1.1
On Thursday 6 February 2020, the Senate referred the provisions of the Australian Business Growth Fund Bill 2019 (the bill) to the Economics Legislation Committee (the committee) for inquiry and report by 21 February 2020.
Purpose of the bill
1.2
The bill authorises the Commonwealth to invest, alongside other financial institutions, in the Australian Business Growth Fund (the Fund).
1.3
The object of the bill is to increase investment in Australian small- and medium-sized enterprises (SMEs) by establishing a fund to provide patient capital to SMEs across a range of industries and locations.
1.4
The Treasurer, the Hon Josh Frydenberg MP, explained the purpose of the bill is to provide long-term equity finance and business guidance to eligible businesses:
Small- and medium-sized businesses (SMEs) are a key driver of activity and growth in the Australian economy. SMEs generate employment, drive innovation and boost competition in markets. In 2016–17, there were over 2.2 million SMEs (those employing up to 199 employees) in Australia, accounting for around 68 per cent of private sector employment … A challenge for SMEs seeking to grow can be access to capital … Patient capital can provide entrepreneurs the finance needed to expand without relinquishing control of their business.
1.5
A number of financial institutions are also involved in what is predicted to be an initial investment capacity of $540 million. National Australia Bank, Westpac, Commonwealth Bank of Australia and ANZ have agreed to commit $100 million each. Macquarie Group and HSBC will commit $20 million.
Background
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A growth fund for small and family businesses was announced on 23 April 2019 during the Federal election campaign. On 27 November 2019, the Treasurer stated the government had agreed to terms with the participating financial institutions to establish the Fund. These terms have not been made available.
1.7
As highlighted by the Treasurer in his second reading speech, the Reserve Bank of Australia (RBA) and the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) have released reports discussing the difficulties SMEs face accessing finance—whether through attracting appropriately targeted equity investment or obtaining loans. These reports discussed banking institutions' lending to SMEs, and options to encourage longer-term equity finance such as patient capital.
1.8
For some businesses, equity investment in the form of patient capital can have advantages over loans and venture capital, including:
businesses do not have to realise immediate profits in order to repay debt; and
businesses do not have to sell equity or cede control to professional investors who may have short investment horizons.
Reserve Bank report on access to small business finance
1.9
Drawing upon insights provided by its Small Business Finance Advisory Panel, the RBA confirmed many small businesses looking to grow find it challenging to access finance, particularly without providing real estate as security. It stated there 'appears' to be a funding gap for established small businesses that cannot obtain additional debt finance or attract the limited supply of venture capital finance, though there was no discussion on the size of this gap or whether this constituted a market failure requiring Government intervention.
1.10
A number of issues affect bank lending (debt finance) to SMEs, though of the SMEs that do apply for debt finance, nearly 90 per cent are successful. Issues affecting bank lending to SMEs include:
prudential capital requirements that reflect the higher risk of lending to SMEs; and
obtaining the information required to accurately assess loans to SMEs.
1.11
Although some businesses were reporting an increase in the number of approaches from private equity investors, the RBA stated these investors tended to specialise in particular industries and target a few businesses with high growth potential. Further, the supply of venture capital in Australia is small despite a significant increase in fund raising for venture capital in recent years, mainly from superannuation funds and government initiatives. Industry surveys suggest venture capital funds have been investing only around
$500 million per year in around 100 companies.
Reserve Bank findings
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Importantly, the RBA made no recommendations. It did, however, briefly discuss several suggestions raised during its consultation that could potentially improve small business access to credit, including:
improving the financial capability of small business owners who can have relatively low level financial knowledge or awareness of factors that can affect lenders' assessments of their creditworthiness;
providing lenders with better information to make lending decisions (noting the upcoming comprehensive credit reporting regime and open banking would positively contribute);
making it easier to use personal property or other assets (machinery and equipment) as security;
establishing an Australian Business Growth Fund (as suggested by the ASBFEO); and
government involvement in the supply of finance for small business (as suggested by the ASBFEO).
