The federal government has finally got the big banks to chip into its business growth fund, which is set to launch next year with more than $500 million in its coffers.
But the SME-focused fund has been labelled “startup policy by stealth”, with questions raised over the amount of equity to be taken in local investee companies as well as the requirement that only companies that have been profitable for three years are eligible.
The Coalition announced in April that it would contribute $100 million to the Australian Business Growth Fund as part of an election commitment. The fund will provide “patient capital” to local SMEs to help with growth and expansion, taking minority stakes in the companies.
The government has largely shied away from mentioning startups or the tech sector when discussing the fund. But it has been labelled “startup policy by stealth” and will likely be highly appealing to early-stage tech firms.
The fund will only invest in companies with revenue of more than $2 million and three years of profitability, effectively excluding the vast majority of startups and early-stage tech firms.
The big four banks have now been convinced to each invest $100 million into the fund, with HSBC to also contributed $20 million. With the government’s own $100 million investment, the fund will have $520 million in firepower when it launches by July next year.
Treasurer Josh Frydenberg discussed the business growth fund and its aim to fill a gap in the funding market not directly addressed by venture capital or private equity in a speech on Wednesday.
“An area of key focus for the government is backing small and medium-sized businesses who together employ more than seven million Australians. These businesses are central to every sector of the economy, from retail to real estate, hospitality to health, transport to technology and manufacturing to mining,” Mr Frydenberg said.
“While there are many important issues affecting small businesses, including regulation, tax, skills and infrastructure, one that is also front of mind is access to the necessary capital to enable the business to innovate and grow.”
“It is a point acknowledged by the Reserve Bank who has said of small business, ‘it’s not the absence of entrepreneurial spirit, it’s the absence of entrepreneurial finance that’s been the main factor holding that part of the economy back’.”
While draft legislation released earlier this month provided little information on how the fund will operate, the government has now outlined some specifics.
The Australian Business Growth Fund will provide long-term equity capital investments of between $5 million and $15 million to SMEs generating revenue between $2 million and $100 million that can demonstrate three years of revenue growth and profitability.
It will take a stake in these companies of between 10 and 40 per cent, allowing founders to retain control of the business but giving it “sufficient influence to encourage business growth”.
This will raise concerns for startups however, Shootsa co-founder Tim Moylan said.
“One of the keys to running a successful business is strategic advice and support, and I really question the level of non-financial guidance the big four banks and government could provide,” Mr Moylan told InnovationAus.com.
“I also question the level of equity being taken here. Having a government entity take up to a 40 per cent stake in a business is a red flag to us.”
The fund will operate commercially and will be independent of the government and big banks, although they will be able to refer customers to it. It will be run by a board, with investment decisions made by professional managers and its performance assessed according to private sector funding models.
The government is looking to eventually grow the fund to $1 billion and is in discussions with other financial institutions and superfunds to contribute to it.
Legislation paving the way for the creation of the fund and appropriating the Commonwealth funds is set to be introduced to Parliament next week and will likely sail through. Treasury released the draft legislation earlier this month, giving only five days for consultations.
Mr Frydenberg has pointed to a manufacturing company looking to buy new plant equipment, local breweries and restaurants as potential applicants to the fund.
But it is likely to receive a lot of interests from tech firms, which are significantly more likely to pursue this additional funding for expansion or runway, and are less likely to be able to receive a more traditional loan or debt funding. The revenue and profit hurdles could prove troublesome for startups looking to access the fund.
While the government has avoided mentioning this fact, it is acknowledged in the draft legislation.
“The Reserve Bank of Australia found that banks were reluctant to finance startups given the high risks involved. Entrepreneurs found it difficult to borrow more than around $100,000 on an unsecured basis to support their day-to-day trading activities,” the draft exposure said.
“In addition, medium-sized businesses reported that it was hard to obtain additional finance once they have pledged all of their real estate as collateral. As a result, many entrepreneurs delay expanding their businesses until the expansion can be funded from retained profits.”
The new fund is “startup policy by stealth”, Fintech Australia general manager Rebecca Schot-Guppy said.
“How many SMBs have three years of strong-growing revenue, are willing to give up at most 40 per cent of their equity and have an exit strategy in mind? While SMBs may be the focus, startups and FinTechs will inevitably apply for this scheme, as they are most suited to the criteria and are used to pitching for this kind of funding,” Ms Schot-Guppy told InnovationAus.com.
Giant Leap Fund managing director Will Richardson said the fund is the “right idea, but perhaps the wrong target”, with a bigger gap in the market being between seed and Series A funding rounds rather than larger ones.
“In recent years, there has been a flood of capital into the Australian VC sector, with some funds now holding on to over $340 million in capital to invest. From Series A onwards, securing placement in a deal is competitive,” Mr Richardson said.
“Startups now have their choice of funder. Earlier on, however, from angel funding to seed and from seed to Series A, it’s a drastically different story.
“While we welcome any government support for startups, we would urge the government to look at Israel’s model where government-approved incubators receive funding that supercharges investment by early-stage seed funds. That is where resources are needed.”
Pax Republic chief executive Barbara Sharp said the fund will “likely do little to help early-stage innovation” due to its focus on more traditional industries.
“While we as a country should support small family run companies, there are many high-growth companies who are the future of this economy, which need seed and Series A rounds to get their innovations off the ground,” Ms Sharp said.
“Venture capital is already picking winners for more established companies, but the real struggle for new businesses and innovation in Australia is getting funding and support through the initial growth stage,” she said.