Across Australia, we estimate that there could be well over 10,000 Larger SMEs with revenue of $10-50 million that have opportunities to grow.
That’s about 20% of “Medium Sized Businesses” as they are officially called, employing 20-199 staff and looking to add more. Internationally, they are often called Scale-Ups.
Larger SMEs provide 1 in 4 jobs in Australia and represent our best chance of creating badly needed jobs and growth.
After umpteen inquiries over many years and given the enormous challenge that we now face to get Australians working again, it's time to recognise that the lack of finance for the backbone of Australian business – Larger SMEs - is a key constraint on investment and job creation.
The Australian Business Growth Fund is a move in the right direction but is relatively small and only focused on Equity.
Meanwhile, lending to Larger SMEs has been in the doldrums for some time and now with COVID-19 credit is much harder to access. Any sizeable government supported SME Loan will require Property security.
Businesses are created with less assets now. Banks do secured lending. If you don’t have security, it's much harder to raise traditional secured financing.
Which sectors are the most likely to deliver growth?
According to the ABS, in 2018-19 five industries accounted for more than 60% of growth in businesses with turnover of $10 million or more; these were:
· Manufacturing
· Construction
· Wholesale trade
· Financial and insurance services
· Professional, scientific and technical services
We need to focus on Scale-Ups. Typically, they are family-owned/privately owned businesses that can and will invest for the long term and are the biggest driver of job creation.
As concluded in the Department of Industry’s 2017 Innovation System report:
High Growth Firms are likely to be Medium Sized, ie with 20-199 staff
46% of jobs between 2004 and 2012 were created by 11,000 High Growth Firms.
Professional, scientific and technical services
Our main knowledge-based business sector, Professional, scientific and technical services, employs over 1.2 million Australians with average pay of $81k. Most people working in the sector are aged under 40.
The sector generates revenue of over $250 billion and adds over $135 billion to the economy annually.
Many firms in this sector (we include IT) help other businesses innovate using their products and services.
“Over recent times, one of the central themes in the RBA’s discussions with businesses has been the much greater use of information technology to increase productivity. Among other things, we hear about the possibilities and the challenges of data analytics, machine learning, artificial intelligence, the better use of sensors to control production and the automation of processes and production methods.
In every industry – in manufacturing, mining, agriculture, the health sector and business services – businesses are having to make investments in information technology to remain competitive. This is changing the way we think about investment.”
This is one of our largest and most promising sectors. Its prospects remain strong despite COVID-19. However, it is the most challenged in finding working capital.
What’s holding back growth?
As service businesses, they have little or no Property or Tangible Fixed Assets. When your business is Business to Business, as so many are in this sector, financing growth in Accounts Receivable is the main headache/constraint.
Taking on a new contract requires working capital given the long delays in being paid.
Banks are unlikely to provide an overdraft representing much more than 5% of historic revenue without Property security due to the risk weighting system enforced by APRA and invented in Switzerland (BIS). Factoring doesn’t work: confidentiality, intangible assets, milestone payments, legal/PPSA issues etc.
Economists would say but they are growing so what’s the problem!
The small ones grow to < 20 staff. These firms account for about 50% of the sector’s employees, mainly <5 staff. The very large ones with over 200 staff (20% sector) can grow but they’re often more interested in deploying technology and AI rather than adding staff.
The ones in the middle (30%) mostly get stuck, although some do succeed in continuing to grow.
“Medium-sized businesses report that it is hard to obtain additional finance once they have pledged all of their real estate as collateral. As a result, many entrepreneurs delay expansion until it can be funded from retained profits.
Large businesses continue to impose onerous payment terms: some large businesses require small business suppliers to accept payment times well beyond 30 days.”
Reserve Bank Bulletin, September 2018
Economists say: Raise private capital then!
Good luck raising private capital if your business is not a typical early or late stage high tech company that can attract venture capital! Most of our Larger SMEs aren’t and anyway most do not want outside shareholders. But many are innovating and able to grow.
We meet them all the time. They way outnumber start-ups (which we need as well).
Meanwhile, capital in the trillions accumulates in our Superannuation system but is mainly invested in Large Corporates in Australia and overseas. Even the Future Fund only allocates about 6% of its funds to Australian companies.
This problem is not unique to Australia - the UK is trying to tackle it too.
We see this problem first hand. And it doesn’t need to stay like this. We have a unique opportunity now to cut through and find a better way.
Now would be a good time to fix this
Regardless of theory, it is beyond doubt that we have:
A mortgage-driven banking system that cannot finance the needs of our most promising entrepreneurial businesses; and
A Superannuation system that is not incentivised to fill the void.
We believe that the solution is not about tax cuts. Dividends from the bulk of Australian businesses are taxed in Australia as Income Tax with an offset for any Corporation Tax paid. There may be a case for attracting overseas capital but this needs to be tied to making Australian workers better off.
Our focus should be all about re-shaping our mortgage-driven finance system to support the real job creators with capital to grow, usually this is working capital.
There is plenty of capital in Australia but the system clearly isn't working. We need to create the right structures and incentives to make capital available to our most talented entrepreneurs.
Jobs by Age in Professional, scientific and technical services, ABS