We still need to talk about SMEs
There is now an increased recognition, both among domestic policymakers and at European level that a meaningful recovery in labour markets will not be possible without a strong base of thriving smaller firms. Germany has thrived in large part because of its celebrated network of strong family firms, manufacturers with roots in local communities going back for generations.
However, one of the features of the current crisis is the way so many European SMEs have been left with their backs to the wall.
And certainly, Ireland has been no exception in this regard.
Many of our SMEs businesses find themselves saddled with huge property debt, as a result of investment strategies followed in the bubble years. The owners are often carrying a heavy personal debt load and many have seen the value of their investments eviscerated.
The debt overhang runs into tens of billions of euro, with default rates of over 50% in some sectors.
Tackling the SME debt bomb is proving to be a huge task for the banks that doled out the funds with little thought as to the consequences and for society as a whole. Meanwhile, early-stage start-up companies face a different set of challenges, operating within a funding system which in many ways, remains dysfunctional, more than six years after the economy went into near meltdown.
At least policymakers and thinkers have now moved behind the stage of firefighting to a more rounded consideration of future strategy.
On Friday, the ESRI hosted a conference on the SME financing landscape, with particular emphasis on the importance of broadening sources of finance beyond the banking sector.
ESRI researchers, Dr Conor O Toole, and Martina Lawless, have produced some very interesting findings.
Their report is entitled: ‘Financing SMEs in economic recovery.’
According to O Toole, Irish SMEs use differing forms of finance across the life cycle. At the infant/ toddler stage, there is heavy reliance on seed-finance and ‘business angels’, family or friends. As the firms — some, at least — grow, they begin to access early-stage venture capital funding, then bank loans and guarantees, more formal venture capital support, leading finally, in exceptional cases to a public flotation.
One of O’Toole’s key findings is the extent to which firms here rely on trade credit, that is, on the goodwill and patience of their suppliers.
Loans from friends and family also feature strongly. That this should be so is symptomatic of the stressed nature of the banking sector.
At the same time, Irish SMEs remain, comparatively speaking, highly reliant on the banks, with limited use of formal sources of non-bank debt.
This is part of a wider problem. Capital markets across Europe tend to be far less well-developed than in the US.
As O Toole points out, “the low use of equity is an international phenomenon.”
To his surprise, reliance on equity by Irish firms is relatively high by European standards, but it may be simply that we are among the better of a bad lot.
It is accepted that the gates of credit must be reopened, even if the great torrents of loan finance of a decade ago are gone forever. The European Commission and European Central Bank are acutely aware of the role that SMEs could play in recovery, but their early attempts to prime the pump have met with modest success.
Much more hope is invested in the new €7bn low-cost loan fund which will be administered by banks in each member state.
The new Minister of State at the Department of Finance, Simon Harris, was certainly talking up this fund, insisting that “there are few precedents for sovereign global funds with such a mandate.”
For the first time, the ECB has gathered survey data on the so-called discouraged borrowers, those who are in need of local capital, but do not even apply. A key constraint lies with the cost of credit, particularly high in the Irish context. The new low-cost loan fund should address this issue, at least in part.
The State comes in for criticism, both over aspects of tax policy seen as inimical to risk taking, and in the way some of its schemes are conceived and administered.
The Irish Venture Capital Association and Patricia Callan, director of the Small Firms Association, have taken aim at the 33% Capital Gains Tax rate which they contrast with the position in the UK where a rate of just 10% applies. As a result, they argue, key projects are being lost to this country.
More cautious souls question whether a sharp drop in the rate of CGT might not simply encourage a new wave of Celtic Tiger-style get-rich-quick schemes. That said, the Department of Finance clearly needs to put its thinking cap back on when it comes to fostering wealth creation.
On Friday, a number of participants criticised the continued failure to put in place a proper scheme of export credit insurance.
The much-touted credit guarantee scheme is also widely believed to have flopped due to excessively strict terms: it does not apply in the case of loan refinancing and covers a period of just three years, too short a period, many believe.
Ireland, despite its huge reliance on trade, is almost alone among OECD states now in lacking a strong scheme — a fact that may be connected to the abuse of a previous export credit guarantee scheme, more than 20 years ago by powerful interests close to the then government.
A sobering contribution was made to the discussion by John O'Sullivan, general partner with ACT Venture Capital.
Mr O’Sullivan observed that just 1,500 to 2,000 SMEs could be described as “companies on their way to success”. Many operate below the radar, eschewing publicity, operating in unglamorous sectors. They have the potential to serve as key drivers of growth.
They are to be distinguished from the broad mass of small firms operating at a local level.
While the first group of dynamic firms are key generators of income, the bulk of the jobs are to be found among this second category.
It is this second group that have born the brunt of the recession and the property price collapse.
The challenge will be in coaxing some of the firms in the second group into the first group, breaking into export markets and getting on the way to becoming significant international, even global players like Glen Dimplex and of course, Kerry Group.
How many will be content simply to remain as lifestyle businesses, generating enough to see the kids through college and perhaps a little beyond, one wonders? The mood, in general, is far less downbeat than was the case, 18 months ago, but the policy challenges remain considerable.
In truth, our SMEs are a pretty varied, eclectic bunch. Many of the funding initiatives appear well-suited to the needs of the emerging ICT companies. Many new mechanisms such as crowd funding appear well-suited to the needs of this group.
The banks are scouting for business again, particularly in the food sector, but there is a real sense among borrowers and policymakers that firms should never again have to rely on these lending institutions alone.
The Government, meanwhile, announces fine schemes, but too often they are strangled in red tape, and rarely made use of, something which one suspects, does not trouble officials in finance whose job, after all, is to husband the taxpayers’ money.
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