The vast majority of Australian businesses are being deprived of the capital they need to achieve their potential and those that are able to secure additional capital are required to pay a high premium for it, way out of proportion to any associated increase in risk. A high premium is payable even where the associated risk is lower. This is having an enormous adverse effect on the Australian economy and needs to be rectified.
In this article I have set out what I regard as the cause of the problem and what should be done to ensure that the majority of Australian businesses get access to the capital they need to reach their potential and pay a price of it that reflects the associated risk.
In an efficient market capital is available to businesses across the market, from start-ups to blue-chips, and incremental increases in risk are matched by incremental increases in pricing. The reality however is that the majority of Australian businesses have great difficulty securing (non-bank) capital and those who are able to secure additional capital pay a handsome premium for it.
The vast majority of Australian businesses, the unlisted businesses, have great difficulty attracting capital because our financial services industry allocates capital away from unlisted businesses and our legislation adds significantly to the costs and risks associated with raising capital.
The vast majority (or at least enormous amounts of) superannuation contributions get paid into managed funds and those with additional savings who seek financial advice from the financial planning industry get advised to invest in one or other managed fund. The financial planning industry merely provides a sales function for the funds management industry. Financial planners are generally unable – due to being associated with some or other exclusive platform comprised of managed funds, insurance cover restrictions, ownership structures (being sister companies to fund managers) and not having the necessary skills – to recommend investments in debt, equity or hybrid instruments issued by unlisted companies. The Fund Management industry in turn invests the vast majority of their capital in the debt and equity securities of the larger companies listed on the ASX and other major stock exchanges around the world. Some capital is invested in large commercial, industrial and retail properties and in infrastructure assets. A small proportion is invested in private equity and venture capital funds, who in turn invest in unlisted businesses. The private equity and venture capital funds are however not interested in providing capital to the vast majority of unlisted companies and the vast majority of unlisted companies are not willing to accept the modus operandi of the private equity and venture capital fund managers, who invariably want ‘control’ and want the business sold within a predetermined period. As a result money that could otherwise have been allocated to investments in unlisted companies is allocated mainly to investing in blue-chip companies.
The Corporations Act (Chapter 6D) also makes it difficult for unlisted companies to attract (non-bank) capital. The legislation places restrictions on the promotion of investment opportunities and requires the preparation of ‘product disclosure statements’, which adds significantly to the costs and risks of undertaking a capital raising. These documents are essentially prepared by (or at least require significant input by) compliance lawyers, which not only adds significant cost to the preparation of those documents but results in the documents being largely meaningless for investors. They do not include the very information required by prospective investors on the business.
The difficulty unlisted businesses have in securing additional (non-bank) capital is holding back the Australian economy. Having access to capital at a reasonable cost will enable unlisted businesses to achieve their potential. They will, for example, be able to make more acquisitions, undertake more projects, fund the additional working capital needed to increase their sales and so on. By doing so they will increase their profits and therefore also the income tax they pay. This will lead to a reduction in unemployment and under employment, to an increase in salaries and wages, an increase in personal income tax paid and an increase in consumer spending, thereby stimulating the economy.
Also, by allocating capital away from the top end of the stock exchanges around the world (which is generating returns on investment that are in my opinion way below the returns one would ordinarily accept for the associated level of price volatility) to unlisted companies paying higher returns to investors, the retirement savings of the Australian population will grow at a faster rate. This in turn will result in more Australian retirees being self-funded.
The following should be done with a view to improving the Australian economy:
- The legislation relating to the preparation of ‘product disclosure statements’ and the restrictions on the promotion of investment opportunities should be scrapped and replaced by guidelines for their interpretation. These days’ product disclosure statements (prospectuses for the retail market) are prepared by compliance lawyers and lack the information needed by the investment community. There have been numerous corporate and trust collapses despite having issued product disclosure statements, so it is hard to argue that they are effective in protecting investors.
- The financial planning industry should prohibited from promoting themselves as providing financial or investment advice if they receive sales commissions or similar on any product or service recommended to a client and should be required to disclose in ‘big & bold’ statements that they are acting for ‘the other side’.
- The Future Fund should be encouraged to allocate capital to investing in (debt, equity and hybrid securities issued by) unlisted companies and establish a team to assess and evaluate such opportunities.
- The various Unions should encourage their associated Industry Funds to invest in unlisted companies in their sector. This would increase employment in their sector, increase union memberships, increase business profitability and therefore also increase salary and wage growth in their industry.
By: Mark M.J. Morris