China will continue to prosper by making capital more readily available for startups

For me, topics of conversation during dinner with friends are always the best way to gauge social and economic trends. This is especially true in Shanghai, China's financial center, where I live.

For more than a decade, real estate and stock markets often dominated our dinner conversations. Parenting has moved up on our agenda in the past few years, as most of us have become fathers and mothers.

But in the past year or two, a new topic frequently has been discussed: setting up a business.

A few friends of mine have already quit their jobs with big companies or government agencies to start their own businesses, most of which are on the Internet, and consumer-goods and financial industries fields, while others have plans either to do so or invest money in startups.

Apparently, China is in the midst of a boom in entrepreneurship thanks to a number of favorable factors such as business entry deregulation, government incentives, opportunities resulting from the burgeoning e-commerce sector and a growing number of mobile Internet users.

The enthusiasm of being one's own boss also is a big draw. Last year, more than 1,000 business entities were registered each day. The boom, described by Premier Li Keqiang as "mass innovation", is exactly what the government encourages because it is expected to create job opportunities, boost consumption, facilitate commercialization of technologies, and update economic quality at a time when growth has dipped to a multiyear low. The boom also can help nurture the next generation of entrepreneurs with global visions.

Despite the mushrooming of startups, however, a lingering challenge continues to haunt those who are eager to ride the crest of this new round tide of entrepreneurship. The challenge lies in a funding shortage.

No matter how technologically advanced or conceptually innovative, startups are usually small and medium-sized enterprises at birth. Just like millions of other SMEs, startups often find it hard to get their first bucket of gold.

According to a survey by Tsinghua University's National Entrepreneurship Research Center in 2014, 72 percent of those interviewed believed starting a business was a good career option, but only 22.4 percent expected to actually start their own business. More than 80 percent cited shortages of funding as a major reason hindering them.

The situation actually reflects a few deeply rooted problems in China's economic system.

The first problem is that China's financial system is too monopolistic, with indirect financing, as represented by banks, dominating the provision of financing. In China, banks still control about 85 percent of capital available in the market. However, because of their high-risk nature and scant collateral that startups can pledge, banks are reluctant to provide financing for startups.

In recent years, a number of alternative methods of financing - peer-to-peer financing, venture capital, mass funding and equity markets - have developed rapidly to help finance startups. But the help they can provide still lags far behind the capital demand of startups.

In this sense, the dominance of state banks must be reduced to foster the development of a multilayered financial system. On the one hand, private and Internet-savvy banks should continue to be encouraged to better serve SMEs, startups included. On the other hand, alternative financing methods, especially those based on the Internet, should be allowed to play a big role as long as due regulatory supervision can be put in place to prevent systematic financial problems.

The second problem that hinders startups from accessing a larger pool of capital lies in China's overall weakness in the protection and commercialization of intellectual property rights.

Despite the improvement in the IPR legal framework and law enforcement in recent years, it is undeniable that the cost and punishment for copycats remain low. With the popularity of the mobile Internet, any idea, business model, invention or technology that is fresh can be duplicated by many imitators without paying the author or owner. Because of generally poor awareness of IPR protection, China's system for accepting intellectual property rights as collateral for loans remains very underdeveloped, resulting in a number of aspiring entrepreneurs failing to utilize their valuable technologies, patents or inventions for generating funds to a startup.

Last but not least, the government-dominated incubator system does not maximize the role of market forces. China often relies on government actions to make economic adjustments and spur a certain industry. There is nothing wrong with the government helping to guide and nurture the market when an industry is budding and small. That is why governments at all levels have established many industry guide funds and incubators in the past years to nurture startups. China now has more than 1,600 incubators for tech startups. Last year, governments at various levels established a total of 39 industry funds to help incubate startups.

However, the operations of a number of these funds and incubators are outdated. For example, some funds simply hand out subsidies while incubators' help to startups goes no further than the provision of free or low-rental offices.

As demand by startups grows and diversifies, it is time for governments to allow the market to play a bigger role. They should leverage the financial strength and passion of private investors to participate in the development of venture capital funds and incubators based on commercial principles. Only by doing so will the capital pool multiply and the efficiency of capital be improved.

The author is a Shanghai-based financial analyst.

(China Daily European Weekly 06/12/2015 page9)