Australia's Business Growth Fund: Policy props

Launched in 2011 with GBP2.5 billion (then $4 billion) in funding from five major banks, the UK's Business Growth Fund had invested GBP2 billion in 285 companies across retail, energy, hospitality, engineering and healthcare as of last November. It typically makes deployments of GBP2-10 million and takes minority stakes of less than 40%. 

"Any initial skepticism about the relative merits of the fund was doused by its success in delivering equity finance across the UK on good terms and in an efficient manner, increasing sales and jobs in the process. The UK fund is now the world's most active investor by volume and has a diverse portfolio that allows it to manage its overall risks by offsetting losses in some companies with gains elsewhere, taking a long-term approach to investing," according to HSBC, which noted that a similar initiative is underway in Canada.

HSBC is one of the backers of the UK fund. These remarks were made in response to the unveiling of the Australian Business Growth Fund last year. HSBC has teamed up with four local lenders – ANZ Bank, Commonwealth Bank of Australia, Westpac, and National Australia Bank – to put in A$440 million ($291 million), while the government will commit a further A$100 million. It is suggested local superannuation funds might pitch in as well, taking the corpus to a tentative A$1 billion.

Despite all the gushing endorsements the initiative has received from banks, corporates and trade associations for the positive impact it can make on small business, local private equity investors are not convinced. "It's a terrible policy," says one manager. "Why on earth would the government subsidize a cartel of the largest four banks in Australia plus HSBC and help them compete with existing private capital investing in the sector? I don't know anyone who likes the idea."

An unmet need?

The fund will follow a similar remit to its UK counterpart, paying A$5-15 million for minority stakes in companies with revenues of A$2-100 million and offering strategic advice and mentoring. 

Numerous studies have been cited as part of efforts to articulate the funding crisis facing the 2.2 million small and medium-sized enterprises (SMEs) – companies employing fewer than 200 people – that account for 57% of GDP and 67% of jobs. Notably, a report by the Australia Small Business & Family Enterprise Ombudsman found that SMEs struggle to access financing without providing real estate as collateral, while only 15% of businesses seek debt or equity financing from alternate lenders. Establishing the Business Growth Fund was one of several recommendations it made.

But the private equity industry contests what the draft legislation describes as "a funding gap for established small businesses that cannot obtain additional debt finance or attract the limited supply of venture capital finance," pointing to the shift in capital from public to private markets globally. Moreover, the timing of the announcement – before a federal election and after the banks suffered a bloody nose in the Financial Services Royal Commission – is not lost on anyone. 

"We didn't see a compelling business case for this fund to be established – and we certainly didn't see a business case for A$100 million of taxpayer money to be allocated to the fund," says Yasser El-Ansary, CEO of the Australian Investment Council (AIC). "At a time when government was cutting expenditure in other vital areas of policy, including areas as important as the research and development tax concession, there was a clear policy conflict in my eyes."

There is no guarantee the legislation will win enough political support to pass into law. Assuming it does, attention will shift to the structure, governance, and management of the vehicle, where there are still more questions than answers. It is unclear, for example, to what extent it will resemble the global industry standard for private equity funds. How to benchmark performance – to ensure a positive contribution is being made to the economy – and deliver returns to investors – so it amounts to more than a charitable endeavor – apparently did not receive early consideration.

Execution issues

Local private equity investors, already somewhat skeptical of minority growth investment strategies in Australia, raise additional concerns about the UK's policy of not imposing exit deadlines on entrepreneurs. What happens, they ask, if everything goes wrong and the banks don't want to consolidate any investments on their balance sheets? Presumably, the government would be left with a choice between putting good money after bad or letting businesses fall over.

More detail is also required as to how the vehicle will be managed and by whom. The UK vehicle claims a staff of 150 – investment professionals as well as functional experts – spread across 14 offices. It is unclear whether Australia is thinking equally big.

"I think it needs more scale. Writing little checks for businesses is a velocity game, it's about numbers. You need a scale where you can work state-by-state and do 30 investments a year, that's how the economics make sense. To do this, you need a lot of people on the ground, not a team of five targeting two deals a year," says Steve Byrom, co-founder of Potentum Partners, an institutional advisory firm and previously head of private equity at Future Fund.

This would present obvious recruitment challenges. In contrast, when the Victoria state government unveiled its own business growth fund last year, the plan was to invest A$250 million in up to 20 companies. An independent manager will be tasked with looking after the vehicle. 

It is too early to say whether the Australian Business Growth Fund will turn out to be a panacea for small business, a flawed vanity project, or yet another mothballed policy proposal. In the meantime, investors operating around that A$5-15 million equity check space – where there is a risk that the fund could choke off some of their deal flow – are watching with interest.

"Even though the pool of opportunities is large, If they set it up well and hire someone competent to run it, I would be a bit worried about the emergence of a well-funded competitor that has a reasonable degree of overlap with my strategy," says Marcus Lim, a managing director at Axle Equity Partners, which makes deal-by-deal investments from high single digits to A$20-25 million. "As it stands, I don't know. They've put the cart before the horse and have raised money but there's no one to manage it."

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• Topics
• Australasia
• Fundraising
• Growth
• Advisory
• GPs
• Australia
• Australian Investment Council (AIC)
• SME