Oireachtas Joint and Select Committees
Tuesday, 27 May 2014
Joint Oireachtas Committee on Jobs, Enterprise and Innovation
Access to Finance for SMEs: Discussion (Resumed)
The first session this afternoon is a meeting with Ms Regina Breheny, director general of the Irish Venture Capital Association, to discuss access to finance for the SME sector. I welcome Ms Regina Breheny, Mr. Mark Horgan, chair of the association, and Mr. John Flynn, vice chair.
I advise the witnesses that, by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If they are directed by the committee to cease giving evidence on a particular matter and they continue to so do, they are entitled thereafter only to qualified privilege in respect of their evidence.
Witnesses are further directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable. Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the Houses or an official, either by name or in such a way as to make him or her identifiable.
I invite Ms Breheny to make her opening statement, after which I will take questions from members.
Ms Regina Breheny:
My colleagues and I welcome the opportunity to meet with the committee today. The Irish Venture Capital Association, IVCA, is the representative organisation for venture capital, VC, firms in Ireland. These VC firms have specialist domain knowledge and invest primarily in fast-growing, high-tech companies operating in the information and communications technology, ICT, and life sciences, chiefly medical technology, sectors. The companies are developing deep technologies, addressing global markets and creating thousands of high-calibre jobs.
Venture capital refers to the provision of equity capital to fund the start-up, growth and expansion of innovative small to medium-sized enterprises which are high-risk and high-potential but are unable to access credit markets because their underlying assets are typically based on intellectual property. Venture capital firms bridge that five to ten-year funding gap between the small amounts of money raised from friends and family and the funding from bank debt that comes at a much later stage. While banks do not lend to these companies, they support them by investing in venture capital funds, particularly at the seed and start-up stage.
A particular feature of the VC model is that funds are precluded from taking on debt. Instead, they usually invest equity in return for a minority shareholding. Leverage is not an issue and, therefore, venture capital activity does not pose any systemic risk. Venture capital teams usually have a technology background - scientists, engineers, researchers and so on - or a business background with deep industry experience. A core skill is the ability to identify novel technologies that have the potential to generate high commercial returns at an early stage. Normally, the interests of the VC fund and entrepreneurs are aligned, with both having a common interest in building a business and exiting it through an initial public offering, IPO, or trade sale over time.
The VC fund is normally structured as a limited partnership with a fixed ten-year life. Capital is provided by long-term private and public investment funds, such as pension funds, life insurance companies, endowment funds, foundations, sovereign wealth funds and state bodies. VC fund managers also invest alongside other investors. The capital is only drawn down as the fund makes its investments; VC funds do not hold cash. The investment period for the fund is generally five years, after which the focus is on managing and making follow-on investments in an existing portfolio. After an initial investment is made in a portfolio company, additional capital is reserved to fund further development but is only drawn down from investors as it is required. Investments are sold through an IPO or trade sale, the cash is returned to the investors and the fund is closed. In effect, the fund is self-liquidating. After the five-year investment period, the VC firm raises capital for a new fund. VC companies in this State are regulated by the Central Bank of Ireland under the alternative investment fund manager, AIFM, directive.
The venture capital industry in Ireland is performing very well. While the level of VC investment activity worldwide has been adversely affected by the credit crunch, with no growth and significant volatility in recent years, there was strong investment in Ireland throughout the recession. In 2013 alone, €285 million was raised by Irish SMEs. The focus of venture capital activity is on investment in high-tech, early-stage companies in the ICT and the med tech sectors. More than 350 of these companies have been supported by Irish VCs in the past ten years and, consequently, Ireland is recognised as a major force in technology development.
In the past decade, €1 billion in capital has been imported by Irish VCs through syndication with United States and European-based venture funds. On average, every one euro invested by an Irish VC is matched by one euro from an international VC. Irish VCs add significant value to portfolio companies by syndicating with tier one international VC funds and corporate investors, introducing international business partners, customers and acquirers, recruiting senior management, introducing corporate governance, and endorsing the business and management team to the sector in which it operates. Since 1997, the number of VC funds operating in Ireland has more than doubled and their average size has increased from €20 million to €75 million. In addition, in response to increasing demand from SMEs, the market is now segmented, with both seed and start-up and early and-or expansion-stage funds present. Irish VCs have invested in a wide range of deal types from research and development commercialisation to start-up and early-stage technology companies and companies requiring later-stage growth equity and development capital. Many of the VC firms are entering their fourth investment cycle and have specialist domain knowledge in the sectors in which they invest.
