Developments in SME Financing in Australia: Wallis Report Findings and

Corporations Law and Stock Exchange Initiatives

School of Commerce

Flinders University of South Australia

Research Paper Series: 00-4

ISSN: 1441-3906

Developments in SME Financing in Australia: Wallis Report Findings and

Corporations Law and Stock Exchange Initiatives

Mr Anthony M. J. Stanger

Lecturer, School of Commerce

The Flinders University of South Australia Telephone (08) 8201 2764

GPO Box 2100 Fax (08) 8201 2644

Adelaide, SA 5001 Email Tony.Stanger@flinders.edu.au

Abstract

Key policy and private sector initiatives since 1996 impacting upon the debt and equity financing of small and medium size enterprises (SMEs) in Australia are reviewed. The initiatives include the submissions, findings and recommendations relating to SMEs of the Financial System Inquiry (Wallis Report) into the Australian financial sector; developments in the Australian Corporations Law (ACL); and the advent of the Australian Stock Exchange (ASX) Enterprise Market and the Newcastle Stock Exchange (NSX).

The Wallis Report finds that on the financing supply side, in terms of sources of competition in SME financial products, with the exception of term loans, banks are the primary suppliers of SME financing products such as transaction banking, overdrafts, commercial bills, leasing, and credit card merchant facilities. In terms of marketing practices by product bundling, SMEs have access to convenience-based bundling, but less access to rewards-based bundling. With new delivery mechanisms (electronic and Internet banking), a physical branch presence is declining in importance. Regional banks outperform major banks in fees and charges, but not with regard to loan interest rates. SME access to debt capital is adequate while obtaining equity capital is more difficult.

Access to equity capital is likely to be improved through ACL changes, which provide relief from onerous prospectus requirements through Offer Information Statement, small scale offerings and sophisticated investors exemptions. The ASX Enterprise Market provides a stepping stone to main board listing and is internet-based capital market for non-listed entities needing to raise capital through the issue of various debt and equity securities without the need for a prospectus. The NSX aids fundraising by SMEs due to a small minimum issue quantity and scope to avoid the preparation of a prospectus. Both equity and debt security issues can be listed by way of an offer to the public to subscribe to new securities and an offer to the public of securities already issued or agreed to be subscribed.

These initiatives have also created other benefits for SMEs and their owners, and have expanded the assistance and advisory role of accountants to SMEs.

INTRODUCTION

This paper reviews policy developments and private sector initiatives impacting upon the

financing of small and medium sized enterprises (SMEs) in Australia since 1996. First, the

Financial System Inquiry (Inquiry), also known as the Wallis Report, is reviewed for

submissions, findings and recommendations on the financial sector in relation to SME

financing. This is followed by an expose of developments in the Corporations Law, the

Australian Stock Exchange’s (ASX) Enterprise Market and the Newcastle Stock Exchange

(NSX), that provide SMEs with some relief from the onerous burden of prospectus

requirements.

As accountants are the universally most used source of assistance and advice by SMEs

(Roffey et al, 1996), awareness of these recent developments amongst accounting

practitioners is imperative. In addition, practitioners are able to benefit commercially through

direct participation in the fundraising process as a sponsor or advisor, as well as indirectly

through the marketing generated in the process.

THE WALLIS REPORT

The terms of reference of the recent Financial System Inquiry do not specifically mention

SMEs, however they have been given due consideration in addressing the following terms:

The effects of deregulation of the Campbell Report (1981) on the range, quality and cost

of financial services available to consumers and other users;

The development of the financial institutions and their products; and

Regulatory arrangements affecting the operation of the financial system with regard to

promoting the most efficient and cost effective services for users (Financial System

Inquiry Final Report (FSIFR), 1997).

The interim report of the Inquiry, the Financial System Inquiry Discussion Paper (FSIDP)

(1996), discusses the role of the financial markets in providing debt and equity financing to

SMEs. At the time of the Inquiry SMEs experienced some relief from the Corporations Law

requirements on equity issues with the relaxing of prospectus rules applying to some small

offers made to less than 20 persons and individual offers to wholesale investors of over

$500,000. However, ASX listing rules tended to exclude most SMEs due to the minimum

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size limit of an issue. Despite changes in the prudential requirements of the Reserve Bank of

Australia (RBA) allowing banks to make long-term investments in non-financial firms,

relatively little equity investment in SMEs has been made. It is estimated that in the mid 90’s

SMEs had approximately $46 billion in debt financing and just $2 billion of institutional

equity financing.

Submissions to the Wallis Report

The views presented in submissions from interested parties to the Inquiry are described in the

FSIDP (1996) in five broad areas.

