CHAPTER 4
INVESTING IN SMALLER ENTERPRISES
As national savings become increasingly channelled into superannuation
funds, the importance of this source of saving for investment into small
business further increases whilst the pool of savings traditionally available
for small business proportionally reduces. [1]
4.1 Small business has traditionally looked to banks and similar institutions
as its basic source of debt financing. Since the advent of the super system
now in place, however, the role of superannuation funds as a source of
saving has grown and superannuation savings have tended to displace the
more traditional savings. Thus Small Business Victoria pointed out to
the Committee the concomitant increase in importance of superannuation
savings to small business in need of finance.
4.2 The Industry Policy Division of the Department of Industry, Science
and Tourism (DIST) also referred to the traditional reliance of small
and medium sized enterprises (SMEs) on debt finance, and to the fact that
banks and 'bank-like institutions' were the main provider, but it said:
... the shift in the direction of household savings away from
banks to superannuation funds may mean that the funds become a more
important indirect financier of SMEs. This could occur as the banks
continue to access an increasing proportion of their finance from the
wholesale capital markets by issuing bills and other securities, and
as superannuation funds continue to increase their purchase of these
securities to replace the reduction in the supply of government debt.
[2]
4.3 The Committee recognises an increasing sophistication in the capital
and savings markets. In particular the growth in the securitisation industry,
'combined with the growth in demand by superannuation funds for securities,
may lead to the securitisation of SME debt including loans and leases'.
[3] The Committee is encouraged by this
possible development as it would have the two-fold effect of:
- opening up the opportunity for SMEs to access the wider market for
investment by superannuation funds, correspondingly assisting the funds
with diversification in their investment spread; and
- helping to solve the inequalities in the matching equation between
large superannuation investment amounts and the much smaller individual
financing requirements of small business.
4.4 DIST commented that this might require government support, as in
the US 'where the securitisation of small business loans is stimulated
by a Federal government guarantee attached to the principal of Small Business
Administration loans'. [4] The Committee
is not in favour of such a guarantee as it considers such a move an unwarranted
incursion by government into the field of commercial business finance.
A credit-rating system
4.5 The Committee does sees merit in an alternative proposed by DIST,
the development of a credit-rating system which could:
- facilitate more accurate 'price risk' assessment of SMEs by institutions
and therefore assist in increased non-secured lending to SMEs; and
- stimulate the process of SME loan securitisation and so enable the
flow of debt capital from superannuation funds to SMEs. [5]
4.6 Such a system would support and strengthen the natural processes
of business financing and the opening up of opportunity. The Committee
envisions such a system as a joint initiative of government and those
business groups representative of SMEs, jointly funded by government and
those groups. The intelligence gathered and made available by such a system
would be along the lines of normal credit assessment, plus those additional
sophistications which are deemed helpful to the investment decisions by
superannuation funds.
Recommendation 4.1:
| The Committee recommends the government investigate
the establishment of an independent and investor based credit-rating
system for SMEs as a joint initiative of government and the
relevant business groups. |
4.7 Independence would come from the establishment of a small specialised
agency to undertake the assessment work and deal with the inquiries. After
the establishment and initial research period, the Committee considers
such an agency could be largely self-funding through the charging of fees
to those potential investors who wish to use its services. However, some
measure of on-going financial support by both government and the relevant
business groups would also be seen as appropriate as evidence of their
commitment to the scheme.
Business loans
4.8 An initiative which the Committee notes with approval is the Super
Business Loans Program which was established by Industry Funds Services
and National Mutual Funds Management. This program facilitates commercial
loans at competitive rates to SMEs.
Through a new investment vehicle "Super Business Loans Trust",
around $200 million will be contributed by participating superannuation
funds and loans will range from $100,000 to $10 million. [6]
4.9 The program also allows investors to request loans to be allocated
in specific ways, 'such as to a particular industry or geographical region,
to the benefit of employers and employees in that area'. [7]
Returns from investments made under the scheme can be measured against
fixed interest benchmarks.The Committee considers such programs go to
the heart of what it considers to be a desirable, but difficult to achieve,
marriage between the investment of superannuation savings and the needs
of SMEs. It encourages the further development of this and similar schemes.
