2.1
This chapter summarises evidence provided to the committee in submissions and during the public hearing. The committee received several submissions that supported the bill and its intent to increase investment in Australian small- and medium-size enterprises (SMEs) through the Australian Business Growth Fund (the Fund).
2.2
Other submissions and evidence discussed issues in the following areas:
whether there is market failure in the supply of equity to SMEs that has to be rectified;
the need for government investment;
compliance with the competitive neutrality policy and the prudential treatment for contributions to the Fund;
the lack of detail on the investment mandate and governance arrangements; and
Support for the bill
2.3
The Australian Banking Association, the National Australia Bank, and ANZ supported the bill. The National Australia Bank stated the Fund would support economic growth and employment by giving SMEs greater access to long-term equity capital that will help them grow, invest in new technology, and create more jobs. The Fund would also offer the Bank the opportunity to refer its customers who are looking to grow and expand with equity financing to the Fund.
2.4
Titomic submitted to the inquiry that investment from the Fund has the potential to support Australia becoming a global leader in advanced technology, and many SMEs can do a lot more with the support of investors:
Innovative SMEs, like us, need investors who have patience beyond the usual 18 months attention span and invest for the long run as they do in the UK or the US.
When Titomic first listed on the ASX, we had just developed a patent on an additive manufacturing process using Titanium, developed with the CSIRO. It was an exciting opportunity but it took time to develop a skilled workforce, a warehouse, a national and global clientele and investors who shared our long term visions for us, as an innovative defence industry export business.
2.5
The Australian Small Business and Family Enterprise Ombudsman (ASBFEO) also supported the bill, stating:
The purpose of the ABGF [the Fund] is to provide small and family enterprises with patient capital over 5–10 years. For this to be effective, a planned exit strategy is required to work with the owners who retain long term control. The ABGF is the most effective model for delivering this outcome.
Broad views on the bill
Market conditions for equity investment
2.6
The committee heard from a number of witnesses that there was a funding 'gap' in the market for established small businesses that cannot access either debt finance or equity capital. Some characterised this inability to access capital on terms more favourable than those offered for standard debt finance as a 'market failure' requiring government intervention, while others stated the current landscape was clear evidence the market was working efficiently.
2.7
The Australian Small Business and Family Enterprise Ombudsman, Ms Kate Carnell, told the committee:
… the feedback from small to medium businesses in Australia was that there was a huge funding gap, particularly for fast-growth businesses that needed more than half a million dollars … the private equity market in Australia, which we looked at quite heavily, is fairly new and fairly immature. There is good access … to capital for very fast-growth potential businesses that are in a position to grow incredibly quickly and then sell or go to IPO quickly. Now, that's a very small group of businesses, so access to patient capital in the Australian SME market is really small.
2.8
Furthermore, the ASBFEO stated that this lack of access to capital for SMEs is a market failure. The Ombudsman argues the limited competition and the markets' risk-weighted appetite focussing on real estate collateral limits lending to SMEs and as such could be seen as inefficient, leading to sub-optimal economic outcomes.
2.9
The Productivity Commission, in its 2018 publication, Competition in the Australian financial system, noted that SMEs that are successful in raising loans generally do so by mortgaging real estate (usually a house). At the time, it noted nearly 90 per cent of SMEs that decided to apply for debt finance were successful.
2.10
The National Australia Bank stated that from its observations and feedback from customers, SMEs find it difficult to attract patient [long-term] equity investment without taking on additional debt or relinquishing control of their business.
2.11
Titomic, in its submission to the committee, identified a number of issues in the provision of capital, including:
early stage technology firms find it difficult to attract start-up funding;
if firms decide to IPO through the Australian Stock Exchange, investors expect a return within 12 to 18 months; and
many investment organisations have strict guidelines for the firms in which they will invest.
2.12
The Reserve Bank of Australia (RBA) stated some small businesses looking to grow find it challenging to access finance, particularly without providing real estate as security. It said 'there appears to be funding gap for established small businesses that cannot obtain additional debt finance or attract the limited supply of venture capital finance'. As noted previously, the RBA did not identify the size of this gap or recommend any policy response.
