Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Kate Carnell made the recommendation, one of eight outlined in the newly released Affordable capital for SME growth report, to help address the “market failure” that is resulting in a limited supply of patient capital for growth for SMEs.
The report reads: “Limited competition — and risk-weighted appetite focused on real estate — limits lending to SMEs. The market failure arises where SMEs have limited collateral, other than a family home, to provide security for a loan. While private equity is an alternative source of capital, the majority of investors seek a rapid return. Private equity investors attempt to implement managerial and operational changes to improve the company’s performance before selling it for a profit…
“Alternate lenders do not require bricks-and-mortar security but do charge significantly higher interest rates, offer low amounts over short terms and may seek a personal guarantee… These finance solutions might provide a useful, short-term stop-gap but cannot provide patient capital for growth over time.”
The report says that in order to address market failure, there needs to be “an increase in the supply of capital in Australia for SME lending and increased competition between financial providers”.
While the Ombudsman noted that state governments are increasingly taking the initiative to support their SMEs with access to capital, she said that “the result will be a patchwork of offerings”.
“Without a national solution, the capacity to access affordable capital will be at least partially dependent on where a business is located,” Ms Carnell wrote.
As such, the Ombudsman has suggested that a new Business Growth Fund be established by the private sector to provide a national solution (similar to the growth fund in the UK).
Business Growth Fund
According to the ASBFEO, this fund could offer both debt (loans) and equity (investment) to support SME growth, with businesses being able to apply for amounts between $250,000 and $5 million, with terms up to seven years, secured against the business and owner/director guarantees.
SMEs that receive funding would also be provided with mentoring, coaching and access to a talent pool of expert staff to maximise the benefits of the patient capital investment.
The fund would operate commercially, independent of government, and would most likely use technology to create a “low-cost delivery model” and an automated triage platform that would require SMEs to lodge key documents (such as business plans and cash flow projections) for assessment. The credibility of the application would then be undertaken face-to-face.
The Ombudsman has suggested that an initial pool of $1.5 billion in capital could be sourced from the Future Fund, superannuation funds and banks.
Loan and investment decisions would then be made by professional managers independent of government, with performance assessed on “a fully commercial basis according to private sector funding models, against average annual rates of return”.
Ms Carnell added that an independent investment committee would be responsible for setting the overall parameters for lending and investments, and the government’s only role would be the initial promotion of the partnership construct and to assist clearance of possible regulatory barriers.
However, other recommendations do give the government a leading role. Ms Carnell suggested that an Australian Government Guarantee Scheme (GGS) could be established.
The scheme would partially guarantee for instances when SMEs who do not qualify for bank funding because they do not have a real estate security, the loan required is for more than three years (the maximum limit to which banks tend to lend) and the SME operates in a sector for which the banks have debt appetite restrictions.
A guarantee would then be accessible to members of the scheme with eligibility limited to ADIs (banks). This will ensure the guarantee is issued within existing prudential regulations for lending.
The federal government would also establish a Capital Enhancement Fund to provide Tier 2 capital instruments to banks to enable a “capital build” for by providing access to a new pool of capital.
The fund would reportedly “address the funding differential that is known to exist between tier-one banks and other banks”, which the RBA states is around 20 to 40 basis points (or worth $1.9 billion annually to the major banks).
Other recommendations include:
- APRA moving from the one-size-fits-all model and allowing regulated institutions to apply risk weightings to specific risk factors.
- The Australian Financial Security Authority (AFSA) overhauling the Personal Property Security Register — at a minimum the public interface — to make it fit for purpose so a non-legally trained individual can accurately register title, to best utilise assets as security against lending.
- SMEs working with their trusted advisers (including accountants, lawyers, brokers, business advisers etc) to get their business finance-ready.
- Government implementing and promote government initiatives of comprehensive credit reporting and the consumer data right in banking — part of Open Banking — in line with the government’s schedule and the benefits “widely promoted to SMEs”.
- ASBFEO developing a short guide on financial providers, the range of financial products available and what stage of a business cycle each product is designed to fit. The guide will be distributed through the networks of SME advocates and publicised through social media.
Ms Carnell said: “In Australia, lenders consider SMEs high risk and offer capital with restrictive terms and conditions, at high interest rates and demand bricks and mortar as security, which is usually the family home.
“Unfortunately, the unintended consequences of the financial services royal commission for SMEs might be an increase in banking regulation, making it even more difficult for them to access affordable growth capital.”
She continued: “I regularly remind people that SMEs are the engine room of the economy, but the engine won’t work without petrol, which is seed capital and growth finance.
“We have made eight recommendations outlining initiatives to increase the supply of capital, and inform and prepare SMEs to be finance-ready to address the market failure.”
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Annie Kane is the editor of The Adviser and Mortgage Business.
As well as writing about the Australian broking industry, the mortgage market, financial regulation, fintechs and the wider lending landscape – Annie is also the host of the Elite Broker and In Focus podcasts and The Adviser Live webcasts.