Equity capital
4.10 4.11 Good business practice suggests that it is generally wise to
have a mixture of debt and equity capital. This is as true of SMEs as
it is for big business. Mr Chris Siddons, General Manager, Small Business
Victoria, pointed to the problems of small business being purely funded
by debt and consequently being extremely vulnerable to interest rate hikes,
such as in the early 1990s. He said of those businesses:
They have not got the buffer, as big companies do, of being able
to say, 'Sorry, we can't pay dividends for a few years, until we get
through the rough patch. We will then resume paying dividends'. That
is what the big companies did. The small companies just went under.
[8]
4.12 As a matter of principle the Committee considers it desirable that
there be avenues for superannuation funds to provide equity capital to
small business. The Committee recognises, however, the practical difficulties
for funds in assessing the merits of actually investing in this way within
their overall investment strategy.
4.13 Whether it be for the more developmental and venture companies,
or established small businesses in need of capital infusion, the problems
are similar. Indeed, the large volume of money most funds have available
to allocate to individual investment decisions may itself be a barrier
to funds taking up the investigation of investing in individual businesses,
where the amounts sought may be considerably less than the funds have
to offer.
The problem of matching
4.14 There is a difficulty of matching the investment of superannuation
savings to the needs of investor ready business projects. The issue of
small and medium sized businesses being investor ready is particularly
significant, as the absence of such readiness is a natural barrier to
the flow of investment. There is a degree of understandable rectitude
in the case of many entrepreneurial (in the genuine sense) enterprises,
where proprietors are reluctant to let go, especially on an equity basis,
of their sole financial control. The bridge to outside investment is not
easy to cross.
4.15 An initiative of the previous government which came to light during
the course of the inquiry was the establishment of an institutional investor
information service (IIIS) which was designed to attract financial support
for regional projects. In relation to this service or register the Committee
received this advice from the Association of Superannuation Funds of Australia
(ASFA):
Certainly some government money was provided. Officers from the
department controlled the initial stages of it, but it was certainly
the investment managers who were running it ... but AusCID was to manage
the register. The investment community would be vetted and a list of
advisers would come from the investment community who could go out and
look at proposals and help the people get them into a ready stage. [9]
4.16 In its submission, the Australian Council for Infrastructure Development
(AusCID) said its members had no experience of a capital shortage for
well-conceived and financially viable projects:
There may, however, be a market defect in relation to the information
flows between some classes of project sponsors/promoters and the providers
of finance. [10]
4.17 AusCID considers that government support may be warranted to underpin
the mechanisms to address the suspected market failure. It noted the initiatives
'under way through the regional development mechanisms of the Federal
Department of Transport and Regional Development' to address the issue.
The Committee noted that Aus CID was 'prepared, subject to financial approval,
to participate in and manage the operation of a register of investor-ready
infrastructure projects in regional Australia'. [11]
4.18 The Committee sought advice from the Parliamentary Secretary responsible
for the project, the Hon Michael Ronaldson, MP. He advised that the IIIS
project was still being developed, although the Commonwealth 'had agreed
in principle to fund part of the establishment and running costs of the
IIIS for a period of two years, subject to State and Territory governments
agreeing to participation in and support for the project'. He said also
that a number of governments had shown interest in linking up with the
proposal. Departmental officials were working on funding arrangements
with them. [12]
4.19 In the Committee's view this is an important initiative, and the
Committee is pleased that its development continues despite the change
of government since it was first mooted. It should provide a cost effective
method of combining projects and capital that together will be significant
for Australia's regional development. If it proves to be as successful
as is predicted, it will be a useful model.