2.13
On-Market BookBuilds CEO, Mr Ben Bucknell, an operator of one platform for SME capital raising, questioned the quality of the evidence of market failure. Mr Ben Bucknell stated it was not clear:
how many SMEs in Australia fall into the $2 million to $100 million turnover category; and
are seeking minority long-term investment from the private sector; and
2.14
Treasury acknowledged there is no quality data on small business finance to properly quantify the issues affecting SMEs. As a consequence, when providing advice to government, it relied heavily upon the work of other third party institutions on the availability and constraints on small business funding. This included the RBA, ASBFEO, private sector analysis of funding gaps, surveys of small business access to finance, and roundtable events.
2.15
Mr Ben Bucknell stated there are established ways for companies to gain equity capital through the market, and he was of the view no case for market failure has been made.
2.16
Professor Paul Latimer also questioned whether the evidence of market failure reflected contemporary circumstances.
Government role in the market
2.17
In his second reading speech, the Treasurer stated the Fund is modelled on the established UK and Canadian equivalents 'where a company collectively owned by financial institutions provides long-term capital and business guidance to small- and medium-sized businesses'.
2.18
When making its recommendation for a growth fund, the ASBFEO specified clearly:
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.
2.19
The Fund, as announced by the government in 2019, will obtain $100 million from the government (approximately 19 per cent of its initial capital), and consequent of the Fund being established as an independent entity under the Corporations Act, the government will not have the ability to direct the use of this capital.
2.20
The committee heard that while the UK and Canadian growth funds were essentially established for similar reasons—to address a gap in the availability of (non-leveraged) finance for profitable growing firms—neither growth fund received any government funding and both have operated successfully without government funds. Both funds were also open to any investors to take part in the ventures.
2.21
Five years after the establishment of the UK Business Growth Fund, however, the UK government identified a lack of patient capital to support SMEs. Following a review, the UK established a dedicated 'British Patient Capital' fund in June 2018, which is a wholly owned commercial subsidiary of the British Business Bank (a state-owned economic development bank). British Patient Capital is not authorised or regulated by the Prudential Regulation Authority or the Financial Conduct Authority.
2.22
As discussed in chapter 1, the aim with this fund is that it becomes a leading investor in patient capital across the UK. Once established, and having demonstrated a sufficient track record, the intention is for it to be privatised.
2.23
Because early efforts to interest the major Australian banks in providing long-term patient capital had not been successful, the Australian Small Business and Family Enterprise Ombudsman stated in her evidence to the committee, the government now needs to take a leadership position and intervene in the market. Ms Carnell said:
… banks in Australia haven't been involved in equity financing … a number of years ago ANZ put a toe in the water, which wasn't all that successful. The whole area of long-term patient capital is something that our banks have shied away from. Some of that's because of APRA requirements … at the moment, the banks are significantly better placed putting their money elsewhere. So it really needed government leadership here to get this fund over the line.
2.24
The Treasury confirmed the government's intent was to provide leadership to stimulate and provide a catalyst for bank involvement.
2.25
The Productivity Commission in 2019 drew attention to a trend for governments to provide project finance as a form of industry assistance, specifically identifying the Australian Business Growth Fund as an example of this trend. The commission stated:
Large-scale finance vehicles have the potential to skew industry assistance to particular firms and projects with minimal public scrutiny until deals are done. These facilities often have the stated rationale to fill a ‘market gap’ for finance, and so necessarily extend finance on terms more favourable than available from commercial lenders.
In general, though, Australia has relatively deep and liquid financial markets. The onus then is on proponents of taxpayer-funded financing of commercial projects to demonstrate how this would serve the public interest. Even where there is an in-principle argument for government assistance, proponents should also explain why financing is the best policy option.