The venture ecosystem in Ireland is well developed, with spin-outs coming from publicly funded research centres. With the emergence of incubation centres and accelerator programmes, these start-up companies are now better prepared in terms of investor readiness than ever before. Almost all of the leading American ICT and pharma, med tech and biotechnology companies have located their European headquarters in Ireland. These enterprises draw talent and are breeding grounds for the entrepreneurs of tomorrow. Most exits in Ireland are through trade sales, mainly to the multinationals, thus further expanding the presence of the multinational industry in Ireland. On a note of caution in this regard, Ireland's tax regime has lost significant competitiveness compared with the United Kingdom. There is a misalignment between the Government's tax policy in regard to entrepreneurship and the key objectives in the Action Plan for Jobs 2014. The IVCA is lobbying the Department of Jobs, Enterprise and Innovation and the Department of Finance to redress this disadvantage.
Returns are poised for a major recovery, because the quantity and quality of the pipeline of investment opportunities has increased greatly. The commercial acumen, international experience and focus of SME management teams is impressive and relevant to what is required for success in world markets. Early-stage valuations are stable after dropping significantly with the onset of the global financial crisis, while exit valuations are growing. Companies are focused on addressing global markets and are scaling faster and building value earlier. Tier one multinational companies have billions of dollars reserved for acquiring technology companies. In addition, mergers and acquisitions activity is strong, leading to attractive exit opportunities for VC investors.
Investment by the State has been key to the success of Irish VC funds in raising capital from the private sector. Since 1997, the Irish venture capital industry has been developed and nurtured by the Government through investment of €348 million via the Enterprise Ireland seed and venture capital programme over three investment rounds. VC firms have leveraged this commitment by raising additional private sector investment both for the fund itself and subsequently through syndicated deals for the individual companies. As a result, nearly €4 billion has been raised by Irish SMEs in this period. The State's commitment has been leveraged upwards by a factor of ten. In fact, payroll taxes of approximately €600 million paid by VC-backed companies over the period 2003 to 2012 have made the programme self-financing from tax revenues alone.
International studies indicate that venture capital stimulates growth, innovation, research and development, new business and entrepreneurialism. In Ireland, VC funding as a percentage of GDP trebled from 0.06% in 2003 to 0.18% in 2012. This is the second highest level in Europe after Finland. Throughout this period, the number of new innovative companies raising seed capital increased fourfold. Irish technology companies have spawned a significant number of new companies and created a new generation of serial entrepreneurs who are now dominant in the early-stage sectors. Three technology companies alone have spawned a further 146 companies.
Irish venture capitalists have driven growth in sectors such as software semiconductors, clean tech and med tech.
Many of the multinationals operating in these sectors have located here and, consequently, Irish VCs have developed specialist sectoral clusters of innovative activities, including medical devices, telecommunications, laser optics, electronic switching devices, business software and gaming.
The IVCA commissioned the Centre for Entrepreneurial Studies in UCD to conduct an in-depth study of the economic impact of venture capital on the Irish economy and data have been gathered on venture-backed companies over the past decade to 2012. The analysis shows that venture-backed companies create more high calibre jobs. Employment is up 11% per annum since 2003. In the past ten years, these companies created 16,400 high calibre jobs. It is estimated that these companies support up to three additional indirect downstream jobs. Hence the true number of direct and indirect jobs generated as a result of venture capital investment in innovative SMEs is approximately 66,000. An additional survey indicated that since 2005, companies originally backed by venture capital and subsequently sold to multinationals went on to increase employment by another 38%.
These venture backed companies are export-led. Exports increased by 12% per annum since 2003 and in the high-tech sector, exports represented 80% of revenues. These companies grow faster and their revenues are up 17% per annum since 2003. They are knowledge based and graduates represent 75% of the workforce. The research and development spend by venture-backed companies represents 30% of all Irish SMEs share of total spend on BERD.
Growing Ireland’s indigenous export orientated SME sector is becoming a national imperative as these companies provide 50% of the jobs in the economy and generate 10% of exports. A strong and well-financed venture capital industry is vital to this growth. The IVCA estimates that over the next five years - 2014 to 2019 - up to 40 start-up companies will be supported every year by the seed funds and start-up funds and 110 existing early stage companies will receive additional expansion capital from the mainstream venture capital funds. Within ten years, these companies could provide up to 21,000 new direct jobs and, based upon a 3:1 multiple, 63,000 additional indirect jobs. They could pay up to €300 million per annum in direct payroll taxes, and over ten years that could exceed €2 billion. They could export in excess of €1 billion per year and spend up to €300 million per annum on research and development.
The investment activity associated with the venture capital funds supported by the last seed and venture capital programme, 2007 to 2012, peaked during 2010 and available funds for new investment has now begun to decline. Investment activity by the seed funds will also see a decline by the end of 2014. Consequently, the number of new investments has started to fall off, bringing about a funding gap for indigenous companies. The IVCA estimates that the capital required over the next five years to fund the growth and expansion of innovative Irish SMEs is €1.65 billion. In response to this, the venture capital industry is in the process of raising new funds to fill this gap.
