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SMEs innovation and entrepreneurial
financing
SMEs face with the aim to help SMEs cross the valley of death (bridge the financing gap). The establishment of specialized development banks/SME banks with special type of loan offerings for SMEs can be seen as part of the government policies to help alleviate SMEs’ financial constraints (Mani, 2004; Hyytinen and Toivanen, 2005; de la Torre et al., 2010).
In recent years, the issue of SME financing has received an increased attention as a way towards building an innovative economy. Many economists argue that despite the heavy concentration of research and development (R&D) expenditure in large firms, it is the small firms that account for most of the important inventions and innovations (Freeman and Soete, 1997). Taking into account the conventional models of innovative economies, Schumpeter’s (1939) Mark 1 theory postulates that small firms predominate in the process of innovation. Arguably, the Mark 1 model stresses the ability of the entrepreneurial small firms to innovate (whereas the Mark 2 model is concerned with the technological innovation developments by large firms). It is argued that small firms play an important role in innovation and industrial development (Freeman and Soete, 1997; World Bank, 2010; Krishnaswamy et al., 2014). Realizing the trend of knowledge-based economy (whereby the basis of competition is increasingly built upon research knowledge and innovation), many governments have developed strategies/policies to support SME financing with the aim in building an innovative economy (Lerner, 1999, 2002; Jeng and Wells, 2000; Mani, 2004).
2.2 VC financing to support SME development Figure 2 shows the funding requirement along the life cycle of SME development. Given the high uncertainties and risks in an early stage of development, the source of finance for new ventures is rather limited. The source of capital to support early stage venture is mainly from seed funds, business angels, VC financing whereas commercial banks and stock markets play a significant role in providing finance in the growth and mature stages (commercial banks providing finance in the form of
Seed Start-up Growth Maturity
High Low
Low Time
Source of funds: seed funds, business angels, venture capital financing
Source of funds: commercial banks, stock markets
R at
e of
g ro
w th
Risk profile Source of funding
Source: Wonglimpiyarat (2007)
Figure 2. Funding requirement along the life cycle of SME development
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loan capital or debt and stock markets providing finance in the form of equity capital) (Black and Gilson, 1998; Mani, 2004; Hyytinen and Toivanen, 2005; Giot and Schwienbacher, 2007; Wonglimpiyarat, 2007).
Taking into account start-up financing, VC provides an important source of business finance to support SME development. By definition, VC is a high risk, potentially high-return investment to support business creation and growth. It is a source of funds that typically finances new and rapidly growing companies through equity participation (Bygrave and Timmons, 1992; Gompers and Lerner, 1999, 2001). VC has characteristics that set it apart from debt financing alternatives and traditional capital markets (Gompers and Lerner, 1999, 2001). It is a high-risk financing investment whereby venture capitalists generally expect high returns in the form of capital gains and dividends (Dixon, 1990; Pandey and Jang, 1996; European Private Equity and Venture Capital Association, 2005). The concept of modern VC is defined by Megginson (2004) as a professionally managed pool of money raised for the purpose of making equity investments in growing private companies with a well defined exit strategy (Giot and Schwienbacher, 2007).
SMEs assume a major influence in the economic development, employment and creation of new innovations (Birch, 1979; Gallagher and Steward, 1986; Sahlman, 1990; Massa and Testa, 2008). However, SMEs generally face difficulties in getting access to finance since investors do not prefer making investments in SMEs due to their risky nature of business operation. Since very small proportion of monies seems to be allocated to early stage ventures, therefore, the provision of risk capital by VC firms may be the most suitable form of external finance. This form of investing brightens SMEs’ prospects by relieving the capital constraints (Bygrave and Timmons, 1992; Gompers and Lerner, 1999, 2001; Wonglimpiyarat, 2007).
Currently, a number of developing countries have introduced VC as an economic development tool whereby the government of these countries takes an operational role in the development of VC industry (Lasserre and Schutte, 1995; Naqi and Hettihewa, 2007; Tsai et al., 2009). The main focus of VC in these countries is similar, i.e., to provide seed capital and financing for technology and innovation development. Nevertheless, the structure of VC financing differs among countries due to different set of interacting institutions and structures of the national innovation system (Lundvall, 1992, 1993, 1998, 1999, 2003).
3. Research methodology This study attempts to fill a gap of existing research of SME financing by linking the aspect of public policies in developing countries to entrepreneurial financing. In particular, the research explores the challenges of SMEs innovation and entrepreneurial financing in the country case of China, the world’s fastest-growing economy. The research study uses the case study approach, a qualitative research (Eisenhardt, 1989; Yin, 2003), to analyze the impacts of the 12th Five-Year National Economic and Social Development Plan on the bank financing and VC financing for supporting entrepreneurial activities.
In exploring the role of financial institutions and banks in SME financing in China, the research also derives evidence from a collection of documentary investigation. The research fieldwork and interviews were undertaken in Beijing and Shanghai, major financial centers in China, with the use of semi-structured questionnaire. The conduct of fieldwork interviews in the financial sector of China was coordinated by the Bank of Thailand, the Securities and Exchange Commission and the Thai Chamber of