4.20 The Victorian Employers' Chamber of Commerce and Industry (VECCI)
established the Business Finance Support Program as a joint initiative
with the federal government (which funded the project initially) to assist
the matching of money and projects. The Program Coordinator, Mr Bob Beaumont,
said of the aims of the program:
The primary considerations are to improve access to finance and
management schemes for growth small business. The secondary focus is
towards developing a gateway or entry point to the establishment of
a more formalised equity market at the SME level. [13]
4.21 The program was launched in December 1994 and began to invite participants
in March 1995. In September 1995 a matching process was begun 'using a
data base and several other mechanisms':
Since that time we have had four dozen, if you like, matches
per se and the capital outflows to date are just short of $5 million.
[14]
4.22 The size of the individual amounts of finance being provided is
between $200 000 and $500 000 at this early stage of the program, but
overseas experience suggests $100 000 may be the eventual lower level.
The availability of capital declared is about $500 million. Projections
of outflows have been made to the end of the 1998 fiscal year and the
predicted figure is 'around the $50 million to $60 million mark'. [15]
4.23 The reason for much of the success of the program is said to be
that 'the small businesses realise they are not going to lose control':
The informal investors really are looking for opportunities to
use their skills and their capital to get a rate of return better than
they might be getting currently, say, in investment funds. [16]
4.24 On the question of rates of return, Mr Beaumont said:
... the expected rate of return that most investors go in for
is a flexible return, usually over a three to five year period. Anywhere
between 30 and 50 per cent is what they look for, which is not unusual.
The beauty of this type of supply [of investors] is that because 90
per cent of them are active, not passive, they bring with them their
management skills. [17]
4.25 The Committee supports this program for what it is doing and for
what it could achieve. In fact it could be seen as something of a model
for the general matching process. However, the sort of matching that is
taking place under this scheme has limited relevance for superannuation
funds. Certainly the funds should be aware of the program and of any advantage
they see in it, but the Committee considers that the relatively low individual
investment amounts being sought mitigates the involvement of superannuation
funds to any great extent.
Directed investment
4.26 Small Business Victoria raised the issue of requiring superannuation
funds to apply (say) one per cent of their savings pool 'towards SMEs
or companies that are in a developmental phase'. [18]
While the Committee is firmly against recommending any form of directed
investment of superannuation savings, it does recognise that the SME sector
is a legitimate investment option for the superannuation funds.
4.27 One of the key problems for superannuation trustees in this area
is the lack of time available to examine and assess the value of investment
in particular businesses. The ASX commented that 'as part of the fiduciary
responsibility of a trustee, they should be made responsible to consider
the range of investment opportunities before them'. [19]
An interesting suggestion by ASX was for a 'statutory requirement directing
trustees to devote some proportion of their time to actively consider
investment in specific types of investments'. [20]
These could include smaller growth companies.
4.28 The ASX commented that intermediaries who deal in specific investments
such as venture and development capital and growth companies report difficulties
in getting busy trustees, or their advisers, to make time to even consider
these options. It seemed, according to the ASX, that:
... this resistance may arise from their lack of awareness of
these types of investments and potential returns and to a lesser extent
their averseness to risk. [21]
4.29 The Committee found this evidence, rather than being critical of
trustees, was more a recognition of the realities facing them in their
investment decision making process. The ASX 'think the problem is an information
gap':
The problem is that people do not know about the existence of
these enterprises wanting capital and, if they were listed, do not know
about their stocks and are not prepared to spend the time and money
researching them because they are too small for it to be worth their
while. [22]
4.30 In response to this situation the ASX referred to an idea they were
developing to bring together the monies and the enterprises. An important
aspect of this new proposal would be to free such enterprises from the
very high costs associated with listing requirements. The ASX were unable
to disclose further detail of their proposal because of the commercial
sensitivities involved. Despite the lack of detail at this stage, the
Committee would be attracted to this concept, as it was presented by the
ASX, if it would operate to enhance the matching process and provide enhanced
investment opportunities for superannuation funds.
4.31 The Committee considers that directly mandating trustee time in
the way suggested by the ASX would not be feasible. In fact, many of the
difficulties in implementing such a proposal were acknowledged in the
discussion Committee members had with representatives of the ASX. [23]
This is not to say, however, that SMEs may not present sound investment
opportunities and trustees should be aware of this.