The economic characteristics of venture-backed companies as outlined above have encouraged and influenced policy-makers to recognise the importance of venture capital activity and, consequently, innovation and venture capital are at the centre of Ireland’s economic policy. The evidence for this is funding initiatives from Enterprise Ireland at the seed stage and in the growth capital space; the establishment of a later stage expansion fund by the National Pensions Reserve Fund; and the commitment by Enterprise Ireland of up to €175 million as a cornerstone investor to venture capital funds under the new seed and venture capital scheme 2013 to 2018. Some €99.5 million of this has been committed to early stage expansion funds. The IVCA believes that the balance of €75.5 million should be committed to regenerate the seed and start-up funds to finance entrepreneurship and to maintain a pipeline of high calibre start-ups.
Irish venture capital funds are currently marketing the Irish opportunity and plan to raise funds from international investors, including the European Investment Fund, international corporate investors and foundations, fund of funds and private investors. In recent weeks, the Ireland Strategic Investment Fund unveiled its plans to invest a €6.8 billion fund in Ireland and indicated that venture capital has a central role to play in growing the Irish economy. However, funds invested by ISIF must be matched by commitments from the private sector but support from the private sector in Ireland is limited. This is because there is a distinct absence in Ireland of certain classes of institutional investors that have historically supported US VCs, such as private equity funds of funds, university endowments, foundations and family offices. Most life insurance companies operating in here are foreign-owned and are managed from abroad, with little influence on decisions to invest in the Irish venture capital asset class. There is a limited pool of Irish pension funds of sufficient scale and with the management resources that have been willing to invest in Irish venture capital. They are largely semi-State or public sector defined benefit schemes. Many of these defined benefit funds are in deficit and have been actively seeking to reduce their risk profile.
The pension industry manages the largest pool of private capital in Ireland. Notwithstanding strong recent returns from Irish venture capital funds, Irish pension funds are not investing. This is because there are regulatory constraints on equity investments in general for pension funds and, in particular, there are regulatory constraints on liquidity issues within defined contribution schemes. Many defined benefit schemes are closing or are converting to defined contribution schemes. There is negative sentiment arising from the pensions levy.
This is inhibiting the development of the Irish venture capital industry and, with it, Ireland’s high-tech SMEs. If pension funds cannot be persuaded to invest in Ireland, it will also greatly impede the ability of the ISIF to invest in Ireland, as it will be unable to access the required matching private sector funding. Initiatives to free up private sector capital should be considered and could include discussions with the pensions industry around the levy and an alternative could be to set up a national pooled mechanism funded by a 1% investment by all private and public pension funds which have received tax relief on contributions. This could create a €700 million to €800 million fund to invest alongside the ISIF; and a Government or an EU initiative to underwrite a liquidity mechanism which allows defined contribution schemes to invest in selected Irish focused investments like venture capital.
I hope these remarks have given some understanding of how the venture capital industry operates, in particular, in regard to its impact on funding innovative SMEs. I thank members for their attention and my colleagues and I look forward to their questions.
I thank Ms Breheny for that explanation. The Irish Venture Capital Association has undertaken a very exciting project. Some of those figures are way beyond anything most of us would have known about. My main query is competition from abroad. Ms Breheny mentioned that the British are involved in tax competition. I remember some years ago a tax was introduced in Ireland which did not apply in Britain. We fought a very hard battle and managed to convince the Government that it made no sense in a marketplace where there was international competition to have a tax here which did not apply elsewhere because capital would automatically shift. Will Ms Breheny touch on the effect of our tax regime on somebody coming to invest in Ireland or on somebody already in Ireland and on the choice of whether to go north of the Border, to Britain and somewhere else? What are the tax implications?
Mr. John Flynn:
If one looks at a very high level, the competition in early stage companies is about the resources and skills we can attract into the companies. We are dealing with a fairly mobile workforce, so it breaks down into the two key categories of income tax and capital gains tax. If one takes the two major economies which would be leaders and competitors of ours - the US and the UK - in both income tax and capital gains tax, we would be inferior.
The two major economies that compete with us are the United States and the United Kingdom. Our income tax and capital gains tax rates are less attractive than theirs.
Our 52% rate of income tax compares with 47% in the UK and 40% in the US. Attracting talent into companies becomes an issue in respect of livelihood. If we take a cut in salary, our net take home pay is lower but we can compensate for that with additional options in companies to help employees and founders own a piece of the company.
Capital gains tax in Ireland is 33%, but in the UK there is tapered relief for entrepreneurs at 10%. Our rate is a major disincentive when we compete against employees in the UK and against people who want to invest in companies where there is less dilution of their ownership because employees can make more out of smaller stakes in their companies. In the US, capital gains tax is approximately 23%. Many of the share option schemes are subjected to income tax in Ireland. We are lobbying to tackle those two tax features to attract the best people into the start-ups which is the key component of building a successful enterprise.
