Banks are tightening lending for small and medium sized businesses, which make up the bulk of Australia’s manufacturing sector. For manufacturers, the key for growth might well come down to finding new sources for capital, from private equity to angel investors. Certainly, they should not be expecting much support from the banks for some time.
Recent National Australia Bank research shows that lending for housing and for small business were on an equal footing a decade ago. The global financial crisis changed all that, curbing the appetite of banks for risk. The NAB research shows that for every $1000 that was loaned for housing, only $600 was available for business.
NAB’s head of business banking Joseph Healy has blamed much of this on the introduction of the Basel ll capital rules in 2007 and 2008 which made it “capital attractive” to lend to households. “There’s undoubtedly been a significant growth in the amount of lending to households,” Mr Healy told ABC Television’s Inside Business. “Banks on average can do three to four times more lending per dollar of capital into household and to mortgages versus businesses so household lending became much more attractive for the banks and we therefore saw a significant shift in the allocation of capital towards the household sector.”
The problem for banks and small business is that banks are required by prudential regulators to put aside more capital on business loans compared to home loans. This gives banks a big incentive to do more home lending because the regulatory costs are much lower. Both the NAB and the Council of Small Business Associations have called on regulators to loosen the constraints but until that happens, banks are unlikely to provide more funding for SMEs, including manufacturers.
Furthermore, the debt crisis in Europe has driven up the cost of money, the basic raw material for banks. Bankers have warned that they are likely to increase interest rates for small and medium sized customers to recoup those higher funding costs.
All this could change with HSBC announcing it will begin targeting Australian SMEs with turnover between $1-10 million, with a focus on businesses that do business internationally.
In banking circles, HSBSC is primarily known for focusing on the top end of town but the bank which came out of Hong Kong and which is headquartered in London says the growing global focus of Australian SMEs make the market more attractive. HSBC sees the reluctance of banks to lend as a significant business opportunity. According to HSBC, 97,000 Australian SMEs do some form of international business, with 14% exporting and 14% doing some form of business with China.
While this sounds promising, HSBC has it work cut out taking market shares from the four majors. A JP Morgan and Fujitsu Australia survey reveals that the major banks have tightened their grip over the SME sector and that’s likely to continue. The big four lenders now hold more than 90% of the SME sector and despite the average costs of funding loans expected to rise, most SMEs would say they have nowhere to go.
However, there are other ways to raise capital. The Advanced Manufacturing Co-operative Research Centre for example identifies innovative manufacturers. It seeks to take them to the next level through co-investment. It plans to have a risk adjusted return of $312 million, targeting such areas as defence, aerospace, biomedical, fine chemical, mining, energy and fabricated metals products sectors.
It also provides manufacturers with relatively inexpensive access to the expertise and technology at such organisations as the CSIRO, Swinburne University of Technology, Deakin University, RMIT University, Monash University, James Cook University and University of New South Wales, ensuring they keep their R&D costs low. The AMCRC assesses the company’s management, its technology and such critical areas as intellectual property protection, market demand and its ability to carve out a niche market.
Many small businesses choose to reinvest profits and forego salary. By doing that, however, they are making themselves more dependent on creating value from the business to fund their retirement.
Another piece of advice is to work with a retired financial professional from the banking or financial services industry. These people can always be found at networking events. They can be vital because they tend to know how the financial services industry, where its priorities lie and they will have invaluable contacts.
Other techniques include finding complementary partners. These will not be direct competitors but they can be companies in a similar space. With a partnership, the there is scope for sharing resources, such as co-marketing opportunities. The partners can also share referrals. Potential partners can be located at networking events.
More conventional sources for funding include private equity, venture capital and angel investors.
Private equity seems to have retreated during the downturn but is showing signs of coming back. Brisbane-based private equity firm Blue Sky, for example, which has stakes in companies including toilet rental business Viking Rentals and national chicken franchise Lenard’s has launched a new $50 million fund that seeks to take advantage of the shortage of bank finance for SMEs. It plans to target profitable SMEs with good growth potential.