Information Problems and Market Failure in SME Financing

From the demand perspective, it was suggested ‘that many SMEs do not yet appreciate the

market value of quality information or may not have an appropriate corporate governance

structure’ (FSIDP, 1996, p. 144). From the supply side perspective, ‘the market has not

delivered mechanisms to capture, process and deliver information widely’ (FSIDP, 1996, p.

144). In terms of equity financing, this has been manifested by a lack of research into

incorporated SMEs and a preference by institutional investors for listed companies or those

rated by rating agencies. It was suggested that search, information and transaction costs be

lowered, matching services facilitated and alternative equity exchanges developed. Banks

have provided the main source of SME debt financing. This is due to the comparative

advantage banks have in information collection derived from their on-going relationship with

SMEs and credit analysis. Competition between major banks and between major and regional

banks has been beneficial in terms of the provision of new products and services and an

increased rate of loan approval from 70 to 80 % a decade ago to 90% currently (FSIDP, 1996,

p. 145).

Amendments to Corporations Law to Improve SME Access to Equity Finance

Submissions received by the inquiry from Thinkbank and Austock Brokers suggested that

prospectus rules should be less onerous by:

Increasing the number of persons to whom an offer can be made without a prospectus

from 20 to 50;

Reducing the minimum amount of an excluded offer from $500,000 to $250,000;

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Allowing security dealers to invest in SME securities without a prospectus both as agents

for clients and as principals; and

The ASX requirement of a minimum of 500 shareholders should be reduced.

Additionally, it was suggested that the Corporations Law amendment no longer requiring the

lodgement of financial reports to the former Australian Securities Commission (ASC) could

result in reduced visibility of small companies to the market (FSIDP, 1996, p. 146).

Cost of New Debt and Equity Capital to SMEs

The cost of new debt and equity is higher for SMEs, compared to other incorporated firms,

because of higher underwriting and prospectus costs due to their fixed cost nature. Table 1

below provides the results of a study commissioned by The National Investment Council on

the costs of capital raising on the ASX. It can be seen that the costs of smaller capital raisings

are higher than larger capital raisings for both new (or initial) issues and other (or subsequent)

issues. Additionally, the cost of new capital raisings for smaller firms is significantly higher

than subsequent offers due to the lack of information on the firm in the market place

(Marsden Jacob Associates, 1995, p. 37).

Table 1: Costs of Capital Raising on the ASX in 1994

Capital Raising% of Gross capital On Offer

UnderwritingCosts

%

ProspectusCosts

%

Total Capital Raising Costs

%All Surveyed firmsAverage 3.3 3.3 6.6Over $10 million 2.7 2.6 5.3$10 million and below 3.9 3.9 7.8New OffersAverage 3.7 4.0 7.7Over $10 million 3.3 3.3 6.6$10 million and below 4.6 4.7 9.3Other OffersAverage 2.8 2.3 5.1Over $10 million 1.3 0.9 2.2$10 million and below 3.5 2.7 6.2

Source: Marsden Jacob Associates, 1995, p. 37.

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With regard to debt financing, the Australian Chamber of Commerce submitted that two-

thirds of its respondent members indicated their loan financing arrangements were either

satisfactory or very satisfactory. However, a large proportion of respondents also indicated

that improvement in the area of interest rates, and fees and charges could be effected. It was

also submitted to the Inquiry that bankruptcy laws have the effect of discouraging debt and

equity financing of SMEs (FSIDP, 1996).

Potential for Securitisation of SME Debt

The Department of Industry, Science and Tourism expressed concern about the suitability of a

government backed securitisation scheme such as that in the US where the Federal

government scheme guarantees from 70 to 90% of SME loans. However, it supported

consideration of a SME debt securitisation program which could involve, for example, the

issue of securities backed by receivables. Securitisation has the potential to reduce the cost of

debt and lead to better products (FSIDP, 1996, p. 148). However, in order for securitisation

to work, it was suggested that a system for rating securitisation issues would be needed in

order to establish a market for lenders. It is unclear whether such a scheme should be a

government or private sector initiative. The private sector would be unlikely to establish a

securitisation rating facility unless it was commercially viable.

Potential for Secondary Markets in SME Equity

A number of submissions from Austock Brokers and Australian Business Chamber canvassed

the idea of developing exchanges for SME equity securities. The form of these suggested

exchanges included:

An exempt stock exchange;

Re-establishing second boards;

A ‘start-ups’ stock exchange; and

Seed funding for the development of an information registry of venture and development

capital users and suppliers (FSIDP, 1996, p. 148).

At the end of the interim reporting phase of the Inquiry, the stated objectives for the final

reporting stage in regard to SME financing were:

‘the extent of information failures in the SME debt and equity markets;

impediments to the development of secondary markets in SME debt and equity securities;

and

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the changes which may be required to the regulatory environment and to legislation to

facilitate the development of such markets’ (FSIDP, 1996, p. 149).

Wallis Report Findings and Recommendations

Demand Issues – Consumer Purchasing Behaviour

On the issue of price sensitivity, the Australian Chamber of Commerce and Industry (ACCI)

noted that SMEs appear to be quite price sensitive i.e. the greater the potential savings, the

more SMEs are price sensitive. In an ACCI survey of its members, it was found that 59.3%

of respondents had sought a different lender during the 3 years before the survey. The main

reason given for this was pricing i.e. fees and charges. About 1% had not considered

changing their lender in the 3 year period (FSI, 1997, p. 438). The Inquiry also considered

the extent to which consumers bundle some of their financial products. However, the data

was not disaggregated at the SME level.

Supply Substitutes

In examining the supply side of SME financing, the Inquiry considered the sources of

competition for individual products and the marketing approaches of financial institutions.

1. Sources of Competition

The Inquiry considered the sources of competition for a number of individual financial

products used by SMEs. These products included transaction banking, overdrafts,

commercial bills, term loans, leasing and credit card merchant facilities. With the exception

of term loans, banks (major, regional and foreign) primarily provided the above mentioned

SME business products. Consumer products were provided by a broader range of institutions

comparatively. In terms of the potential for future non-bank providers of products, greater

scope for the provision of consumer products by non-bank institutions was reported compared

to SME products (FSI, 1997, p. 441, Figure 10.5).

Findings on the main type of financial institution used by small business in 1995 indicate that

there is little competition to banks in the provision of small business banking products:

78% used major banks;

20% used other banks; and

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2% used other financial institutions (Yellow Pages, 1995 in FSI, 1997, p. 443, Figure

10.6).

It was also reported that the majority of SME owners use a single financial institution, with

just 15% having accounts with more than one financial institution (FSI, 1996, p. 442). This

evidence supports the contention that regional banks are the only source of competition to

major banks for small business loans.

The Inquiry also found that banks were the main source of non-startup finance for small

business with:

53% using a secured bank loan;

16% using personal funds;

3% finance company loan;

3% family or friends;

2% overdraft;

2% business profits; and

28% did not require additional financing (Yellow Pages, 1995 in FSI, 1997, p. 444, Figure

10.7).

2. Marketing of Products

The Inquiry also considered the second supply-side issue of marketing practices of different

institutions in terms of product bundling. Convenience based bundling involves linking

accounts for the sake of convenience e.g. credit cards, transaction facilities and cheque

accounts. Rewards based bundling involves for example, the waiving of fees or offering

more competitive interest rates. Convenience based bundling is likely to apply to small

businesses that happen to have the products being bundled in this way. Rewards based

bundling of small business products was found in just two cases in a review of 127 brochures

from the major banks, 3 regional banks and 1 credit union in late 1996. The Inquiry also

suggested that institutions would continue to bundle some, but not all, products.

The Inquiry concludes that small business finance and other SME products are likely to be

factors included in the assessment of any future merger proposals due to the limited number

of non-bank product substitute suppliers. Thus, recommendations on policies on the

assessment of mergers in the financial system focus on the retail sector, which includes

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banking for households and SMEs. The wholesale sector is considered to be competitive and

mergers within the sector less controversial.

Geographic Market Considerations

In considering the geographic dispersion of the market, the Inquiry addressed the basic

question of ‘how important having a physical branch presence is to doing business in a

region’ (FSI, 1997, p. 447). With regard to attracting new business lending from small

business, it was recognised that a branch presence has traditionally been an important factor.

With at least one regional bank offering centralised processing of small business loan

applications, the importance of a branch presence may decline. It was suggested that while

the market for SME products is not yet national, it might become national in the future. With

new delivery mechanisms on the supply side in place (including electronic and Internet

banking), the uptake of these is likely to make the market more national and decrease small

business’s preference for dealing with suppliers with a physical presence.

Importance of Regional Banks

On the role of regional banks, the Inquiry reports the annual Bank of the Year awards run by

Personal Investment Magazine indicate that between 1991 and 1996, regional banks have

outperformed the majors for 5 of these years across a broad array of products, including

business accounts. Awards were based on interest rates on the main products as well as fees

and charges. In terms of overall (business and non business) customer satisfaction, credit

unions and building societies head both major and regional banks. However, perhaps the

most telling indicator is that of interest rate comparisons for business loans. Major banks had

the lowest rates, followed by building societies, regionals and credit unions (FSI, 1997, Figure

10.12, p. 458). To engender further competition between various providers and to be able to

take advantage of products offered by building societies and credit unions, small business

owners and consumers generally need to be aware that these institutions have similar

prudential regulations and thus are comparably safe, offer a wide range of products and are

nationally accessible (FSI, 1997, p. 458).

Improving Market Information

The Campbell Report (1981) and subsequent inquiries into the availability and cost of capital

for SMEs have found SMEs have adequate access to debt financing. Financial deregulation

has enabled banks to provide a greater range of financial products and extend loans to more

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small business clients (FSI, 1997, p. 628). However, equity capital has been more difficult to

obtain (p. 509). Possible reasons provided for this finding include:

Scale – a large proportion of SMEs seek growth finance of less than $500,000. The fixed

cost nature of searching, assessing and monitoring a loan or equity investment results in

disproportionately higher cost of funds.

Risk – SMEs are likely to be perceived as being more risky with startup and high growth

firms often lacking a track record. One submission indicated that capital adequacy

requirements might actually understate the true risk of loans made to SMEs.

Reporting – SMEs tend to not prepare good financial reporting information with

alternative information sources such as credit rating agencies and the ASX being

unavailable (FSI, 1997, p. 510).

The Inquiry considered the information needs of the financial markets with regard to SME

debt and equity financing requirements.

1. Debt

Consistent with findings of earlier research, the Inquiry notes the heavy reliance of SMEs on

bank loans. The Inquiry found evidence that SMEs face higher loan costs and more onerous

loan conditions than larger businesses. These differences attributed, at least in part, to greater

risk, smaller scale of loan and demand for more flexible, and commensurately more expensive

financing such as bank overdraft. Although the Inquiry did not find evidence of any serious

deficiency in the SME debt markets, increased competition in the bank sector will help

improve the cost and flexibility of debt finance to SMEs (p. 511).

2. Equity

The Inquiry noted that many SMEs were not suitable for external equity investment as they

lacked growth prospects, owner-mangers may not be willing to accept dilution of their control

(and possibly increased accountability that follows) and the personal affairs of the owner-

manager(s) may not be separate from the business.

Although a number of submissions to the Inquiry suggested that superannuation fund

investment in SMEs be mandatory, the Inquiry specifically recommends against such a

requirement (Recommendation 97) due to the possible detrimental impact on capital market

efficiency. The Inquiry was also skeptical of calls for the development of an alternative

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equity due to the lack of probity associated with some companies listed on the Second Boards

in Australia between 1984 and 1992, and the lack of liquidity and share price volatility

associated with low market capitalisation firms (FSI, 1997, p. 515). Finally, the Inquiry

supported steps taken by the ASC in 1997 to reduce the onerous requirements on prospectus

and advertising for matching services for investments up to $5 million.

3. Improving Information on SMEs

The Inquiry recognised the importance of improved information on SMEs in suggesting that

‘data collection on SMEs should consider the needs of rating agencies and fund managers’

(Recommendation 98) p. 517. In achieving this, Government SME data collections should

balance reducing business costs through less onerous financial reporting imperatives on

SMEs, with ABS data collections. It also believes that potential private sector investors of

SMEs, such as fund managers and venture capitalists, have adequate commercial incentive to

develop necessary benchmarking and performance measurement data on SME investment

pools (p. 516).

DEVELOPMENTS SINCE THE WALLIS REPORT

Developments in SME financing since the Inquiry are reviewed below and include changes to

Corporations Law, the ASX’s Enterprise Market and the Newcastle Stock Exchange.

Changes to the Australian Corporations Law

Recent changes to the Australia Corporations Law (Corporations Law) have their genesis in

the Corporate Law Economic Reform Program (CLERP) announced by the Coalition

Treasurer in March 1997 (Treasury, 2000a). The overall aim of CLERP is to improve the

efficiency and competitiveness of the business environment. With regard to fundraising by

SMEs, consideration was given to reforming the prospectus requirements. This is consistent

with recommendations of the Inquiry which either directly or indirectly impact upon

fundraising (namely Recommendations 4, 9 and especially 10) (Treasury, 2000b).

At the time of the CLERP Proposal for Reform: Paper No.2 – Fundraising (CLERP, 1997), a

number of exemptions to the prospectus requirement in offering securities in SMEs, as in

other corporations existed:

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1. Up to 20 investors may be offered securities in a 12 month (20 offers of securities in 12

months exception). Relief to this exemption was provided by Class Order [CO97/2329]

which did ‘not require other categories of excluded offers [e.g. public meetings] to be

counted towards the twenty’ (ASIC, 1998, p. 6); and

2. Investors investing at least $500,000 in an issue (sophisticated investor exemption)

(CLERP, 1997, p. 50). This ‘sophisticated investor’ exemption is based on a person’s

‘ability to obtain pertinent information from the issuer because of their bargaining power

and proximity [to the issuer]’ (CLERP, 1997, p. 59).

These exemptions also applied to introduction or matching services when used by issuers.

These services identify potential investors and issuers of securities by disseminating

information on investment opportunities by brochures, bulletin boards, internet and meetings

to the general public or subscribers of the service (ASIC 1998, p. 2).

The CLERP Proposal for Reform: Paper No.2 – Fundraising (1997) proposed that a

corporation (including SMEs) should:

1. Be able to raise up to $5 million using an Offer Information Statement (OIS) which would

explain why the funds are sought, disclose material information (including audited

accounts), warn investors of the risk of investing without a prospectus and the

conventional due diligence inquiries, and recommending independent professional advice

be sought. With an OIS, liability of the promoters would be modified in accordance with

the reduced disclosure requirements (CLERP, 1997, p. 57). This proposed modification

provided flexibility by allowing use of the single OIS to raise several tranches of funds

provided the total raised was no more than $500,000;

2. Not be required to prepare a prospectus or OIS ‘if no more than 20 issues of securities are

made in a rolling 12 month period, based on personal offers of those securities, and no

more than $2 million is to be raised’ (CLERP, 1997, p. 57).

This proposed exemption extended the preceding exemption by replacing 20 personal

offers in 12 months with actual issues to 20 investors. This would help SMEs attain their

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funding target as 20 offers could be rejected. Additionally, administration of the

exemption would be simplified as it is easier to determine when an issue is made due to

supporting documentation, as compared with an offer (Corporate Law Economic Reform

Program, 1998); and

3. Be permitted to issue any amount of securities without a prospectus to persons who either:

Invest at least $500,000 and who may be regarded as a sophisticated investor (as

discussed above); or

Have net assets of $2.5 million or gross income for the last two financial years of

$250,000 or more (CLERP, 1997, p. 59).

To qualify as a sophisticated investor, an investor needs a certificate, dated in the last 6

months, from a ‘qualified accountant’ certifying an investor’s asset or income position.

Full members of the ASCPA, the ICA and the National Institute of Accountants are

recognised as ‘qualified accountants’ (Cockburn, 2000). The extension of the original

$500,000 minimum exemption previously discussed is aimed at overcoming problems of

when less than $500,000 is sought or where investors are unwilling to invest the relatively

large sum of $500,000 (Corporate Law Economic Reform Bill, 1998).

These developments can be found in the Corporations Law subsections:

709(4) - Offer Information Statement;

708(1) - small scale offerings (20 issues or sales in 12 months). Subsection 708(6)

modifies this provision for Managed Investment Schemes by disregarding issues and sales

made under certain conditions; and

708(8) - sophisticated investors.

In addition to these prospectus relief exemptions relating specifically to SMEs, the ACL

continues to offer prospectus relief of fundraising provisions to business activities that SMEs

may possibly undertake. These include ‘small scale’ horse racing syndicates and breeding

schemes, film investment schemes, property trusts and property syndicates (ASIC 2000).

Applications for relief to new fundraising provisions may be made under Policy Statement 51

– Applications for Relief [PS 51]. These fundraising provisions may be modified as the

Australian Security and Investment Commission (ASIC) continues to review its policies in

regard to fundraising (Cockburn, 2000).

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ASX Prospectus Requirement Changes - Enterprise Market

The Enterprise Market, commonly referred to as e.m, commenced in March 1998 and is an

internet-based capital market for non-listed entities needing to raise capital. The types of

entities involved include unlisted public company, proprietary company, partnership, joint

venture, trust or cooperative and in certain circumstance a proprietary subsidiary of a publicly

listed parent company (ASX, 1999a). The types of securities that may be issued by

businesses entering Enterprise Market include shares, options, debentures, convertible notes

and convertible preference shares (ASX, 2000).

It has been estimated that some 10,000 such businesses were seeking equity financing to

commercialise an idea or to grow their business in 1998/99 (ASX, 1999g & 1999h). By May

1999 there were over 250 subscribers to the online service (Stewart, 1999) and $21 million

had been raised by businesses through the Enterprise Market as at the 31 July 1999 (ASX,

1999i). The Enterprise Market is a useful intermediate step towards a business owner

attaining ultimate Main Board listing on the ASX. In particular, it has been suggested by

leading I.T incubator centres that the Enterprise Market has an important role to play in the

development of high technology industry in Australia (ASX, 1999g). Developments in the

Enterprise Market since implementation include the Commonwealth Bank bringing bank

customers to the Enterprise Market in order to raise equity capital in place of $15 million of

debt currently held with the bank (ASX, 1999i). Additionally, the Tasmanian and NSW

governments have agreed to strategic joint ventures with Enterprise Market to act as advisers

for SMEs to access the Enterprise Market (ASX, 1999i).

Advantages for Capital Raisers

Raising capital through the Enterprise Market provides a general exemption from the onerous

prospectus requirements of the ACL. In this way, the Enterprise Market facilitates the

detailed description of a business to a potentially wide audience of investors without the need

for a prospectus which can cost in the range from $200,000 to over $500,000 (ASX, 1999j).

In order for a prospectus not to be required with such a capital raising activity, the information

presented in the Enterprise Market must ‘not constitute an offer, contain specific pricing

information of securities or include an Application Form for shares’ (ASX, 1999a, p. 1). The

need to prepare a prospectus may also arise once Enterprise Market is no longer in use and

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parties commence negotiating an investment, notwithstanding the ACL prospectus

exemptions previously described.

The detailed information provided by Enterprise Market can be entered by a promoter of the

business, or through the assistance of an advisor. The Enterprise Market provides examples

of the information required in order to prepare an entry and maximise the likelihood of

securing financial backers/investors. The type of information provided includes basic

business profile, current situation, financial summary and sponsor certificate or endorsement

(ASX, 1999b).

The sponsor provides validation of some of the information in the documents submitted to the

Enterprise Market. A list of registered Sponsors is maintained by the Enterprise Market and

in order to be listed the sponsor needs to have current accreditation with the relevant

professional body or industry association. Examples of the type of information that may be

sponsored include historic and current business accounts, business plans, testimonials,

intellectual property, and management skills and competencies (ASX, 2000). The sponsor

certificate may be the business’s accountants and/ or auditors who attest to the financial

statements and that their preparation is consistent with accounting principles and comment on

the audit results of the last two or three years. The Sponsor’s endorsement is in the form of a

document which is attached to the other documents of the business in the Enterprise Market.

The identity of the sponsor and their opinion on the information provided on the business is

attached and cannot be altered. Should the Sponsor have reason to believe the business’ entry

contains misleading information, the endorsement can be withdrawn and the entry is de-

activated and inaccessible to investors until the problem is resolved between the business, the

sponsors and the ASX (ASX, 1999d). The Enterprise Market provides warnings of the risk

associated with this market and the sponsor is not likely to be liable as long as it can be shown

reasonable steps were taken to ascertain the endorsement was valid (ASX, 1999d).

In order to satisfactorily provide the above information to attract an investor, guidelines on

making the business ‘investor ready’ or ‘investment ready’ are outlined in ASX (1999a).

These two states of readiness are cumulative. Basically, investor readiness generally relates

to smaller business or young businesses with growth potential and includes the requirement

that the owner has separated personal affairs from those of their business (ASX, 1999a).

‘Investment ready’ businesses may be described as those seeking reasonable amounts of

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capital and are in a position to use the funds sought ‘immediately’ in order to grow the

business.

The firm may state the preferred investor involvement e.g. part or full time executive,

director, executive director or mentor (ASX, 1999b). In this way businesses are able to attract

the pecuniary and non-pecuniary participation of investors, who in the latter case, act as

mentors to the business (Stewart, 1999). Additionally, the firm provides an indication of the

total amount sought, the minimum investment and the preferred type of financing (i.e. debt or

equity).

The Enterprise Market allows the business identities to remain confidential, in which case an

interested investor or advisor can be put in touch with a nominated advisor, who can

investigate the bona fides of the investor before direct contact with the business owners is

established (ASX, 1999a).

Capital raisers can gain exposure on the Enterprise Market for 6 months for as little as $1,000

for $200,000 capital raising. For amounts above this up to $500,000 the cost is $2,000. Up to

$1 million $3,000 and $5,000 for over $1 million upto $5 million (ASX, 1999e). A change in

the information and a further 6 months exposure can be purchased for 10% of the initial fee

and subsequent to this for 25% of the original fee (ASX, 1999e). As the market grows and

advisors are able to use pro forma documents rather than prepare one-off documentation, fees

are likely to become even more cost effective (ASX, 1999h).