Australian Small Business and Family Enterprise Ombudsman report
1.13
The ASBFEO stated in its report, Affordable capital for SME growth, that a combination of limited competition and a preoccupation with housing collateral to allay risk concerns had affected lending to SMEs. This, the ASFEBO states, has led to a market failure for those SMEs that have limited assets, other than a family home, to provide as security for a loan.
1.14
The ASBFEO found SMEs have some options when looking to expand their businesses:
debt capital from banks in the form of loans, generally for up to three years if they own real estate (typically the family home) and are willing to use it as security;
short-term, low value and higher-cost capital from alternative lenders where the lender has access to the transaction history on business performance and has security over assets such as plant, equipment, stock and debtors; and
crowdsource funding or private shareholder investment giving investors equity in the business.
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However, it is of the view there are shortcomings in the approach banks take to lending to SMEs, and the availability and nature of equity investment is not optimal for many SMEs.
Equity investment
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The Ombudsman highlighted several characteristics of equity investment that often make it an unattractive option for SMEs. Equity investors:
require SMEs to divest partial or full control of the business;
tend to have an investment time limit and look to sell their shares for a profit within that time;
typically take a targeted approach to the market, seeking established businesses that can be taken on a high-growth path; and
do not want to invest in large parts of the SME marketplace.
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One form of equity investment is patient capital. However, the Ombudsman found there is a limited supply of patient capital for SME growth. No figures were put on the unmet demand for patient capital.
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The ASBFEO made eight recommendations to improve SME access to finance, including that a business growth fund be established to operate commercially and independent of government:
The private sector to establish an investment fund focussed on long-term funding solutions for SMEs. The fund will offer both debt (loans) and equity (investment) to support SME growth. SMEs can apply for amounts between $250,000 and $5 million, with terms up to seven years, secured against the business.
1.19
Equity would be available in the form of purchasing shares in a business taking a non-controlling interest. The fund would also provide mentoring, coaching and access to expert staff to help SMEs maximise the benefits of the patient capital investment. An initial pool of $1.5 billion in capital could be sourced from the Future Fund, superannuation funds, and banks. It noted the model provided by the UK Business Growth Fund and the Canadian Business Growth Fund.
1.20
The ASFBEO also recommended:
the government establish a guarantee scheme for member banks to draw on as a form of security (rather than requiring real estate) for loans to SMEs;
the government establish a capital enhancement fund to provide tier two capital instruments to banks to address the funding differential between tier one banks and other banks;
a change in APRA risk weightings; and
SMEs work with advisers to get their businesses finance-ready.
Other business growth funds
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The Treasurer noted business growth funds currently operate in the United Kingdom and Canada, and the Australian Business Growth Fund would be modelled on these established equivalents. The Treasury identified these funds as the UK's Business Growth Fund and the Canadian Business Growth Fund.
United Kingdom—Business Growth Fund
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The Business Growth Fund was established following a 2009 review commissioned by the UK Department for Business Innovation and Skills into the provision of growth capital to small and medium sized enterprises (known as the Rowlands review after its chair, Chris Rowlands).
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The Rowlands review identified a gap in the availability of (non-leveraged) finance for profitable growing firms for investments below £10 million—so-called growth capital (the Rowlands review does not mention 'patient capital').
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The review defined growth capital as funding that allows established firms to expand; it can be debt from traditional sources such as banks, or equity or equity-type investments. What differentiates growth capital from other types of investment is its level of risk. The report stated:
It is positioned between the two extremes of high-risk high-return pure equity investment and lower risk, usually fully secured, bank lending. Growth capital involves moderate risk with some security and, as a result, providers expect a moderate return.
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In 2011, the Business Growth Fund was set up as an independent investment company with financial backing from Barclays, HSBC, Lloyds, RBS, and Standard Chartered. It was authorised and registered with the Financial Conduct Authority (FCA).
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By 2012, it had invested £100 million, growing to £500 million in 2015, and £1 billion in 2016. It has offices in 14 locations and has invested in almost 300 private and public companies across a variety of industries, including energy, oil and gas, life sciences, healthcare, and education.
