Australia’s economy is a testament to the resilience of small to medium enterprises (SMEs). SMEs, despite the hurdles, account fortwo-thirds of private sector employment and just under 60% of the nation’s company profits. More than ever, Australian SMEs are investing in innovation at a higher intensity than their big-business counterparts. While considered risky to some investors, innovation is a significant source of differentiation for businesses, foundational productivity, and boosting national living standards. Despite the ongoing challenges, SMEs continue to strive, making funding innovation a tough but not insurmountable task.
Here, we’ve summarised a speech published by the Reserve Bank Australia (RBA) last month regarding challenges and opportunities in front of Australia’s small-to-medium enterprises (SMEs) seeking to fund innovation and business growth.
SME’s Contribution to Innovation in Australia
Australia’s SMEs are on a trajectory of unprecedented innovation. Small businesses are now investing around 25% more in R&D than big businesses - a significant shift from the past. While big business spending on Innovation has regressed to mid-2000s levels, R&D Investment at firms with 1-200 employees has more than doubled, marking a substantial growth in SME innovation (See: Graph 1).
This surge in innovation is not just a trend, but a financial boon for small businesses. The percentage of revenue Australian small to medium businesses generate from innovation is, proportionately, much higher than that of large enterprises. Currently, 12% of Australia’s SMEs are reaping the rewards, making more than 50% of their revenue from their innovative products and services. In contrast, large enterprises, despite their diverse revenue sources, only see 2% of their annual revenue coming from innovation.
Historically, Australia is much more likely to import new-to-the-world innovation than regions like the US. These innovations are riskier to produce, and tougher to finance. If they succeed, however, firms that own novel innovations enjoy higher yields and inject massive benefits into Australia’s economy. However, between 2019 and 2021, Australian SMEs were almost twice as likely to bring original innovation to light compared with enterprise firms (Graph 3).
Similar to the US, larger Australian entities have shifted in recent years, securing innovation through acquiring successful, bold-and-nimble small businesses rather than generating innovation in-house.
Hurdles to Australian SME Innovation Funding
Although half of Australia’s bank lending to businesses goes to SMEs, long-held challenges exist for small to medium businesses. This is especially true for those with innovation at the core of their business due to multiple factors, including:
· Investors are more likely to feel ‘safe’ investing in larger businesses. There’s a presumption of greater scale, stability, and transparency with financial data publicly available by enterprise firms.
· By default, banks' risk weighting and lending models contribute to tighter lending conditions and higher borrowing costs for small businesses (See: Graph 4).
· Unlike those loans to large businesses, SME bank loans almost always require physical collateral. A lot of younger start-up founders and entrepreneurs either haven’t entered the property market or aren’t willing to put the family home up as collateral. Meanwhile, innovation-based assets are mostly, or entirely, intangible, magnifying issues for SMEs who typically need physical assets to satisfy traditional lending structures.
Thus, just like their counterparts in the US, start-ups, scale ups and SMEs are more likely to borrow from non-bank institutions. This includes loans from friends, family, venture capitalists and private equity firms (Graph 5).
A lack of practical funding options and more scalable capital sources may harm innovation rates in Australia. Indeed, Australian-born innovation is known to thrive offshore, in more mature start-up ecosystems and where investors have higher risk tolerance. The good news is that a number of government efforts and industry changes make funding innovation slightly more accommodating for start-ups, scaleups and innovating SMEs alike.
Maturation Of Australia’s Venture Capitalist Industry:
Australia’s venture capitalist (VC) industry has matured in recent years to represent the growth of assets under VC management from just$2.5 Billion to $20 Billion in ten years.
This provides our most innovative and potentially scalable SMEs at a loss-making stage of ideation, prototyping and minimum viable product development access to less risk-averse funding sources. It’s worth noting:
· For those few innovating firms that apply and secure VC investment, the average size of deals in Australia is $ 10 million -$ 20 million; this may be too large or too small for some firms.
· Deals do typically go to firms serving industries with greater funding success more generally. Namely, those firms in software, manufacturing and IT applications in finance or health services.
Easier Banking Conditions for SMEs:
As of January 2023, APRA reduced the capital requirement burden for small business loans on banks, easing financing conditions for the sector.
Meanwhile, various SaaS platforms, more open data regimes and credit reporting systems are reducing the lack of information that traditionally disadvantages start-ups and new small businesses from accessing debt financing.
Some non-traditional lenders, including tech and payment companies, use their transactional data to identify low-risk SMEs for unsecured credit, according to their own balance sheets.
Finally, the Australian Business Securitisation Fund invests in securitisations backed by SME loans issued by small banks and non-bank lenders. This also has the potential to ease financial constraints for SMEs (although a small number of investments have been made so far).
Conclusion
With more than 99% of Aussie businesses employing less than 200 employees, Australia’s innovation ecosystem must continue supporting continued investments in innovation, which is encouraged by our nimbler, IP-rich SMEs. As you navigate the dynamic landscape of funding innovation and business growth, our team stands ready to support you. Reach out today at enquiry@primefinancial.com.au to explore how we can empower your business to thrive in Australia’s ever-evolving economy.
