Company unable to cover its costs.

Based on the Company's processes for monitoring costs, share price discount, the Manager's compliance with the investment objective, policies and business model, asset allocation and the portfolio risk profile, the Directors have concluded that there is a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the three year period to 30 September 2024.

Returns to Investors

Dividend policy

The Board will decide the annual dividends each year and the level of the dividends will depend on investment performance, the level of realised returns and available liquidity. The dividend policy guidelines below are not binding and the Board retains the ability to pay higher or lower dividends relevant to prevailing circumstances. However, the Board confirms the following two guidelines that shape its dividend policy:

·     The Board will, wherever possible, seek to pay two dividends to shareholders in each calendar year, typically an interim in September and a final dividend following the AGM in February/March; and

·     The Board will use, as a guide, when setting the dividends for a financial year, a sum representing 7 per cent of the opening NAV of that financial year.

Shareholder choice

The Board wishes to provide shareholders with a number of choices that enable them to utilise their investment in the Company in ways that best suit their personal investment and tax planning and in a way that treats all shareholders equally.

·   Fund raising | From time to time the Company seeks to raise additional funds by issuing new shares at a premium to the latest published net asset value to account for costs. The Company currently has an Offer open to raise up to £25 million, with an additional £12.5 million overallotment facility available, as required.

·     Dividend Reinvestment Plan | The Company offers a Dividend Reinvestment Plan which enables shareholders to purchase additional shares through the market in lieu of cash dividends. Approximately 2,100,000 shares were bought in this way during the year to 30 September 2021.

·     Buy back of shares | From time to time the Company buys its own shares through the market in accordance with its share price discount policy. Subject to certain conditions, the Company seeks to maintain a mid-share price discount of approximately 5 per cent to net asset value where possible. However, shareholders should note this discount may widen during the periods of market volatility.

·     Secondary market | The Company's shares are listed on the London Stock Exchange and can be bought using a stockbroker or authorised share dealing service in the same way as shares of any other listed company. Approximately 1,722,000 shares were bought by investors in the Company's existing shares in the year to 30 September 2021.

Directors' duties

Overview

Section 172 of the Companies Act 2006 (the "Act") requires the Directors to act in good faith and in a way that is most likely to promote the success of the Company for the benefit of its shareholders.

Directors must consider the long-term consequences of any decision they make. They must also consider the interests of the various stakeholders of the Company, the impact the Company has on the environment and community, and operate in a manner which maintains their reputation for having high standards of business conduct and fair treatment between shareholders.

Fulfilling this duty naturally supports the Company in its investment objective of achieving long-term investment returns for private investors and helps ensure that all decisions are made in a responsible and sustainable way. In accordance with the requirements of the Companies (Miscellaneous Reporting) Regulations 2018, and the AIC Code, the information below explains how the Directors have individually and collectively discharged their duties under section 172.

To ensure they are aware of and understand their duties, Directors are provided with a detailed induction outlining their legal and regulatory duties as a Director of a UK public limited company upon appointment. They also receive regular regulatory updates and training as appropriate. A Company Secretarial Report is included within the papers of every Board meeting, which reminds the Directors of their duties and emphasises the importance of stakeholder consideration during decision making. Directors also receive technical updates from the Company's advisers and from the Manager on a regular basis.

The Directors have access to the advice and services of the Company Secretary and a range of other reputable service providers and, when deemed necessary, the Directors may seek independent professional advice in the furtherance of their duties, at the Company's expense.

The Company has a Schedule of Matters Reserved for the Board which describe the Board's duties and responsibilities. Terms of Reference of the Board's Committees are in place, which outline the duties of those Committees that are delegated from the Board, including their statutory and regulatory responsibilities. Both the Schedule of Matters Reserved for the Board and the Committees' Terms of Reference are reviewed on at least an annual basis.

The Audit & Risk Committee has responsibility for the ongoing review of the Company's risk management and internal controls. To the extent that they are applicable, risks related to the matters set out in Section 172 are included within the Company's Risk Register and are subject to regular review and monitoring.

Decision making

The importance of stakeholder considerations, in the context of decision making, is taken into account at every Board meeting. All discussions involve careful consideration of the longer-term consequences of any decisions and their implications for stakeholders. Further information on the role of the Board in safeguarding stakeholder interests and monitoring ongoing investment activity can be found below.

Stakeholder engagement

Following a comprehensive review by the Board, which regularly keeps stakeholder engagement mechanisms under review, it was agreed that, as the Company is an externally managed Venture Capital Trust and does not have any employees or customers, the Company's key stakeholders are:

·           The Company's shareholders

·           The Manager

·           The portfolio of investee companies, and the wider communities in which they operate

·           HMRC and the Company's governing bodies, including the FCA

·           The Association of Investment Companies ("AIC")

·           A range of reputable external service providers

Details of how the Board seeks to understand the needs and priorities of these stakeholders and how these are taken into consideration during its discussions as part of its decision-making, are described in the table below: