27/08/2014

When the bank will only lend against real estate you don't have, but your SME still needs money to grow, can you raise venture capital?

The definition of a banker is a bloke who lends you money when you don't need it.  

The definition points up the fact that most businesses need money in growth stages (initial or subsequent) at which point because the bank will only lend against the security of real estate which the owners of the business don't have, the business can't raise bank finance.

Later when you're successful and have masses of real estate but don't need the money your banker is only too happy to lend it to you.

'Balance sheet lending' is where the bank takes security mainly over your business.  It requires the bank to assess your chances of success because if you fail their security will be worthless.  It's big in the States but then they've had a lot more bank failures over there than we have.  The absence of 'balance sheet lending' in Australia is part of the price we pay to have an oligarchy of four big banks that don't fail.

So if your bank won't lend you the money for your small business, can you raise it elsewhere without real estate security?

Recently we've seen a growth in the use of convertible notes by small companies who've attracted investors.

A convertible note involves a loan to the company that the lender can convert into shares in the company at some point in the future.  The loan can be secured over the company's assets and earn interest prior to conversion to shares or repayment by the company.

Convertible notes allow the investor to have a somewhat more secure interest in the company initially (of course if the company fails their security will not be worth much) before becoming a fully exposed shareholder in the company.

The next issue is how you find that lender.

Small private companies are generally not permitted to raise money from the public – see s.113(3) of the Corporations Act.  However s.708 of the Act provides some exemptions including:

•    up to 20 personal offers per year to raise a maximum of $2 million
•    offers to company staff
•    offers worth more than $500,000
•    offers to people with $2½ million of net assets or $250,000 average annual income.

Fund raising for small companies has always been difficult because often the amounts involved don't justify the cost of the expertise, effort and documentation needed to find and secure a private lender.  Note to Joe Hockey: if you want to get our economy moving, solve this problem!

For further information, contact Townsends Business & Corporate Lawyers on (02) 8296 6222.