Mr. Mark Horgan:
Within Ireland there is competition between the various asset classes. The Government gives a capital gains tax holiday to property investors. If they buy properties now and hold them for seven years they do not pay capital gains tax on the profits. That does not exist from an entrepreneur’s point of view and in promoting entrepreneurship. People who have the choice between investing in a property or in a business choose the property investment because the tax environment is far more attractive. If a person invests in a business and sells it after five or six years, having possibly created 100 jobs, the profit on the proceeds will be taxed at 33%. The Government's economic policy as set out in Action Plan for Jobs 2014 is misaligned with its tax policy.
I welcome the panel here today. At the outset the witnesses said they provide equity to companies unable to access credit markets. Why are they unable to access credit? Is it to do with risk or the scale of what they are looking for?
Is the uncompetitive tax regime the main challenge? What other challenges are there for venture capitalists who provide funding? They have said investment activity will decline because of the seed funds and available funding. They have mentioned initiatives that should be taken up, including discussions with the pensions industry and EU initiatives to provide liquidity as a backstop. Have they pursued these with the Department of Finance or Government or are they just hopes?
Mr. Mark Horgan:
Typically, many of the innovative technology-based SMEs that operate around the world and in Ireland do not use debt as a way to fund their business. They would use equity. The most important point for Ireland is to make as much equity available as possible to these SMEs because that is their lifeblood. Debt becomes an important funding factor for these companies at a much later stage. That is critical.
Mr. John Flynn:
The anti-competitive tax regime is one challenge. The two main challenges we face are the tax issues we have outlined and the availability of private sector financing from the pension fund industry. That is a key issue that we need to get over to match money from the public sector markets.
The pension fund industry is undergoing change and is under pressure because most defined benefit schemes are being moved to defined contribution schemes. As a result, the investment managers in these schemes have less autonomy to make investment decisions and within the defined contribution scheme there is also a requirement to have liquidity so that people who own these pensions can sell in and out. One of the drawbacks of our asset class is that it does not provide for a very liquid movement. Hence we recommend putting some support systems in place to improve people’s ability to sell in and out of a pooled resource. That would enable defined contribution schemes, which are the larger market pension schemes, to consider investments in this asset class.
Mr. Horgan referred to the debt feature. The key asset of companies at this stage in their life cycle is intellectual property, their people, their idea and approach to the market, which are predominantly financed by equity funding rather than debt.
Mr. John Flynn:
Absolutely. They are at a very early stage. It would be unfair to say the banks have not participated. The pillar banks in Ireland have participated in funding the equity funds and have relationships with the venture capital managers in the market. As the companies grow and develop, opportunities open up for invoice discounting and working capital before they move into mainstream debt products. There are some moves afoot, with the backing of the European Investment Bank and certain pillar banks in Ireland, to be able to provide an underwritten product for those types of markets. The situation is improving but it is largely focused on equity products and the venture product is the most appropriate one for companies at this stage.
How does this segment of economic activity here compare with other countries? In broad, general terms, are there similar patterns? Can we learn from the experience in other countries? Are we perhaps ahead of them?
Ms Regina Breheny:
We are well ahead of countries in Europe, particularly in respect of the amount of venture capital in the economy and in the number of new companies being supported and brought on. There are difficulties around the world in funding venture capital from the private sector. We are probably a bit behind the Americans because we have fewer institutional investors to choose from.
Mr. John Flynn:
There are a couple of statistics that would shed light on that. There has been a significant increase in investment activity as a percentage of gross domestic product, GDP. We are second in Europe on that scale.
Other initiatives have been taken by certain agencies, including, most notably, Enterprise Ireland, and also IDA Ireland, the Ireland Strategic Investment Fund and the venture capital community over the past period. That has propelled Ireland to a very good platform at the moment for an expansive opportunity in a competitive sense. This includes the seed investment programmes brought to bear again through the pillar banks investing and Enterprise Ireland's activities in terms of leadership programmes. There has been a quadrupling from 16 to 64 seed investments per annum, which is a significant improvement, and we have also had quite a lot of investment into what we would term "pre-pipeline" development, with approximately 18 or so incubators and accelerators which help very early stage companies come together with mentor programmes. That would compare well with any other geography. There tends to be clusters of different venture and early stage activity, and Dublin is one of the hotter clusters within a European context. It is second to main clusters in the US, which are on the west coast at Silicon Valley.
Mr. Mark Horgan:
We are preparing a submission to Enterprise Ireland as part of its call for submissions this week. It is important that the remaining €75 million from the allocated €175 for the seed and venture capital fund should be given for seed and start-up funds. If it is not, we could lose the momentum from the work done over the past number of years with those funds. The €75 million should now be allocated by the Government to seed and start-up funds.
Mr. Mark Horgan:
Not at all. There is an ongoing public consultation and as part of our submission, we will make this point. People at the coal face like ourselves know that the improvement in the pipeline and quality of early stage companies coming through - as compared to when I started 15 years ago - is significant. If we want to continue the momentum, we must ensure the €75 million is allocated.