Competitive neutrality
2.26
Evidence received during the inquiry questioned whether the Fund would comply with the competitive neutrality policy of Australian governments. Mr Bucknell suggested the special prudential treatment given only to Fund members raised competitive neutrality issues and would have a detrimental impact on existing businesses in the equity finance market:
A core tenet of that policy is that competitive neutrality requires that governments should not use their legislative or fiscal powers to advantage their own business over the private sector … Why should the banks only have to put aside 26.25c in the dollar, and how has competitive neutrality been addressed?
2.27
The Australian Government's approach to implementing competitive neutrality is set out in its 1996 Competitive Neutrality Policy Statement, which requires:
… that government business activities should not enjoy net competitive advantages over their private sector competitors simply by virtue of public sector ownership.
2.28
According to the policy, for the purposes of competitive neutrality in the Commonwealth sector, to be considered a 'business activity' the following criteria must be met:
there must be user-charging for goods or services (the user may be in the private sector or public sector) [this may be a return on investment];
there must be an actual or potential competitor (either in the private or public sector) i.e. users are not restricted by law or policy from choosing alternative sources of supply; and
managers of the activity have a degree of independence in relation to the production or supply of the good or service and the price at which it is provided.
2.29
The Australian Government Competitive Neutrality Complaints Office (AGCNCO) provided the following advice:
On the basis of information we have to date, it would appear that the BGF would meet each and all of these necessary criteria [for what constitutes a business]. Accordingly, the preliminary view of the AGCNCO is that it would qualify as a ‘business’ for the purpose of being subject to competitive neutrality policy.
2.30
With regard to the whether the Fund meets the test for what constitutes a government business activity, the AGCNCO stated:
… it has been the AGCNCO’s position that any level of Australian Government ownership in a significant business activity is sufficient to render it subject to competitive neutrality policy and the complaints mechanism.
On this basis, the AGCNCO’s preliminary view is that the Australian Government’s near 20 per cent share of the BGF would mean that this is a government business for the purpose of being subject to competitive neutrality policy.
This means that the BGF would be subject to the competitive neutrality requirements for tax, debt and regulatory neutrality, for full cost pricing and for earning a commercial rate of return. It also means the business would also be subject to the competitive neutrality complaints mechanism.
2.31
The bill's explanatory memorandum states clauses 13(1)–13(3), with regard to Constitutional authority, are not intended to prevent the Fund from generating a commercial return. Further, Treasury confirmed all investments made by the Fund will be made on a commercial basis with an expected return on investment.
Regulatory treatment for contributions to the fund
2.32
It was reported that during initial discussions with the government, the banks had stated the Fund could not be commercially viable without a softening of the capital deductions for banks' equity investments.
2.33
On 9 December 2019, APRA announced publicly it was adjusting its capital framework for authorised deposit-taking institutions (ADIs) to support the establishment of the Fund.
2.34
An ADI investing in the Fund will be able to apply a risk weight of 250 per cent to their investment. This compares to the current requirement that equity investments by banks be fully deducted from their regulatory capital. An ADI will be able to invest up to 2 per cent of its Level 1 CET1 capital in the Fund.
2.35
In effect, this reduction in the risk weighting allows participating ADIs to treat high-risk equity investments made through the Fund as loans (that is, debt funded) and improves the commercial return to ADIs participating in the Fund.
2.36
This treatment is not available for other funds or non-participating ADIs. APRA stated it would give special treatment to the Fund because:
the wider financial system benefits that would come from increasing access to financing for SMEs; and
the Australian Government was a founding shareholder.
2.37
Treasury officials acknowledged APRA was providing a risk-weighted capital ratio to the Fund that is 'less onerous than the one that exists for equity investments at the moment'. However, it is of the view this does not constitute a subsidy or cheap financing. Mr Tease told the committee:
… the issue of competition is, I would say, exaggerated in this point, because APRA is not providing a significant subsidy to the banks.
2.38
The AGCNCO acknowledged assessing the value of this treatment would be a necessary next step in assessing competitive neutrality implications. It stated:
Subject to the preliminary assessment … that BGF would be subject to competitive neutrality policy, the second step for a valid complaint would be whether and to what degree BGF would be afforded an advantage through its treatment with regard to prudential regulations.
