A vital cash injection

FUNDING:ASK THE BANKS and they'll say they're open for business but there is no demand for lending. Talk to the small and medium sized enterprise sector and they'll say they're being starved of bank funds.

Whoever is right, it is apparent there is a need for alternative sources of financing for SMEs. There have been a number of innovations, some of which were reiterated in last week’s Budget. But will they work?

Earlier this year, the Government announced a €10 million micro-finance fund, which will help early-stage start-up companies secure funding of between €5,000 and €25,000.

While Mark Fielding, chief executive of Isme (Irish Small and Medium Enterprises), says it will “certainly be a help” for struggling businesses, he is sceptical as to whether it will be launched, as is now projected, in the first quarter of 2012.

“It’s been announced eight or nine times already,” he said.

In addition, a temporary, partial loan guarantee scheme is to be introduced in the first quarter of next year, which would assist up to 5,000 companies. Under this, up to €150 million would be guaranteed next year, extending to €450 million over three years.

The scheme would involve the Government partially guaranteeing loans by traditional lenders to viable businesses that have difficulties accessing credit.

“It’s not a silver bullet, but it will help borderline cases to get across the line,” noted Fielding, adding: “It won’t be the answer for everybody, but it certainly will be a help for smaller businesses.”

And for smaller companies, one reliable form of funding has always been the Business Expansion Scheme (BES). In 2008, €135.8 million was raised by companies through the BES, but this has fallen to just €58.6 million last year.

However, it is still a vital source of funding, particularly given the tough banking environment, and the number of companies accessing the scheme remains high. As of the start of this month, for example, 328 companies have applied for BES funding.

Introduced in 1984 to help manufacturing companies raise money, the scheme was given a makeover in last year’s budget, a change which was finally approved by the European Commission at the end of last month.

So how will the Employment and Investment Incentive (EII) scheme, which is set to replace the BES from the end of this year, differ?

Firstly, it will make it easier for companies to raise funds, as the range of qualifying activities has been extended. Previously, the BES was restricted to manufacturing and internationally traded services companies, but now most companies can qualify, with the exclusion of certain activities such as financing and dealing activities, land development and operating guest accommodation.

It has also increased the amount a company can raise. Under the BES, a lifetime limit of €2 million applied (or €1.5 million in one year), but this has been increased to €10 million, €2.5 million of which can be raised in one year.

This means that the range – and quality – of companies applying to the BES will likely increase. It also means companies which had previously reached the funding limit may be enticed back for more.

“Strong companies that would have traditionally gone to the bank will now go to EII for funding,” says Sinéad Heaney, a partner in BDO, which co-manages the Davy BES Fund, adding: “It makes it less risky for investors because more established companies will try and access it.”

Under the EII, there is also a shorter investment term, as it will run for just three years, rather than five under the BES. For smaller companies, this may make it less attractive, as they will have to come up with the funds to repay investors sooner; but for larger ones, a shorter repayment term might be more attractive.

“There is a gap in the market for well-established businesses to finance their growth, maintain and increase their employment numbers,” notes Heaney.

In addition, there has also been a change in how tax relief is granted. While investors can still get relief at 41 per cent, it will be granted on the basis of 30 per cent in the first year and 11 per cent at the end of the three-year period. This 11 per cent is subject to certain criteria, which means investors are likely to favour companies that have the best chances of creating employment or investing in research and development.

Indeed, this will be a key determinant when the managers of the Davy BES fund make their investment decisions.

The fund manager has already been approached by a number of “extremely strong” companies.

History and heritage company Eneclann is hoping to raise €500,000 through the scheme this year. According to chief executive Brian Donovan, the company has raised money on a number of occasions in the past through the BES.

“The primary value for a business is it allows you the opportunity to raise funds at a far more competitive price than going to a bank,” says Donovan, adding that, in the “absence of a real banking system”, it has become even more attractive.

But, while there may be an increased demand from companies to raise money in this way, will investors supply the funds?

“The reality is that people don’t have as much income to shelter as they would have done previously; they don’t have as much cash in their pockets,” says Heaney. As such, she expects it will be “more difficult to raise money” this year.

Indeed, in the boom years, Davy typically raised €15 million for the fund, but last year this had dropped back to just €4 million. And the wider statistics back up this trend. In 2008 there were almost 2,500 BES investors, but last year this halved to 1,227.

According to Fielding, companies that do get investment under the BES tend to do so the “old fashioned way” – from family and friends.

The easing of restrictions as to what types of companies can qualify, plus the increase in the amount that can be raised, means that there is likely to be much greater competition for investors’ funds.

“We’re seeing a lot more demand from companies and there is increased competition out there,” notes Heaney.

Nonetheless Donovan is optimistic about the prospects for his firm.

While he concedes that “it’s not easy” raising money through the BES, pointing out that “you have to convince your audience that you have something worth investing in”, he is sanguine about Eneclann’s prospects, pointing out the firm’s 14-year track record.

“It gives people a certain degree of confidence that we’ll be around in five years,” he notes.

If his company was to get the funds it hopes, “it would secure us really well”.

“I think we’ve a good chance of getting that – there is good interest right now,” he says, adding that Eneclann will use the funds for the creation of digital assets which it can exploit online, such as the publishing of online information and original records.

Corporate bonds

Could an Irish corporate bond market be a solution for cash-strapped companies?

Businessman Denis O'Brien seems to think so. Earlier this month he suggested that Irish companies should be able to access a bond market to raise money, thus circumventing the tight banking credit market. Such an approach could involve putting together a €100 billion fund from international bond investors and the National Pension Reserve Fund to be allocated to Irish companies.

Its something that appears to be working in Germany. Over the past 12 months, four of Germanys eight stock exchanges have started their own markets for “Mittelstand bonds”, issued by small and medium sized businesses which are frequently family owned, with typical issuances of the order of €15 million to €225 million. And theyre turning to bonds for the same reason that Irish companies would: a tough market for equity issuance and a shortage of bank lending.

Investors in Mittelstand bonds are offered a chance to directly invest in debt instruments which provide for a relatively high rate of interest – typically more than 7 per cent in comparison to interest on savings accounts of less than 3 per cent.

So is this something we could see on the Irish Stock Exchange? According to a spokeswoman, it is something that the ISE has considered in the past; it even put forward a pre-budget submission on the topic in 2009.

However, the main stumbling block to such a market remains the current tax treatment of corporate bonds for retail investors. Unlike gains in equities, which are liable for capital gains tax at 30 per cent, or deposit, which is liable to DIRT at 30 per cent, income from corporate bonds is taxed at the marginal rate of income. So, for higher rate tax payers, it is not an attractive option.