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The BGF provides equity and loans to businesses, as well as business advice and assistance. It takes a minority partnership in a business and does not impose funding cycles or exit deadlines. Initial investments are typically between £2 million and £10 million, with potential follow-on funding. There is little accessible information available on the performance of the BGF fund or its return to shareholders.
UK patient capital review
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Five years after the Business Growth Fund was established, the UK Prime Minister announced a patient capital review in November 2016, recognising the lack of patient capital to support SMEs.
1.29
The UK government defines patient capital as 'long-term investment in innovative firms led by ambitious entrepreneurs who want to build large-scale businesses'. Patient capital supports business owners and investors to make a return from the growth of a business rather than through short-term profits from low-risk projects. The investment time horizon varies depending on the sector: from 3 to 5 years to as long as 10 to 15 years. It is crucial in sectors that require substantial investment by new firms before a financial return is made, for instance firms without existing revenues looking to commercialise research and development (R&D).
1.30
The review examined the extent of the need for patient capital in the UK:
Only some firms need patient capital to grow to scale. External equity finance is used by about 1% of the UK small business population and use by firms that fit into the standard policy definition of ‘high-growth’ has been estimated to be between 4% and 14%.
External equity becomes much more important to firms with ambitious plans for growth and those focusing on the commercialisation of technology, where revenues often lag investment significantly. For example, nearly half of high-growth technology firms use external equity finance and external equity investment becomes essential for firms without existing revenues looking to commercialise R&D.
These innovative firms have a disproportionate impact on productivity through the new ideas that they commercialise and bring to market.
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In 2017, the UK Treasury published a report on its consultation and recommended, amongst other things, the establishment of a national investment fund to channel new investment into patient capital. This would require some government support, and several models were discussed.
Government investment can crowd in private investment into patient capital if it is seen to signal good potential investments. By making ‘cornerstone’ investments into funds, it can also reduce some of the information asymmetries that hold back private investment.
Government response to patient capital review
1.33
Amongst other measures to assist SMEs access capital, the UK government undertook to set up a dedicated subsidiary of the British Business Bank (a state-owned economic development bank) to become a leading investor in patient capital across the UK. The intention for the fund was that it would be privatised once it demonstrated a sufficient track record.
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The subsidiary would provide transparency to other investors about its investment strategy and returns, and capitalised with £2.5 billion in government funding. Private investment is expected to be £7.5 billion.
British Patient Capital
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British Patient Capital was established in June 2018 as a wholly owned commercial subsidiary of the British Business Bank. Its 2019 annual report states it currently has £2.5 billion of funds to invest and is aiming to bring a further £5 billion in patient capital investment over the next decade. During 2018–19, it committed £334 million to five venture funds and seven venture growth funds. At the end of the year, its portfolio consisted of 31 fund investments with total commitments of almost £600 million.
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Although it reported an 8.2 per cent return on capital, this included a return on a seed portfolio of investments acquired from British Business Investments (a commercial subsidiary of the British Business Bank).
Canadian Business Growth Fund
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The Canadian Business Growth Fund was established following a recommendation from the Canadian Minister of Finance's Advisory Council on Economic Growth (the council) in its Unlocking innovation to drive scale and growth report.
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The council recommended the government encourage the private sector to establish one or more business growth funds to provide patient capital for high-growth businesses through minority equity or loans for SMEs. The fund/s would consist of pre-committed capital from Canada's leading banks and financial institutions and receive 'appropriate capital treatment under the current Office of the Superintendent of Financial Institutions (OSFI) regulations'.
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It called on the Canadian government to play a role by highlighting the potential capital need; convening and coordinating the different sources of capital; and clarifying the capital treatment for investments. The council recommended the fund would serve firms seeking deals between C$7.5 million and $25 million, but would target established revenue-generating firms looking to finance their next phase of growth with capital injections of between $10 million and $20 million.
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The council made clear it was favourable capital treatment for this type of growth capital that would encourage financial institutions to invest together. The council noted the UK Business Growth Fund had required regulators only to lighten capital requirements on the committed funds and this was permitted under Canadian prudential regulations.