2.39
Treasury stated the Fund had been designed to minimise potential detrimental effects on competition 'in a manner consistent with achieving competitive neutrality as much as possible'.
2.40
Treasury acknowledged APRA is applying a risk weight of 250 per cent to an ADI's investment in the ABGF. This is below the current full deduction for Common Equity Tier 1 capital for equity investments and the effect of this treatment is to reduce the cost of capital for participating ADI's investment in the Fund.
2.41
Treasury also stated the impact on competition and competitive neutrality is mitigated by a number of factors, including:
Non-regulated investors in the SME market are not subject to APRA's capital requirements so do not face the same additional increment to their cost of capital as ADIs. Their funding costs are subject to market forces reflecting the risks and characteristics of their businesses
…
Partly to ensure that other ADIs can receive the same risk treatment and access to patient equity investment opportunities as founding shareholders, the ABGF will remain open to ADI and other investors over time.
2.42
Mr Ben Bucknell stated the prudential changes gave an advantage to the Fund, 'This provides them with an enormously lower cost of capital—I would say in the mid single digits. No-one else in the market can compete with that'.
Existing capital-raising businesses
2.43
The committee was presented with conflicting views on whether the Fund would crowd-out existing SME capital-raising businesses. Disagreement stemmed from two issues:
uncertainty as to the size of the 'investable universe' (the number of SMEs that will be eligible) in comparison to the size of the SME capital market and the number of investments the Fund will make; and
whether the Fund would cherry pick the best investments rather than increase the availability of capital funding.
Investable universe
2.44
According to government announcements, to be eligible for Fund equity, small businesses will have to demonstrate:
three years of revenue growth;
annual revenue between $2 million and $100 million;
2.45
Further, the Fund is aimed at SMEs who either are not receiving sufficient external funding or are obtaining a form of funding that is not well suited to their businesses. It is not clear, though, whether a requirement to this effect may be in the Fund's investment mandate if one is produced.
2.46
Although acknowledging an absence of quality data on small business finance, the Treasury provided an estimate from Australian Tax Office (ATO) data that a pool of 40,000 small businesses would satisfy the investment criteria of the Fund. It is not clear, however, whether this is businesses who satisfy the
$2 million–$100 million turnover requirement only, or who satisfy this turnover requirement, have three years of revenue growth, are seeking long-term patient capital investment, and are unable to receive sufficient or appropriate funding for their business.
2.47
In combination with the fact the Fund will make only 30 to 50 investments each year (around 0.12 per cent of the estimated 40,000) when it is in full operation, Treasury officials stated the Fund would meet the need of only a 'small fraction' of the estimated investable universe and there is 'little to no risk of crowding out'.
2.48
The ASBFEO conversely estimated the pool to be around 200,000 SMEs with a turnover of between $2 million and $100 million. The Ombudsman stated it would be about eight per cent of businesses (around 16,000) that would benefit from the Fund as they have:
growth potential but don't fit into the slot of short-term private equity investment and can't get the sort of money they need from the banks or, for that matter, the fintech sector.
2.49
In the view of the Ombudsman, the small number of investments that will be made by the Fund, and the absence of a market for these particular companies, means it is not possible for the Fund to skew the market.
2.50
However, Mr Bucknell submitted to the committee there was no robust research on the size of the investable universe that met all criteria and were the SMEs being targeted by the Fund: turnover between $2 million and $100 million; revenue growth for three years; profitability; inability to obtain equity from the private sector. He suggested if all these criteria were taken into consideration, the number could be as low as around 5,000 companies, though independent research is required.
2.51
Further he argued there is an existing established market for SME equity capital investment—citing his business which has 50,000 investors investing in minority positions in SMEs by buying perpetual ordinary equity instruments.
2.52
Mr Bucknell also told the committee that in 2019, there were 67 IPOs in the market. His company had involvement in around 30 per cent. His company has been approached by more than 400 SMEs seeking equity finance, of the 148 for which it has attempted to raise equity, 80 per cent have been successful.