Development capital
4.32 DIST provided an outline of the development of the Australian development
capital sector from which the SMEs have benefited. [24]
The value of the sector is estimated (probably conservatively) at $1.9
billion. DIST points out that:
... superannuation funds usually do not provide development capital
directly to small businesses, but rather a few put a small amount of
their portfolio in the hands of some of the development capitalists
who use their expertise to choose, through careful and diligent analysis,
which small businesses to invest in. [25]
4.33 A survey of the members of the Australian Development Capital Association
Ltd (ADCAL) indicated 'that there was $868 million of capital under management
for SME-based investments (companies with turnover of less than $100 million)
at the end of 1995'. [26] Superannuation
funds provided about 37% of this and 50% of all new capital raised for
SME-based investments in 1995.
4.34 These are positive developments, although the figures are modest
in absolute terms. According to DIST:
Only about 8 per cent of all small firms aspire to significant
(or high) growth and of these, less than one-quarter are actively seeking
additional finance, with most looking for amounts of $500,000 or less.
[27]
4.35 Therefore only about two per cent of Australian small firms are
in the high-growth category seeking additional finance. The National Investment
Council reported that 'even among the small minority of firms that seek
high growth and want external equity, relatively few understand what is
needed to attract external equity investment'. [28]
Another study found that only nine of 52 firms met the fundamental requirements
to attract external investors, those requirements being:
- appropriate governance - separation of proprietor's business and personal
affairs;
- lack of dependence on key personnel; and
- an established market niche. [29]
4.36 The Committee considers there is a question of responsibility within
the individual SMEs themselves in relation to being investment ready.
SMEs need to come to terms with what is required to make themselves attractive
to potential investors, especially superannuation funds with their particular
need for clear and precise investment indicators. This is not a problem
that governments or the financial community can overcome for them.
Conclusion
4.37 The Committee considers there is only a limited role for government
in promoting superannuation investment in SMEs. It notes the increasing
sophistication of the financial markets and the growing participation
of superannuation funds in these market developments.Superannuation trustees
are increasingly turning to a wider range of investment opportunities,
albeit from a low base. Modern portfolio theory provides the sound principles
of increased diversification of investment, while the SIS regulatory regime
with its investment strategy requirement provides the support in practice.The
Committee is not persuaded that there is a 'special case' for SMEs over
other types of non-traditional superannuation investment. It considers
there is need for SMEs themselves to become more involved and better educated
about what is happening in the financial markets around them, in order
that they may 'present' more attractively to those markets as potential
avenues for investment, and perhaps that they may avail themselves of
the investment opportunities available to enhance their businesses.
[Return to Table of Contents]
Footnotes
[1] Submission SI-16 (Small Business Victoria).
[2] Submission SI-17, p6.
[3] Submission SI-17, p7.
[4] Submission SI-17, p7.
[5] Submission SI-17, p7.
[6] Submission SI-18, p17.
[7] Submission SI-18, p17.
[8] Evidence (Mr Siddons), pS94.
[9] Evidence (Dr Anderson), pS20.
[10] Submission SI-5, p3.
[11] Submission SI-5, p3.
[12] Letter from the Hon Michael Ronaldson
MP, Parliamentary Secretary, Transport and Regional Development, to Senator
John Watson, Chair of the Committee.
[13] Evidence, pS78.
[14] Evidence (Mr Beaumont), pS79.
[15] Evidence (Mr Beaumont), pS86.
[16] Evidence (Mr Beaumont), pS81.
[17] Evidence, pS82.
[18] Evidence (Mr Siddons), pS90.
[19] Evidence (Mr Bladier), pS42.
[20] Submission SI-19, p11.
[21] Submission SI-19, p11.
[22] Evidence (Mr Costello), p S44.
[23] Evidence, ppS41-2.
[24] Submission SI-17, p7.
[25] Submission SI-17, p8.
[26] Submission SI-17, p8.
[27] Submission SI-17, p8.
[28] Submission SI-17, p8.
[29] Submission SI-17, p9.
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