Should an investor wish to sell-down or dispose of their entire investment, the Enterprise

Market can also assist, unlike typical matching services. The business need only list on the

Enterprise Market again to sell the investment, rather than raise new capital. While this does

not provide the liquidity of the Main Board, it does provide a mechanism for contact with

potential investors.

Benefits for Investors

The Enterprise Market helps overcome the problem of investors in non-listed companies of

finding businesses matching their area of interest and/ or expertise (ASX, 1999c). And

although investment in non-listed businesses is relatively riskier due to the absence of listing

requirements of the ASX Main Board stocks, returns can be commensurately higher and

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investors are able to personally involve themselves in the business management (ASX,

1999c).

Annual subscription to the Enterprise Market costs $100 and can be made via the internet site

http://www.asx.com.au/e.m or by forwarding a signed General Subscriber or Advisor

contract, providing a profile of the prospective investor’s interests (ASX, 1999e). Prospective

investors may browse the SME entries in the Enterprise Market of their own accord or the

Enterprise Market may send an automatic message alert via email within 1 working day of a

matching investor profile and a new or changed business registration.

Once a potential investor is identified, the Enterprise Market provides the necessary

information on the company about operations and activities, possibly including accounts,

management details, business plan, market research, customer testimonials, management

assessments and geographical data (ASX, 1999, p. 1). This is equivalent to the rather onerous

‘due diligence’ process that otherwise may have to be undertaken and which could possible

scare potential investors away. While the ASX does not validate or guarantee the information

supplied by a business, the endorsement of a sponsor such as accountant, auditor, lawyers,

stockbroker or investment advisors may be arranged by the business to ensure the information

provided has been scrutinized by a reputable professional (ASX, 1999c). The ASX provides

an Enterprise Market newsletter that contains information for investors (and capital raisers)

about recent developments in the Enterprise Market and successful matches.

The Role of Advisors

The ASX does not provide services directly to SMEs considering the Enterprise Market. It

relies on and promotes the services of advisors listed on its public website for both capital

raisers and investors. An advisor’s function is to assist a business to prepare for raising

capital, and may be an individual or firm that has signed an Enterprise Market Advisor

Agreement.

Accountants, as the most widely used source of advice and assistance by SMEs and with well-

developed professional networks (ASX, 1999j), can contribute and benefit greatly through

their involvement in the Enterprise Market. Through their contribution in the preparation and

audit of accounts, accountants are ideally placed to assist less experienced and skilled

business owners/promoters with: documentation for entry into the Enterprise Market;

15

preparation of a business plan; verifying the accuracy of some of the information provided in

a sponsoring role; realistic valuation of a business prior to the equity raising; and separation of

owner’s personal affairs from that of the business (ASX, 2000, p. 18).

These services can be provided cost-effectively as the volume of such activities increase with

Enterprise Market activity and accountants are in a position of being aware and able to access

government programs that may exist to subsidise their fees (ASX, 1999j). Advisors are

expected to charge a fee, which may be taken in part as equity in the business. Advisers can

also benefit from the exposure they receive through involvement in the Enterprise Market

public web-site both as general Enterprise Market Community Members as well as Advisors

to registered SMEs (ASX, 2000). Such Advisors are likely to be the first point of contact by

interested investors.

Advisors may also act on behalf of investors (buyers), along with other groups such as

stockbrokers, accountants, lawyers, financial planners and merchant banks, by introducing

clients to investment opportunities in non-listed businesses on the Enterprise Market.

However, care should be taken where potential conflict of interest may arise in acting as

advisor to both businesses in Enterprise Market and investing clients.

Under the prospectus exemptions applicable to the Enterprise Market, advisors should

recognise they have legal responsibilities under the Corporations Law:

1. Ensuring the prospective investor understands the importance of gathering their own

information on the investment, possibly from an independent professional advisor; and

2. The prospective investor is aware of the inherent risks of the investment and that the entire

investment could be lost.

3. Avoid fraudulent, misleading or deceptive practices and defamation (ASX, 1999j).

Newcastle Stock Exchange

The Stock Exchange of Newcastle Limited (NSX) was reactivated on 21 March 2000 after a

10 years of inactivity (Williams, 2000). Approval for recommencement of operations was

received in February 2000 after three years of effort in obtaining regulatory approval,

negotiating a strategic alliance with the ASX and drafting listing business rules. Trading on

the NSX is through the Newcastle Electronic Trading System (NETS) which operates under

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license from the ASX and is based on its successful Stock Exchange Automated Trading

System (SEATS) trading platform (NSX, 2000e). These transactions are efficiently and

securely settled electronically on CHESS (Clearing House Electronic Sub-register System).

