THE time was when businesses in search of funding had to go cap-in-hand to big banks to ask for loans. But today start-ups requiring investment need look no further than the nearest venture capitalist.

Venture capitalists usually take a certain amount of shares in the company they invest in as collateral in the hope their risky cash injection will bring high returns.

There is no doubt that venture capitalists, currently laying the foundations for the cyber-based economy, have already become one of the most active economic powers in the current capital market.

But the problem in China is there just isn’t enough venture capital to go around.

Pressure on banks

Although several leading Internet-based companies in China are the fruit of international venture capital investment, it is estimated that only 2.3 per cent of scientific and high-tech achievements that are finally put into production every year in China enjoy support from venture capitalists.

And with just 10-15 per cent of the 170,000 potentially lucrative scientific and high-tech discoveries ultimately being marketed each year, most of China’s research accomplishments are going to waste.

In the US, meanwhile, over half of industrialized research is backed by venture capital.

Experts link the problem with China’s underdeveloped capital market and the absence of a proper legal framework.

In recent years, the government has launched a number of venture capital funds in major Chinese cities, such as Beijing, Shanghai and Shenzhen where high-tech industries are growing rapidly. In Shanghai, the city government has helped establish several companies through sole allocation of venture capital.

But this kind of funding is never-the-less rare in China and has an unproven track-record here.

The few venture capital funded companies that now exist in China do not change the fact that most high-tech companies are looking to cash-strapped commercial banks to swell their company accounts.

Experts warn that this heavy reliance on the banking sector will likely have a negative or even dangerous impact on both the moneylenders and the high-tech industries which borrow from them. “Banks – which seek stable returns – are not suited to issuing loans for high-risk projects; but all high-tech start-ups are high-risk ventures,” said Yang Wuzhong, a financial expert with Shanghai Academy of Social Sciences.

Yang advises against Chinese commercial banks offering high-tech start-ups too much financing so as to diminish financial risk.

“Technology start-ups should shift their attention to venture capital, the most effective means of achieving rapid business expansion in the modern economy,” said Yang.

He is also adamant that government venture capital only be treated as seed funds; once companies which employ this money get started, he says, they should look to other sources for funding. “The government should not have the power to intervene too much in economic activities,” said Yang, who claims the government’s role is to ensure smooth and favourable conditions for the business growth in the country.

Wu Chunlin, another financial expert with Shanghai Jiaotong University (SJTU), agrees the government should take a laissez-faire approach to the sector. He explained successful venture capitalists are mainly enterprises, private investors and pension funds, which have made government venture capital all but obsolete in Western countries.

Untapped potential

It is estimated that over 7,000 billion yuan ($845 billion) of savings, currently lying dormant in deposit accounts around the country, is money that could be enticed out of banks and into start-ups.

“The government should spare no efforts to encourage private capital into the venture capital market,” said Wu, an expert from SJTU’s Business School.

It is common belief that private capital could become the major force behind venture capitalism.

In Wu’s view, the ideal path of growth for venture capitalism would be involvement of private investors and foreign capital with minor government input.

Although the high-tech field has tremendous market potential, private Chinese investors still seem very reluctant to tap this promising and profitable sector; this is why most of China’s leading dotcoms are financed by foreign venture capital.

Another obstacle to involvement of private funds is the immaturity of the venture capital market which as yet has no withdrawal mechanism, say industry experts.

Venture capital is generally extracted from its investment vehicle once that company has grown big enough to profit, said He Yu, deputy chief representative of Merrill Lynch International China Office. But in China there is no protocol for venture capitalists wishing to resign from their investment, he said.

Other aspects of the Chinese business environment likely to deter potential investors are: the absence of a stock market catering specifically to high-tech firms and the lack of sophistication in the legal framework governing mergers and acquisitions.