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The council estimated there was a C$200 million to C$350 million annual gap in financing for high-growth firms with at least C$10 million in revenue. To avoid creating an oversupply of capital in the market, the council suggested launching the fund with a total size of approximately C $1 billion. This would address the conservative C$200 million estimate of the expansion-stage capital gap over five years.
1.42
The Canadian Business Growth Fund was launched in June 2018 with an initial commitment of $545 million from 13 banks and insurers. Its aim is to make investments between $3 million and $20 million in established mid-market companies with $5 million or more in annual revenue, a demonstrated growth trajectory, and a clear vision for accelerated growth. It seeks ownership stakes of between 10 per cent and 40 per cent. In its first year, the fund completed two transactions, with an aim to complete five to seven in its second year.
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There is little easily accessible information available on the financial performance of this fund.
Provisions of the bill
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The purpose of the bill is to authorise investment by the Commonwealth in the Australian Business Growth Fund. This will allow the Australian government to participate, together with other investors, in the Fund.
1.45
Although it will invest in the Fund, the bill specifies the Commonwealth cannot control the Fund. There is no detail in the bill on how the Fund will be structured or operate, or on its investment mandate, because the Fund will be established under the Corporations Act 2001 as a privately controlled company. Although the bill delegates rule-making power to the Minister, the Minister cannot control the Fund.
1.46
The bill has three parts:
Part 1 contains preliminary details and definitions;
Part 2 provides for the Commonwealth to invest in the Fund and make arrangements with regard to the Fund; and
Part 3 makes a number of provisions, including an appropriation of the Consolidated Revenue Fund, rule-making power, and other administrative provisions.
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The following summarises the key provisions of the bill.
Part 1—Preliminary provisions
Clause 3—Object of the Act
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Clause three contains the object of the Act:
The object of this Act is to increase investment in small and medium Australian enterprises by the Commonwealth participating in, and investing in (together with other persons), the Australian Business Growth Fund in accordance with this Act.
Part 2—Commonwealth investment in the Australian Business Growth Fund
Clause 9—Simplified outline
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Clause 9 outlines the purpose of Part 2: to allow the Commonwealth to invest in a Corporations Act company (which will become the Australian Business Growth Fund) for the purpose of providing small and medium Australian enterprises with access to capital.
1.50
While the Commonwealth may make arrangements relating to the operations of the Fund, it cannot control the Fund.
Clause 10—Commonwealth investment in the Australian Business Growth Fund
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The Bill provides that the Fund is formed when the relevant Minister, on behalf of the Commonwealth, takes any of the following actions in relation to a company formed under the Corporations Act 2001:
participates in forming the company;
acquires shares (either by purchase or subscription) in a company, or becomes a member of the company; or
acquires debentures of a company.
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These actions can only be taken with respect to one such company.
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The Parliamentary Library explains:
It is important to note that the bill does not establish the company that will be formed as the Fund. Prior to being formed as the Fund, the relevant entity will be established as a company under the existing requirements relating to incorporation under the Corporations Act. It is only once the Minister takes one of the above actions that the company will become the Fund.
As such the bill can be seen as providing the authority for the Commonwealth to invest in the Fund, as opposed to facilitating the establishment of the entity itself. The investment in the Fund does not sit neatly within the existing categories of authorised investment provided for under the Public Governance, Performance and Accountability Act 2013 (PGPA Act), and so the bill is likely required to provide this authority.
Clause 11—Arrangements relating to the operation of the Fund
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Clause 11 allows the Minister to make arrangements with the Fund, a member of the Fund, or a subsidiary of the Fund with regard to the operation of the Fund. These arrangements cannot result in the Fund becoming a Commonwealth company.
Clause 12—Minister has powers of the Commonwealth
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Under clause 12, the Minister would have the rights, responsibilities, duties and powers associated with being a member or shareholder of the Fund, holding debentures or being a party to arrangements relating to the operation of the Fund.
Clause 13—Constitutional limits
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Clause 13 relates to the power of the Parliament under the Constitution to make laws. It requires certain arrangements to be made before the Fund makes any investment. These arrangements include that the Fund can only apply money received from the Commonwealth:
with respect to trade or commerce between Australia and places outside Australia, among the states, or within and between the states and territories; and
with respect to a Territory.