Selection of SMEs
2.53
The committee heard there is concern about the capacity of the Fund to attract the better SME investments in the market, thereby crowding out existing businesses and not leading to an increase in SME investment.
2.54
Mr Bucknell submitted the Fund will be able to compete with existing capital raising businesses by: offering more attractive terms; and by offering more competitive finance as a consequence of the relaxed prudential arrangements not available to others in the market.
2.55
Existing private sector equity (venture capital) often requires listing on the ASX with associated disclosure, corporate governance and other reporting requirements. Exit strategies for venture capital are also required.
2.56
In contrast, recipients of equity from the Fund will acquire government-and-bank-backed long-term equity investment and may not have to offer shares to public investors, accede to governance requirements of the ASX, or abide by venture capital exit requirements and terms.
2.57
On-Market BookBuilds argued the prudential concessions provided by APRA will allow the Fund to give superior market terms to SMEs. This will allow the Fund to choose the most attractive SMEs in which to invest. Mr Bucknell stated:
It would be natural for SMEs to choose to go to the BGF first. The reason for that is that the BGF has the lowest cost of capital, which has been artificially created through the change of APRA ratios and the government's $100 million. They will go there because they have a pool of $540 million that's ready to deploy.
2.58
As to the effect on existing businesses, Mr Bucknell explained:
If the ten best SME raisings, bearing in mind the BGF is targeting 10 to 30 per year, are cherry-picked by the BGF, then we cannot in good faith put out BGF rejects for the rest of the market to invest in … not only because that would be ethically questionable but also because it would be economically unsustainable.
Because of the positive skew, the top performers in our portfolio bring the average up and bring the returns up. The positive skew means that the average return is positive but the median return is negative, so more companies go down than up. It's just that those that go up in value go up spectacularly. So, in terms of our business, it wold be very difficult to continue under our current business model.
2.59
Mr Bucknell estimated equity crowdfunding intermediaries in the United Kingdom have suffered accumulated losses of around $80 million while trying to compete against the UK Business Growth Fund. He suggested this was evidence it is unsustainable to offer 'BGF rejects' to the public.
2.60
In response, Treasury argued the Fund would provide services largely absent from the market rather than displace existing funders:
… concerns about 'cherry picking' or 'crowding out' have an implicit assumption that the SME universe is fully funded and that a new entrant like the ABGF [the Fund] will displace other investors or leave those investors access to a limited number of SMEs. This is inconsistent with current market conditions of funding constraints …
The starting point in Australia is one of a general funding gap for SMEs, a predominance of debt funding, limited access to equity funding, or the provision of equity funding via venture capital or private equity firms that did not suit the needs of many SMEs, particularly those whose owners wish to retain control of their businesses and who desire a long-term funding source.
Availability of capital for SMEs
2.61
Submissions to the inquiry suggested the Fund will target SMEs who can already access capital on commercial terms and will not lead to an increase in SME funding.
2.62
Digital Finance Analytics provided a summary of the SME sector, including:
91.3 per cent have an annual turnover of less than $2 million each year;
most low-turnover businesses are unincorporated—businesses with larger turnovers are more likely to be formed as a company; and
nearly half of all SMEs have been trading for less than 4 years.
2.63
Digital Finance Analytics stated their research indicates the Fund target segment is small and can already obtain funding for expansion. It further stated:
It seems that this is more orientated to offer investors and the financial sector a return, than being shaped best to provide support for those small businesses which need assistance the most. The small number of transaction envisaged will not assist many businesses, and the target is clearly not the bulk of those with real funding needs.
Investment mandate and governance arrangements
2.64
Some concern was raised about the lack of detail on how the Fund will operate, including:
how it will be legally constituted;
the standards of conduct, accountability and integrity that will be followed in the awarding of finance;
how profits or losses will be shared;
the relationship between the Fund and the business lending of the funders that might give rise to conflicts of interest; and
2.65
Treasury confirmed the legal arrangements for the Fund, including the investment mandate and the governance arrangements provided for in the Shareholders' Agreement, would not be made public as they included legal specifications sensitive to the investment posture and commercial arrangements of the proposed shareholders.