‘The principal function of the Exchange is to provide a fair, orderly and efficient market from

the trading of securities issued by issuers which have either a primary or secondary listing on

the Exchange’ (NSX, 2000a, rule 1.2). Listing Rules ‘comprise both requirements which

have to be met before securities may be granted a listing on the exchange (such as the

minimum requirements for listing, application procedure and fees payable, the contents of any

prospectus published by the issuer and the requirement for a new applicant to be sponsored)

and continuing obligations with which an issuer must comply once a listing has been granted

(even if its listing is suspended) and also the powers of the Exchange with regard to the

suspension and/or cancellation of a listing’ (NSX, 2000a, Rule 1.2).

The NSX aids fundraising by SMEs due to a small minimum issue quantity and scope to

avoid the preparation of a prospectus. Both equity and debt security issues can be listed on

the NSX by way of an offer to the public to subscribe to new securities (primary market) and

an offer to the public of securities already issued or agreed to be subscribed (secondary

market), by placement, rights issue, bonus issue and the exercise of options, warrants or rights

(NSX, 2000a, rules 2.11 – 2.17). This applies to both new applicants seeking a listing as well

as listed issuers (i.e. issuers with a security already listed in the NSX). In the former case, the

new applicant for listing must be sponsored by a Participating Organisation registered on the

Exchange’s approved list of sponsors. The responsibilities of the sponsor include providing

guidance and advice on the application of the Listing Rules, completion and lodgement of

necessary documentation to the NSX and maintaining communication with the NSX

throughout the application process (NSX, 2000a, rule 2.2). In the latter case, a listed issuer

must appoint a nominated advisor who may be on the NSX’s list of approved nominate

advisors, its sponsor or with NSX consent, two members of the issuer’s senior management

(NSX, 2000a, rule 2.4).

In order to attain a listing of equity or debt securities, an SME issuer must be a corporation

and both the issuer and its business must be considered suitable for a listing by the NSX. In

the case of a new applicant, it ‘must have an adequate track record [at least two years unless

the offer is fully underwritten] under substantially the same management which must be of

17

known character and integrity’ (NSX, 2000b, rule 3.6; and NSX, 2000c, rule 3.6). In the case

of equity issues:

1. A minimum of 25% of securities must be held by the public at all times, with a minimum

of 50 shareholders (NSX, 2000b, rule 3.9); and

2. A new applicant must have an expected minimum market capitalisation for all securities

of $500,000 (NSX, 2000b, rule 3.10).

In the case of debt issues:

1. There must be a minimum of 25 security holders at all times from the public (NSX,

2000c, rule 3.9); and

2. If the issuer does not have equity listed on the NSX, it must have a minimum $2 million in

net assets and a minimum nominal amount for each class of debt securities seeking listing

of $500,000, unless otherwise deemed by the NSX (NSX, 2000c, rule 3.10).

Applications for listing of either equity or debt securities requires the preparation of a

prospectus unless:

The applicant has not raised any capital in the last 3 months and does not expect to raise

any capital in the next 3 months; and

The security ownership spread complies with Rule 3.9; or

In the case of a listed issuer, a prospectus is not required to be lodged with ASIC in

accordance with the ACL (NSX, 2000b & 2000c, Rules 4.4(2)).

In lieu of a prospectus, the issuer is required to prepare an information memorandum (also

called a letter of application) containing information including: the securities to be issued;

share capital and ownership; business history and nature, earnings and balance sheet history

(last three years if possible); child entities; dividend record in the case of issued equity

securities; properties of applicant and child entities; litigation history for the past 5 years;

management; and sponsors and banks (NSX, 2000b & 2000c).

OVERVIEW

The developments in SME financing described above have brought relief to SMEs attempting

to raise finance in Australia. Firstly, the further relaxation of onerous prospectus

requirements has been brought about by changes to the Corporations Law. Furthermore, the

18

establishment of the ASX’s Enterprise Market and the NSX has facilitated the process of

matching issuers and investors, thus facilitating the issue and subsequent sale of securities in

the primary and secondary markets respectively. Additionally, fund raising has been assisted

through small minimum issue quantities. Other advantages for SMEs and their owners

include the ability to fund business growth without the traditional need for security, an

intermediate step to public listing, improved financial reporting and control, improved

financial structure stability and the associated benefits on a firm’s credit rating, access to

management expertise, encouraging directors to focus on strategic direction and the ability for

owners to realise wealth tied up in the business (Raby, 2000).

These initiatives serve to only further the contribution accountants can make to SMEs

attempting to raise finance through the advisor and sponsor roles that have been created as

well as the certification of ‘sophisticated investor’ asset or income positions.

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