I thank the witnesses and I have attended a number of previous briefings for companies. I am delighted at the fact that for most small and medium enterprises, SMEs, the problem is now working capital rather than investment capital. The banks are being allowed to make decisions and they can micro-manage that issue better than the witnesses. What is the average stake taken by venture capitalists, either in start-up companies or those seeking capital to expand? What is the percentage rate of failure? I am worried that there may be cherry-picking of companies which have gone through the process already. I hate to see figures that 90% of companies get capital succeed - I would be much happier if it were 50% - as people learn from failure more than success.
Mr. Mark Horgan:
The average stake is between approximately 15% and 30%. It is typically a minority stake that is taken by a venture capitalist in a privately held company. The rate can differ but the 15% to 30% rate is normal. The percentage rate of failure depends on the stage of development at a particular company. At seed stage and with start-ups, the percentage of failure is quite high, given the risk involved. At the other end of the spectrum, companies funded on various rounds at the growth equity stage - series B and C and more mature investments - the ratio of failure is quite low. Typically, those companies are either sold, with investment returns made for the investors and entrepreneurs, or they continue as a lifestyle company, where they may not make a major exit but they continue to operate and employ people. It depends on the stage of development for a company.
Ms Regina Breheny:
It has been going for approximately 27 years and was started by a small number of venture capitalists operating in Dublin at the time. They included Smurfit, Paribas Bank, AIB and a number of others. Members now comprise the venture capitalist funds operating in Ireland and there are approximately 15 of those. We also have an associate membership category, with the service providers being solicitors and accountants who supply the infrastructure around the venture capital contracts and business. We are totally funded by membership subscriptions.
Ms Regina Breheny:
We employ two people. I operate as the director general and we have an administrator as well. The venture capitalists may have up to 100 people in Ireland among their staff in various firms. It is not a high population industry at the venture capital level but it is when we speak about the companies.
You are well ahead of most companies with that. I thank Ms Breheny, Mr. Flynn and Mr. Horgan for engaging with the committee today as part of our report on access to finance for small and medium enterprises. We appreciate them taking the time to come here today. The significant points made at the end, in particular, will be noted.
The second session will be a discussion with representatives of Forfás regarding access to finance for SMEs.They are Mr. Martin Shanahan, chief executive; Mr. Adrian Devitt, manager for economic analysis, competitiveness, infrastructure and tax and finance policy; and Ms Maria Ginnity, manager for enterprise policy and evaluations. These are a couple of very long titles and there is much responsibility for people in those areas. I welcome the witnesses.
As they know from listening in the Visitors Gallery, I must read out some formalities before getting into the session. By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to the committee. However, if a witness is directed by the committee to cease giving evidence in regard to a particular matter and continues to do so, the witness is entitled thereafter only to a qualified privilege in respect of his evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice that, where possible, they should not criticise or make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable.
Members are reminded of the long-standing parliamentary practice to the effect that members should not comment on, criticise or make charges against a person outside the Houses or an official by name or in such a way as to make him or her identifiable. I invite Mr. Shanahan to make his presentation to the committee and thank him for coming before us today. We will have questions afterwards.
Mr. Martin Shanahan:
I thank the Chairman and committee members for inviting us to discuss access to finance for small and medium enterprises. The Chairman introduced my colleagues and the areas for which they are responsible. Their titles are evidence of productivity in Forfás where people cover many areas.
Mr. Martin Shanahan:
A detailed briefing paper on my presentation has been circulated to committee members, which I hope will be of assistance to the committee in preparing its report on the matter. With the Chairman's permission I intend to take it as read and draw out some of the key messages from the paper for the purposes of my introductory remarks.
Most members are aware of the role of Forfás. It is the national policy advisory board on enterprise, trade, science, technology and innovation. We work closely with our sister agencies, IDA Ireland, Enterprise Ireland and Science Foundation Ireland, and undertake evidence-based research and analysis to advise the Minister for Jobs, Enterprise and Invitation and the Government on a range of policy areas connected to enterprise. Forfás, together with the Department of Jobs, Enterprise and Innovation, also developed the Governments Action Plan for Jobs and is responsible for implementing some of the actions therein.
With regard to the interest of the committee in access to finance for SMEs, in the past two years Forfás has published two reports of direct relevance. The Irish Enterprise Funding Environmentwas published in April 2012 and A Review of the Equity Investment Landscape in Irelandwas published in January last year. Both reports have been circulated to members with my briefing note.
The paper I have circulated clearly shows a number of issues including the importance of SMEs to the Irish economy. SMEs dominate our economy. They account for 99.8% of active enterprises in Ireland and employ seven out of every ten people employed. Young, small and medium-sized enterprises in particular contribute more to employment creation and are therefore extremely important in the context of achieving the targets set out in the Action Plan for Jobs. It is not easy to disentangle the impact of the supply and demand effects on access to finance and there is a range of issues on both sides. On the supply side the availability of credit has declined as has the number of banks. The cost of credit has increased and those banks which remain are concentrating on growing profitability. The banks have reduced resources, particularly with regard to the number of staff and staff with the skills required to assess new lending opportunities. Some of these resources have been diverted to deal with non-performing loans.