2.66
However, Mr Tease sought to assure the committee the governance arrangements would protect the Commonwealth. He stated:
There will be a board formed. Each of the major shareholders will nominate a director, and there will be a number of independent directors. The role of the board will be to oversee the management of the Fund to make sure that the money is being managed in a way that is consistent with the investment mandate and with the legislative requirements for the Fund.
The board's role will be to appoint a CEO, who will oversee the appointment of the investment teams. The investment teams, led by an investment committee, will manage the money according to an investment mandate.
2.67
Treasury was able to provide some high-level detail on how the Fund would operate, noting the government would not control the fund:
The fund will be set up with an investment mandate, and that mandate will define the characteristics of the types of small businesses that the staff of the business growth fund can invest in. Those characteristics are that they have revenue between $2 million and $100 million, that they want funding of minority stakes between 10 and 40 per cent, that they have a track record in revenue growth and profitability, and that they require funding of a certain stage. So that will define a subset of small businesses that will fit into that category, and the investments will be made in a diverse way across the country and also across industries.
2.68
Treasury confirmed its annual report will include a report on the operation of the legislation. It is not clear how much information on the performance of the Fund will be disclosed in this report.
Evaluation
2.69
The bill requires there to be a review of the operation of the Act after three years. The Tax and Transfer Policy Institute raised concern that the evaluation be embedded in the policy proposal, a principle the government committed to in its response to the Thodey review of the Australian Public Service. The Institute recommended:
there be a budget for a rigorous evaluation;
the evaluation be conducted by an independent panel of experts with the majority drawn from academia; and
the evaluation strategy and data infrastructure be designed alongside the implementation of the fund.
2.70
It stated evaluations conducted subsequent to implementation are not always able to obtain baseline measurements of the outcomes that were to be impacted, making it difficult to form a basis of comparison:
Evaluations conducted 'ex post' may also have trouble forming accurate measures of program outcomes and have to resort to whatever data is available rather than those that the program was intended to impact.
Committee view
2.71
The committee acknowledges that as an entity independent of government, many details about the Fund will not be publicly available. However, the Fund will be required to comply with prudential requirements and the provisions of the Corporations Act.
2.72
The committee also notes that other shareholders of the Fund are listed companies with a high level of corporate governance and compliance obligations.
2.73
The committee acknowledges concerns about the competitive neutrality implications of the bill. It encourages Treasury and APRA to consider those issues as the investment mandate and rules are developed, and to also continue to monitor the Fund as it grows and matures.
2.74
The committee is of the view the Fund, effectively targeted, may provide a source of patient capital to some SMEs and fill a potential gap in the market.
2.75
The committee also acknowledges the importance of these SMEs having vital access to capital to allow them to flourish and fulfil their potential, in turn leading to greater job creation and growth in the economy.
2.76
The committee encourages further work by agencies to develop a quality data set on small business finance to inform future policymaking with regard to support for Australian SMEs.
2.77
The committee notes the bill allows for a review to take place after the Act's third anniversary. Considering that the determination to return the funds to the Consolidated Revenue Fund occurs at two years if no funds are expended, see clause 18(2) of the bill, it would seem advisable to stage the review to coincide with this event.
2.78
The committee is of the view an understanding of how the Fund will operate in the market will be important to its success.
2.79
Given the unique structure of the Fund, and the government’s investment, the committee notes that the successful operation of the Fund will depend on maintaining robust accountability and governance arrangements. Furthermore, the committee notes that reporting requirements, such as estimates and annual reports on the Fund, will be important for confidence in the government’s involvement in the Fund.
2.80
The Committee recommends that shareholders, including the government, when developing the investment rules, consider the inclusion of provisions to allow for the underwriting of investments.
2.81
The Committee recommends that the bill be passed.
Senator Slade Brockman
Chair