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If these arrangements are not in place, the Minister must take steps to divest the Commonwealth of its investment in the Fund.
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The bill's explanatory memorandum (EM) explains these provisions are not intended to prevent the Fund from generating a commercial return.
Clause 14—Fund not to become a Commonwealth company
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Clause 14 specifies that the Minister must ensure the Fund does not become a Commonwealth company.
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In effect, this means the Minister must ensure the Commonwealth:
does not control the composition of the Fund's board;
is not in a position to cast, or control the casting of, more than one half of the maximum number of votes that might be cast at a general meeting of the Fund; and
does not hold more than one half of the issued share capital of the Fund, unless it is share capital that carries no right to participate beyond a specified amount in a distribution of either profits or capital.
Clause 16—Rules about the exercise of powers
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Under clause 16, the rules can make provisions for the exercise of rights, responsibilities, duties and powers by the Minister under the Act.
Part 3—Miscellaneous
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Part 3 makes a range of miscellaneous provisions and contains the general rule-making power for the minister.
Clause 18—Appropriation of Consolidated Revenue Fund
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Under clause 18, $100 million is appropriated from the Consolidated Revenue Fund for the following costs or expenses:
participating in the formation of the fund;
acquisition of shares or debentures (either by purchase or subscription);
paying amounts payable under clause 11; and
any other costs, expenses or obligations in connection with the Fund.
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If no amount has been debited against the appropriation after two years from the date of the Act's commencement, the appropriation ceases to have effect.
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The bill's EM states if any amount is debited within two years, there is no time limit on debiting any remaining amounts of the $100 million appropriation.
Clause 19—Delegations by the Minister
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Other than rule-making powers, the Minister may delegate, by written instrument, the Minister's powers or functions under the Act to the Secretary of the Department of the Treasury or an SES employee of the Treasury.
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The delegate must comply with any directions of the Minister.
Clause 20—Annual report
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The annual report of the Treasury must include a report on the operation of the Act.
Clause 21—Review of the operation of the Act
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A review must be taken, as soon as possible, after the third anniversary of the commencement of the Act. The review must include a review of the effectiveness of the Act in increasing investment in small and medium Australian enterprises. It must be tabled in the Parliament.
Clause 22—Rules
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The Minister may, by legislative instrument, make rules prescribing the matters required or permitted by the Act, or necessary or convenient to be prescribed for carrying out or giving effect to the Act.
create an offence or civil penalty;
provide powers of arrest, detention, entry, search or seizure;
set an amount to be appropriated from the Consolidated Revenue Fund; or
directly amend the text of the Act.
Commencement
1.72
The whole of the Act commences the day after the Act receives Royal Assent.
Consultation on the exposure draft of the bill
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The Treasury undertook a consultation on the exposure draft of the bill between 4 November and 8 November 2019. Thirteen submissions were received. Minor changes were made to the bill prior to its introduction in the House of Representatives.
Financial impact
1.74
The bill's EM states the establishment of an Australian Business Growth Fund is estimated to have the following financial impact:
Table 1.1: Financial Impact: Establishing the Fund
Source: Explanatory Memorandum
Legislative scrutiny
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The bill was considered by the Senate Standing Committee for the Scrutiny of Bills, which had no comment.
Human rights implications
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The EM states the bill does not raise any human rights issues.
1.77
The Parliamentary Joint Committee on Human Rights examined the bill and had no comments.
Regulatory impact
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No information was provided on the regulatory impact of the proposed legislation.
Conduct of the inquiry
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The committee advertised the inquiry on its website and wrote to relevant stakeholders and interested parties inviting submissions by 17 February 2020.
1.80
The committee received: 13 submissions; five supplementary submissions; answers to questions on notice; and additional information. These are listed at Appendix 1.
1.81
The committee held one public hearing for the inquiry on Thursday 13 February 2020. The names of witnesses who appeared at the hearing can be found at Appendix 2.