Funding the growth economy

We are forever hearing how SMEs are the “engine room” of the Australian economy, but not all SMEs are the same and not all their engines are revving. Sandy Plunkett considers “growth economy” companies, their importance, and what they need in this interview with the Australian Business Growth Fund’s Anthony Healy.

We can’t manage what we don’t measure, and we can’t build what we don’t fund.

These two truisms are well known to leaders of Australia’s innovation and advanced manufacturing businesses wanting to go for growth.

They are also foundational to the Australian Business Growth Fund (ABGF), a mid-market public private partnership fund set up since 2021 to help fill an estimated $38 billion funding void historically ignored by Australian banks and private equity firms.

The Melbourne-headquartered ABGF has invested $180 million of its $540 million allocation in twelve domestic growth companies. 

ABGF is run by Anthony Healy (pictured), a former National Australia Bank executive and co- funded by the Commonwealth and the big four banks ($100 million each) and $20 million each from Macquarie Bank and HSBC. 

Its purpose is clearly defined: to support the growth of innovative and expanding Australian SMEs by providing them with $5 – $15 million in capital (sometimes higher) in exchange for an ABGF minority stake of up to 49 per cent. 

ABGF’s investee companies range in revenue between $2 and $100 million. 

The portfolio lists highly diversified Australian businesses operating in digital systems and advanced manufacturing, renewables and decarbonisation technologies, utilities and healthcare. 

But they all have key criteria in common says Healy: 

“They are all uniquely innovative Australian-owned companies with at least a [two- to three-year] track record of revenue and profit and they are wanting to expand into new markets domestically and internationally. They are looking for commercial expertise and they want to maintain control of their business.”

Healy was the fund’s original advocate, having seen the success of similar public private partnership investment vehicles working in the United Kingdom since 2011 and, more recently in Canada.

At the time of the Fund’s establishment, the Reserve Bank of Australia, the Australian Small Business and Family Enterprise Ombudsman and the Productivity Commission had identified a clear gap in the market for patient, long-term growth equity capital for a particular class of growth-oriented SMEs with a unique value proposition.  

We are forever hearing how SMEs are the “engine room” of the Australian economy. But not all SMEs are the same and not all their engines are revving. 

Last week, ABGF further defined the problem and the opportunity in its report, Powering the Growth Economy. 

It is the first report dedicated to defining the characteristics, economic impact, growth dynamics and funding needs of the critical 6 per cent of the nation’s 2.5 million SMEs that are quietly and ambitiously driving the nation’s reindustrialisation. 

This cohort accounts for a quarter of Australia’s economic output, 42 per cent of all employment and accounts for nearly 50 per cent of all research and development (R&D) spending. 

Companies in this cohort have a unique value proposition, sophisticated and ambitious management and are international market oriented. 

They are also outstripping other parts of the economy with an annual revenue growth rate of 5.7 per cent (FY18 – 22), compared to the rest of the economy at 4.3 per cent. 

This growth is even more evident in jobs numbers, with Growth Economy businesses achieving 14 per cent growth in employment (FY20 – 22), almost double the employment growth of larger businesses (8.0 per cent) – and nearly five times the employment growth of smaller, micro businesses (3.0 per cent).

ABGF’s report is based on interviews with over 3,500 SMEs, ATO and ABS customised data sets, and economic modelling. 

The report highlights the size and impact of Growth Economy businesses, the rising demand for equity funding, and the potential economic gains if the funding gap is addressed.

Market research and advisory firm East & Partners was commissioned to conduct primary market research which explores SME growth dynamics and capital requirements.

Growth economy companies are historically funded by debt. But equity means growth at a different scale. 

The lack of access to equity funding is a significant handbrake to growth, impacting 79 per cent of Growth Economy businesses. 

Some 34 per cent of larger businesses (revenue between $20 million and $100 million) have some form of equity, compared to 12 per cent of smaller businesses with revenue between $2 million and $20 million.

A comparison of the ratio of outstanding debt to growth capital and venture capital for SMEs across Organisation for Economic Co-operation and Development (OECD) countries reveals a striking contrast between how Australian businesses and their counterparts in other countries fund their operations. 

The report’s analysis reveals Australian SMEs are much more reliant on debt funding than growth capital and venture capital (247x) relative to their peers in other OECD countries such as US, UK, Ireland, Canada and France. 

“Traditional investors haven’t historically seen commercial value in investing in Growth Economy businesses.

“Likewise, Growth Economy businesses don’t perceive value beyond the financing traditional investors provide; and they don’t want to give up control of their business,” the report states.

“Consequently, 90% of investment into Growth Economy businesses comes from family and friends, not institutional investors that have the expertise and connections businesses need to scale.”

Private equity funds under management (FUM) in Australia have reached a record $65.5 billion. However, the vast majority has been used for major recapitalisations and large buyouts, with just 2 per cent of private equity and 0.4 per cent of venture capital funding being used for growth capital. 

While 35 per cent of Growth Economy businesses sought external equity funding in the past three years, 53 per cent were unsuccessful in securing this equity. 

Growth Economy businesses estimate a 24.5 per cent increase in revenue growth if they could access adequate equity funding. 

“These businesses are critical in delivering government priorities to build sovereign capabilities as they disproportionately operate in segments outlined by the National Reconstruction Fund (NRF),” says the ABGF’s Healy.

All the banks and the government are represented on the ABGF board, but the fund is independently operated. 

Former CHAMP Ventures director, Ghazaleh Lyari and former Crescent Capital Partners partner Patrick Verlaine are co-leads on investments. Many of the investment diligence and support executives have SME experience. 

“Investments are made at arm’s length from the government and shareholder banks,” said Healy. “The board becomes aware of investments only days before the deal is publicly announced.”

The equity fund, which is chaired by Elana Rubin, a director of Telstra and Reserve Bank of Australia (RBA) has partnered with the Clean Energy Finance Corporation (CEFC) on a few deals. 

Healy, who wants to double the size of the fund, has also been in talks with the $15 billion NRF to explore additional co-investment opportunities. 

He says he has had productive conversations with treasurer Chalmers and NRF executives. He would also like to see a broadening of new tax benefits to direct investors into the growth company asset class. 

Meanwhile, the long-awaited action from the NRF has finally come into view with this week’s announcement of the first $40 million investment in Queensland mining equipment maker Russell Mineral Equipment (RME). 

That investment is supposed to be followed by five others in coming days or weeks, as industry minister Ed Husic told the annual Tech Council of Australia summit last week that the NRF Corporation had requested a drawdown from the federal government of $300 million. 

To say that industry players are curious to know the size and shape of those first six deals is a massive understatement.

They will provide the market with a more concrete signal of what the NRF investment mandate actually represents and where investor applicants may fit.

Amid the market confusion and angst surrounding the slow pace to launch of the NRF, the ABGF has flown under the radar. 

That low visibility is not deliberate, says Healy. 

“We’ve been busy. We’ve validated the funding gap we are helping to close. We’ve defined the market – that key part of the SME segment that meets our investment mandate and that we define as the Growth Economy, and we’ve been funding great companies.”

Picture: Anthony Healy (supplied)