Small businesses are an innovation powerhouse. For many, it’s still too hard to raise the funds they need
- Written by Colette Southam, Associate Professor of Finance, Bond University
The federal government wants to boost Australia’s productivity levels – as a matter of national priority. It’s impossible to have that conversation without also talking about innovation.
We can be proud of (and perhaps a little surprised by) some of the Australian innovations that have changed the world – such as the refrigerator, the electric drill, and more recently, the CPAP machine and the technology underpinning Google Maps.
Australia is continuing to drive advancements in machine learning, cybersecurity and green technologies. Innovation isn’t confined to the headquarters of big tech companies and university laboratories.
Small and medium enterprises – those with fewer than 200 employees – are a powerhouse of economic growth in Australia. Collectively, they contribute 56% of Australia’s gross domestic product (GDP) and employ 67% of the workforce.
Our own Reserve Bank has recognised they also have a huge role to play in driving innovation. However, they still face many barriers to accessing funding and investment, which can hamper their ability to do so.
Finding the funds to grow
We all know the saying “it takes money to make money”. Those starting or scaling a business have to invest in the present to generate cash in the future. This could involve buying equipment, renting space, or even investing in needed skills and knowledge.
A small, brand new startup might initially rely on debt (such as personal loans or credit cards) and investments from family and friends (sometimes called “love money”).
Having exhausted these sources, it may still need more funds to grow. Bank loans for businesses are common, quick and easy. But these require regular interest payments, which could slow growth.
Selling stakes
Alternatively, a business may want to look for investors to take out ownership stakes.
This investment can take the form of “private equity”, where ownership stakes are sold through private arrangement to investors. These can range from individual “angel investors” through to huge venture capital and private equity firms managing billions in investments.
It can also take the form of “public equity”, where shares are offered and are then able to be bought and sold by anyone on a public stock exchange such as the Australian Securities Exchange (ASX).
Unfortunately, small and medium-sized companies face hurdles to accessing both kinds.
Private investors’ high bar to clear
Research examining the gap in small-scale private equity has found 46% of small and medium-sized firms in Australia would welcome an equity investment – despite saying they were able to acquire debt elsewhere.
They preferred private equity because they also wanted to learn from experienced investors who could help them grow their companies. However, very few small and medium-sized enterprises were able to meet private equity’s investment criteria.
When interviewed, many chief executives and chairs of small private equity firms said their lack of interest in small and medium-sized enterprises came down to cost and difficulty of verifying information about the health and prospects of a business.
To make it easier for investors to compare investments, all public companies are required to disclose their financial information using International Financial Reporting Standards.
In contrast, small private companies can use a simplified set of rules and do not have to share their statements of profit and loss with the general public.
Share markets are costly and complex
Is it possible to list on a stock exchange instead? An initial public offering (IPO) would enable the company to raise funds by selling shares to the public.
Unfortunately, the process of issuing shares on a stock exchange is time-consuming and costly. It requires a team of advisors (accountants, lawyers, and bankers) and filing fees are high.
There are also ongoing costs and obligations associated with being a publicly traded company, including detailed financial reporting.
Last week, the regulator, the Australian Securities and Investments Commission (ASIC), announced new measures to encourage more listings by streamlining the IPO process.
Despite this, many small companies do not meet the listing requirements for the ASX.
These include meeting a profits and assets test and having at least 300 investors (not including family) each with A$2,000.
There is one less well-known alternative – the smaller National Stock Exchange of Australia (NSX), which focuses on early-stage companies. Ideally, this should have been a great alternative for small companies, but it has had limited success. The NSX is now set to be acquired by a Canadian market operator.
Making companies more attractive
Our previous research has highlighted that small and medium-sized businesses should try to make themselves more attractive to private equity companies. This could include improving their financial reporting and using a reputable major auditor.
At their end, private equity companies should cast a wider net and invest a little more time in screening and selecting high-quality smaller companies. That could pay off – if it means they avoid missing out on “the next Google Maps”.
What about the $4 trillion of superannuation?
There are other opportunities we could explore. Australia’s pool of superannuation funds, for example, have begun growing so large they are running out of places to invest.
That’s led to some radical proposals. Ben Thompson, chief executive of Employment Hero, last year proposed big superannuation funds be forced to invest 1% of their cash into start-ups.
Less extreme, regulators could reassess disclosure guidelines for financial providers which may lead funds to prefer more established investments with proven track records.
There is an ongoing debate about whether the Australian Prudential Regulation Authority (APRA), which regulates banks and superannuation, is too cautious. Some believe APRA’s focus on risk management hurts innovation and may result in super funds avoiding startups (which generally have a higher likelihood of failure).
In response, APRA has pointed out the global financial crisis reminded us to be cautious, to ensure financial stability and protect consumers.
This article is part of The Conversation’s series, The Productivity Puzzle.
The author would like to acknowledge her former doctoral student, the late Dr Bruce Dwyer, who made significant contributions to research discussed in this article. Bruce passed away in a tragic accident earlier this year.
Authors: Colette Southam, Associate Professor of Finance, Bond University