Access to finance is broader than just access to banking finance and the committee has already heard today about equity investment through venture capital. There are also other products which are not as well developed in Ireland with regard to equity investment.
On the demand side, issues for some SMEs relate to poor cash flow and low profitability based on a continued weakness in consumer demand, particularly for those reliant on the domestic economy. Over-indebtedness is an issue in some cases. Credit institutions which are risk averse to certain types of businesses or certain sectors are also an issue and there is a lack of wherewithal in some SMEs to develop a business plan or make a business case.
Businesses in Ireland have traditionally been over-reliant on bank debt financing, and other models of financing have not received as much attention. Even before the financial crisis emerged a number of long-standing issues were evident in the market for funding in Ireland. Innovative exporting small and medium-sized enterprises traditionally had trouble in accessing external credit finance. The reasons may be that newer technology and business models might not neatly fit into existing lending criteria of financial institutions, a lack of collateral or a lack of track record.
With regard to current performance, based on the ECB's most recent survey published in April we can see the financial performance of Irish SMEs is starting to show signs of improvement when compared to recent years and other European countries. In aggregate terms turnover is growing and indebtedness is falling, although in net terms SMEs are not yet reporting increased profits. It is important to acknowledge many SMEs have had a very difficult number of years. Many have suffered from flat consumer demand in Ireland, challenging export markets and some managers are struggling with significant debt overhang. The ECB data also suggests that while a high share of Irish SMEs regard access to finance as a pressing issue, demand for bank funding is relatively weak. Demand is also more focused on short-term finance, for example overdrafts for working capital, rather than on longer-term capital for productive investment. Of those Irish SMEs which apply for bank funding, 38% reported they had received the full amount for which they had applied as opposed to 66% of euro area SMEs. The ECB survey finds a relatively high share of SMEs in Ireland, 19%, still face significant financing difficulties versus an EU average of 12%.
Examining the Irish data highlights that over the course of the past six months credit advanced to the enterprise sector has declined at an annual average rate of 5.1% to the end of January 2014. The decline in credit advanced to SMEs was most evident in certain sectors, with hotels, restaurants, business and administrative services and the manufacturing sector having the greatest decline. Irish data also confirms the demand for credit remains relatively weak. The latest data also indicates a higher percentage of businesses believe banks are open for business and bank refusal rates for loans are falling.
The cost of finance continues to be an issue for Irish enterprises. Cost competitiveness may weaken further as the banks need to rebuild profitability and competition has reduced. While demand may be weak the extent to which the financial system can provide adequate funding for firms once aggregate demand recovers and the economy grows may be a challenge. Research highlights that credit constraints affect between 4% and 11% of small and medium-sized enterprises.
As I stated earlier, while banking finance is important it is just one source. Since 2008 we have seen strong growth in the use of share and other equity and the use of accounts receivable. The initiatives on bank lending are now being complemented by greater focus on non-bank sources of finance to increase funding options and ensure SMEs have necessary equity to get bank credit.
I draw members attention to figure No. 2 on page 7 of the presentation circulated to them which demonstrates the supports available at various stages of development of business. The committee has already heard a presentation today on some of these elements. Different types of finance support different types of enterprises at different stages of development.
The State has put in place a number of new schemes and initiatives in recent years to address specific issues, such as the credit guarantee scheme introduced in October 2012 and the microfinance loan fund which was also introduced in 2012. Enterprise Ireland has committed €99.5 million to a new €175 million seed and venture capital scheme which was launched in May last year. The remit of the Credit Review Office was extended in budget 2014 to increase the threshold by which small and medium enterprises can appeal a refusal from €500,000 to €3 million.
The Action Plan for Jobs 2014 sets out a range of additional actions for implementation before the end of the year. These include collating more detailed data from the banks on lending, particularly new lending; increasing participation in Government-sponsored access to finance initiatives for SMEs, including enhancing the credit guarantee scheme and the micro-enterprise loan fund; raising the level of awareness among SMEs and entrepreneurs on the full suite of Government supports available; and developing new sources of finance for SMEs including European sources.
Given the depth of the financial crisis and its legacy impacts on the enterprise sector, the banks and the broader economy, it can be expected that it will be some time before debt levels and funding flows return to what might be regarded as normal levels. As I noted earlier, it should also be remembers that during the good times small innovative export-oriented businesses had difficulties in accessing the appropriate funding.
From the perspective of Forfás, some of the key challenges that face Ireland in this regard includes the continuing need to ensure that the efficacy of measures put in place to improve credit flows through recapitalisation, deleveraging and restructuring of the banks can be assessed and further action taken if required. In this regard, there is a need to continue to monitor bank lending carefully at a detailed level. This is particularly important as the economy returns to growth and demand for funding increases.
