During the credit crunch, global recession and Irish banking meltdown it became, unsurprisingly, extremely difficult for SMEs to raise either loan or equity finance. There are positive signs that the situation has improved – and is about to get even better.
According to a recent cross-border study conducted by InterTradeIreland – ‘Credit constraints and growth’ – the financial position of firms improved between 2012 and 2014, with the percentage of SMEs that are credit constrained halving over that period. And the percentage of firms without signs of financial distress rose from 40% to 63%.
Nevertheless, there are underlying issues that cause concern. SMEs remain over-dependent on short-term sources of finance, particularly overdrafts. While larger and more established SMEs have access to a wider variety of types of finance, smaller and younger firms have less choice and are more likely to be credit constrained.
Aidan Gough, strategy and policy director for InterTradeIreland, explains: “The biggest challenge for SMEs seeking to raise growth finance is to find the most appropriate type of funding for the investment or the life cycle of the business.” He adds: “For younger firms a lack of assets means that risk capital measures can be critically important. Another, much smaller, group of businesses remain in severe, if easing, difficulty and that is those businesses who purchased property after 2005.” Indeed, the study found that property debt overhang continues to be a problem for many businesses.
InterTradeIreland recently launched its ‘Funding for Growth Advisory Service’, backed by Grant Thornton, for SMEs in both the Republic and the North. This is aimed at supporting and growing small firms by improving their access to alternative sources of finance.
“InterTradeIreland’s new advisory service was set up in response to an identified need and recognises that SMEs require assistance to find and access funding alternatives,” says Gough. “We are able to signpost them to practical funding options that best suit their business requirements. With the upturn in the economy, there are now a lot more funding for growth options available to local companies, including private equity, trade credit, peer-to-peer lending and mezzanine finance.
“The challenge facing business is that without spending a huge amount of time researching the different options, it is difficult to know just how to access the money and which best suits your own specific business objectives. As a result, SMEs have continued to resort to tried and tested avenues which may be less economically advantageous and not viable for a sustained period.”
Patricia Callan is director of the Small Firms Association, which represents firms with less than 50 employees. She shares this concern. “At our end of the market most finance is from bank debt, which means Bank of Ireland, AIB and Ulster Bank,” she explains. There is now an improved approach from the banks towards lending to small firms, says Callan, which has been achieved by persuading the banks to focus on cash flow and business potential, rather than just the state of the balance sheets, which may still be burdened with debt and past losses. The banks themselves, she says, “are now well financed for lending”, following the recapitalisation exercises.
The challenge today, argues Callan, is to improve equity financing of small firms, rather than relying on debt. “There are still concerns [by small firms’ owners] about losing control. One approach is through the issuing of preferential, redeemable, shares, which can be bought back.” She also believes the Employment Incentive and Investment Scheme – which provides tax relief for investment in qualifying SME shares – is very important. “We need to make it more attractive to invest in businesses, rather than property or [listed] shares,” she argues. In addition, Callan is keen for greater use of crowdfunding for small firms.
Sinead Heaney, founding partner of the BDO Development Capital Fund in Dublin, is another who believes that the funding landscape has expanded. She explains: “What is distinctive about the new funding environment these companies now find themselves in is the diversity within it. Firstly, bank funding is once again increasing, albeit in the context of a more measured appetite for risk among banks, nevertheless this source of credit will always play an important role in supporting and funding SMEs.
“However, with important lessons learned over the last decade, ambitious management teams also recognise the advantages of de-risking by diversifying their funding sources. Even before the credit crunch and the recession, SMEs often found it difficult to source suitable development and growth capital, meaning that, while accruing bank debt was the chosen route in many cases, it arguably wasn’t the most suitable way to facilitate growth. Against this backdrop, alternative funding sources have become more prominent and are likely to play a key role in both the funding of and scaling-up of indigenous SMEs with a strong export offering.”
One of those new alternative funding sources is the BDO Development Capital Fund, launched last year. This is a €75m fund offering development and growth capital for ambitious, export-focused SMEs, which invests between €2m and €10m and operates as a wholly-owned subsidiary of BDO. The fund draws on expertise from the Bank of Ireland and leading businesses, including Glanbia and Glen Dimplex, plus Enterprise Ireland. “Collectively, they bring to the table a track record of successful internationalisation; an intimate knowledge of overseas markets; and networks on the ground that can assist Irish companies successfully develop in new markets,” says Heaney.
She adds that the Irish government has played an important role in releasing funding to SME by last year converting the National Pensions Reserve Fund into the Ireland Strategic Investment Fund, potentially releasing €7bn into the Irish economy. “SMEs were identified as a key target for this change of emphasis, which has already resulted in significant extra capital being earmarked for investment in the sector,” she says.
John Doddy, a partner in Deloitte’s Corporate Finance department, agrees that this development has been important: “What we have seen is a significant increase in the level of funding available in the market,” he says. “Banks are back in the market, so SMEs with good credit standing are able to borrow. Alternative lending has led to greater availability of funds, predominantly in the mid corporate sector in Ireland for funding of about €10m.
“Where there is still a lack of funding available is probably at the micro or smaller end of SMEs. That is still challenging, because the level of earnings is lower and more volatile and it is more domestic economy based. The reality is that a lot of them are already over-leveraged and extra debt may not be the answer and they need more stable forms of capital – most likely equity.”
Colm O’Callaghan, tax director at PwC’s Private Business Services Practice, agrees that is now necessary for SMEs to think differently when it comes to raising finance. “In our experience of dealing with SMEs, there is not a huge amount of frustrated demand,” he says. “Rather than borrowing to grow, it is now built into the psyche to finance growth from retained earnings, instead of going out to look for new funding.”
O’Callaghan warns: “There’s two sectors of the economy in Ireland today that are booming: the first is exporting, the second is innovating. If you are in those categories you are likely to have no problem borrowing. But that does not cover the vast majority of SMEs. If you have a couple of hotels in the middle of Ireland, you are likely still to be locked out.”