On the other hand, the global financial crisis seems to have reduced the appetite for risk among venture capital firms. At this stage, SMEs should not expect that sector to provide much funding.
The real growth however seems to be coming from angel investors, usually wealthy individuals with a successful track record who invest their own money. Unlike venture capitalists, the angel investors put in their own money. Venture capital firms, by contrast, typically invest the money of others and seek to deliver a good return to investors within a set timeline. This means that venture capital firms look at businesses that have the potential to scale up quickly and into large markets. Not every manufacturer would fit into that bracket.
A recent survey from the Australian Association of Angel Investors shows that in the 2009 calendar year, angels invested $1.4 billion in more than 5000 companies. This created 26,500 jobs. Most of these investments were in seed and start-up companies. There was a heavy focus on biotechnology and IT. Angel investors were also bullish about communications, manufacturing and web-based software.
Most angel investors have found or run companies in the same or related field. If they come from a manufacturing background, they are more likely to back a manufacturing company. Nor is their backing purely financial. In exchange for cash and equity, the angel investors seek to add value to the business by providing contacts, sitting on the board, introducing the entrepreneur to networks and helping with their governance. Some angel investors create advisory boards for the company.
According to the Australian Association of Angel Investors, angels were either investing as individuals or in syndicates using unit trusts. They spent over 40 hours a month on their investment activities, with half that time spent advising the entrepreneurs. According to the survey, the number of angel groups in Australia is increasing. Four years ago, there were three angel groups. At the end of 2009, there were 12.
The association’s web site (http://www.aaai.net.au/) lists several angel groups and their email addresses: BioAngels, Brisbane Angels, Capital Angels, Gold Coast Angels, Hunters Founders Forum, Melbourne Angels, SA Angels and Sydney Angels.
SMEs can also apply for government grants. These include the Enterprise Connect grant of up to $20,000, the Techfast grant of up to $50,000 for companies creating new products with turnover up to $100 million and a series of other grants through different states. The golden rule is to apply for everything.
The Textile, Clothing and Footwear Small Business Program for example offers grants to businesses that boost innovative capability. Grants must be matched on a dollar for dollar basis. As part of the 2010 budget, the Government introduced a further $5 million in funding, and lowered the eligible project funding point from $1 million to $500,000. This would include any government contribution. Funds can be spent on products that foster innovation, market access, business improvement and “ethical practices”.
Another is the Export Market Development Grant which covers 50% of expenses above $20,000 with a maximum of $150,000. Businesses incurring eligible export expenses above $10,000 over two years are eligible for this grant. This is one of the most popular grants available to exporters. For many businesses, it’s regarded as the most necessary. Grants are actually provided for the previous year, so applications for 2009-10 are already being accepted. To apply, businesses need to have revenue below $50 million in the grant year, and must show they have promoted the export of goods, delivery of services outside Australia, inbound tourism or the export of intellectual property. Eligible expenditures qualifying for the grant cover overseas representatives, marketing consultants, marketing visits, communications, free samples, trade fairs and seminars, promotional literature, overseas buyers and registration costs.
The Researchers in Business grant provides business with grants of up to $50,000. Any SME or research organization is eligible. Under the system, researchers are provided for SMEs to help develop skills and technology, improve business, build and test prototypes or investigate new business models. Eligible SMEs need to prove their project develops a new idea and involves activities that are not being carried out within the firm. They also have to show that it is part of the business’s core strategy. Researchers are required to spend a significant amount of time working on-site.
For more details, manufacturers can check out some of the grants at sites like http://www.business.gov.au/Pages/default.aspx and http://www.ausindustry.gov.au/Pages/AusIndustry.aspx.
In credit constrained times, the challenge for every small business is to find alternative funding sources. They are out there. While many will turn to the banks for funding, others will seek out new channels for growth. Identifying these could well be the key to success.