The State needs to continue to work to ensure that the banking system is aligned with the strategic economic growth targets of the economy. In this regard, a move towards a banking system with a deeper understanding of innovative sectors is required such as software, telecoms, digital content, medtech and life sciences. Also, a proactive overseas banking network is required in the medium term.
More immediately there needs to be a focus on supporting internationally trading businesses in terms of both the provision of credit and banking facilities and products. The scaling back of the domestic bank sector and the withdrawal of many foreign banks highlights issues over the levels of competition in the banking sector as the business banking market has become more highly concentrated. A particular challenge exists for SMEs who rely on the banks that are withdrawing from Ireland.
The programme for Government contained a commitment to establish a strategic investment bank. Since I submitted my presentation last week the Government has announced the establishment of the strategic banking corporation of Ireland. The corporation will make €500 million in credit available to SMEs. It will be important that this mechanism and other mechanisms put in place address the challenges that I have outlined here.
Encouraging equity investment represents a mechanism to help some over-indebted but viable businesses to rebalance their balance sheets. Equity begins from the earliest stage of the business life cycle with friends, family and founders investing at the pre-seed stage to business angels, and venture capitalists investing in the seed and start-up phase right up to the latter stages, through mechanisms such as trade sales and initial public offerings. Members will already have heard quite a bit about this matter so I will not go into it again in detail.
The Department of Finance is carrying out a review of the employment and investment incentive scheme and seed capital scheme. The aim is to ensure it delivers on its potential to support the funding needs of growing enterprises so the outcome of the review will be important. The State can also support other forms of funding and recently the committee heard from peer-to-peer lenders and businesses that it has supported. There is strong potential for the State to provide a supportive environment for alternative sources of finance such as these.
I thank the Chairman and the committee for inviting Forfás here today. My colleagues and I are happy to take any questions.
I thank the chief executive. I forgot to mention and extend a welcome to two members of Forfás seated in the Visitors Gallery. My notes tell me that they are Mr. Andrew Colgan and Ms Aideen Fitzgerald. I call Senator Quinn.
I want Mr. Shanahan to outline the role of the strategic investment bank. What does Forfás hope will happen? I am interested to learn more about the figure mentioned by him earlier. He said that 19% of SME applications in Ireland have been turned down but the percentage is only 12% in the rest of Europe. Will the discrepancy be solved by the strategic investment bank? How does Forfás see the bank working?
Mr. Martin Shanahan:
There has been a high level announcement but obviously there is a lot more detail to come. Based on what has been announced to date the fund will provide longer term loans at a lower cost via the existing banking structure, as I understand it, to SMEs. It is positive measure if it leads to SMEs being able to access lower cost debt for longer durations than they are currently able to access. The exact details of how it will operate remain to be seen.
I wish to clarify that the 19% figure from the ECB survey that I quoted does not just relate to businesses that have been refused a loan. It incorporates businesses that did not get the loan that they wanted at the cost that they wanted. Perhaps they were offered loan facilities but not at a rate that they were willing to accept or not for the full amount which they applied for them in the first instance.
It is clear from the ECB survey that the credit environment in Ireland appears to be improving. However, we are still some way off what one might regard as a normal environment if one take the averages experienced across the rest of Europe as normal.
I wish to comment on the point made about the strategic investment bank and my issue with it is based on a couple of aspects. We have discussed access to finance with other witnesses and there are banks that have not been lending to the extent that we would have liked them to do so. Now a fund has been given directly to these high street banks to lend more money but they have not been lending at the levels that we wanted them to reach in the first place.
Given what Mr. Shanahan has said in his report, pillar banks need to have a deeper understanding of the new innovative sectors in order for businesses to be sure of success and have loans granted. The chief executive probably cannot give me the answer to the following questions. Is it not a mistake to allow high street banks to access and deliver the fund considering they will not give out some of the money? That is our opinion, which is supported by what we have heard from other witnesses. Will that be the scheme's downfall? Will people have to admit in a few months' time that this was a mistake? Is it not a mistake to give more money to banks that are not doing what we asked them to do already and to the extent that we would like?
Mr. Martin Shanahan:
It is very difficult to predict what the outcome will be in the absence of details on how the strategic banking corporation will work. Therefore, I do not intend to make a premptive comment.
Let me respond to the point made by the Vice Chairman. At the moment one of the issues is that we do not know enough about what the banks are doing in terms of lending, to whom they are lending and in what types of lending in which they are engaged. We do not know if it is roll-over lending, which is important for existing businesses. We do not know if it is new lending or what sectors they are not lending to. We do not have the full picture.
It is important to have a detailed understanding of the lending that is taking place, particularly by the banks that the State supports, because the prescription may be different depending on what the picture presents. For instance, if innovative companies in new sectors are not able to access this funding then making more funding available may not be the answer. It may be educating those involved in the lending process within those banks. It may be increasing the level of understanding of both the sectors and cash-flow lending, particularly where there is not a significant amount of collateral available against the credit being sought. A detailed understanding of what type of lending is taking place is important. Actions to tackle the matter are contained in this year's action plan but I do not think that we understand the situation.
Is the chief executive saying there are enough processes in place to find out how banks are lending?
Is he saying that those in place will need more in order to have a full picture of how banks are lending and will lend into the future?
Mr. Adrian Devitt:
It is part of the 2014 plan. As to whether the existing banks use the funding from the strategic investment bank, I think there will be requirements to ensure the funding is additional, so it simply cannot replace other funds. Also there will be requirements to ensure that businesses get the value of the lower cost of the credit. The banks cannot take that margin. There will be a strong focus on additionality and making sure the funds are passed through. There is also a goal that if this entity can offer long-term credit at lower costs that one can go to the market and to external banks or, perhaps, more niche credit providers, and ask them to Ireland where there are funds available on which they can draw to serve the Irish market. Hopefully, it reduces a barrier to entry and, perhaps, we may see new entrants coming in.
I wish to raise a couple of points one of which the representatives touched on in their presentations, that is, the cost of funding which SMEs have raised with me. Based on the figures presented, some 83% of people who make application for money get money but the problem is that the cost of it is becoming prohibitive. In terms of the new banking entity, is that one of the conditions that will be raised by the representatives? It was mentioned earlier that funding is being provided to banks. Could that funding be provided at a lower rate than is being provided by themselves because SMEs are squeezed on all the margins?
An objective of the Action Plan for Jobs is a portal for SMEs whereby SMEs, entrepreneurs or people seeking finance can click on something and see what is available. We have been asking about this for the past two years but nothing has happened on it. If it is lost in the Department of the Taoiseach somebody should pull it out because it is vital that it happens. There are many products available for SMEs but they do not know where to go for them. The one portal would help them.
Mr. Martin Shanahan:
I understand, Deputy. I may ask my colleague, Ms Maria Ginnity, to comment on it and what it does. As the Deputy rightly points out, the cost of finance in Ireland is higher than elsewhere. Some 31% higher is the estimate for loans up to €1 million and 27% higher for loans that exceed €1 million. To be fair, the Department of Finance is best placed to comment on what will happen around the strategic banking corporation but it is clear from what has already been announced that one of the intentions is to reduce the cost of finance to the ultimate recipient, that being the SME. We have yet to see the detail of how that will work through the credit institutions that will act as intermediaries for it.
Ms Maria Ginnity:
The establishment of the local enterprise offices, LEOs, will play an important role in enhancing the supports available to all small firms. They will provide a first-stop-shop to signpost firms to direct supports both financial supports and advisory services. Within each of the LEOs an SME online tool is available. It is relatively simple to use. It asks the company to answer eight questions which will be around the sector in which it is involved, its scale, its market orientations and will signpost it to either the direct agency or the supports that are more relevant to it. It is very much a signposting tool but easy to use electronically. There is that online tool in the first instance and, second, the LEO offices acting as the first port of call for all small entities is an important step in that regard.
The question to Ms Maria Ginnity, for which she may not be directly responsible but on which she may be able to shed some light, is on a one-stop shop where people can access information that may be of help in supporting their business. Any private industry that is trying to promote a new commodity has a decent advertising campaign. Where are we at in respect of an advertising campaign of this new one-stop shop online portal?
Mr. Martin Shanahan:
The need for this is probably recognised. I am not sure if I can answer exactly what the plan is today. It is a point we have made a number of times and there is a commitment in the Action Plan for Jobs around promoting the supports available. The State has significant supports for businesses at all stages of development and for all types of business but if people are not being aware of them that is not the best use of State resources. The new initiative is broader than SMEs. It is about all the different supports.
Is this nothing more than a rehash? Sometimes the problem is not a lack of ideas and responses. Sometimes when there are new ideas or ways to promote or support, say, SMEs the budget line that is needed to promote any other commodity or concept does not follow. We have heard from our meetings here, and it is important for Forfás to hear this to advise the Department of Jobs, Enterprise and Innovation in case it does not listen to the committee, that there must be a budget line to promote these through an effective advertising campaign in order that the right people get to hear these things. That must be part of any new strategy, whether it be the Department of Social Protection in terms of an initiative to support taking on new people for labour activation measures or, in this case, directly supporting SMEs. Deputy Anthony Lawlor got it right when he said he did not know about it. I barely knew about it, having come across it by accident. I do not know what hope SMEs have as such but there must be a decent budget line that reflects the work being done to promote supports so that SMEs can access them.
With all due respect, an advertising campaign with a person with an advertising background is needed to promote the issue, because that website does not work. Depending on the chamber, its website may not be sufficiently updated. We are talking about the way a product is promoted such as in a supermarket store where it becomes popular and well known. Unless we are at the races-----