In the United States, the liquidity of our markets promotes entrepreneurship, innovation and corporate growth. Most entrepreneurs, steadfast in their efforts, can usually access the financing they need. However, in other countries accessing capital can be a long and arduous process with limited options.
I gained a greater appreciation for the structure of our banking system and the liquidity of our markets, when I interviewed the founder of a technology company located in the People’s Republic of China. The company was founded in 1996 and has since has grown to $90 million in revenues, employing over 1500 people.
Funding Options for Entrepreneurs
In China, the availability of capital for entrepreneurs is scarce and often the seed money comes through personal relationships. In the case of the technology company, the $50,000 start-up capital came from a customer deposit; provided through a long-term relationship that had been formed by the company’s founder while working in Hong Kong.
According to Jones Day, an international law firm specializing in foreign business transactions, companies are often funded by personal loans obtained through the principles. This is an important point to consider when doing business in China. Due diligence to uncover such financing agreements is crucial, as these transactions are often not documented and can only be discovered through exhaustive investigation. Even with the best efforts, there is still an inherent risk.
Financing the Next Stage of Growth
Obtaining growth capital in China is very complicated. Investments are controlled by state owned enterprises, which according to state capital regulation the investing enterprise must maintain a controlling interest in the company. Valuations are void of intangibles, due to the government’s desire to avoid what they term as “suspicious trading”. The elimination of intangibles would be fatal to many companies in the United States, where high valuations are founded on intellectual property.
By 1998, the company had grown to $1.5 million in revenue, $400,000 in net profit, with approximately 20 employees. The founder realized that he could not reach the next stage of growth without a large infusion of capital. He secured the first venture capital funding in 1999 through a state-owned company. Based on a valuation of $1million in net assets, void of intangibles, the investment of $510,000 provided the investor with a 51% majority ownership and the founders assets where valued at $490,000.
Once obtained, the funding provided the company the needed stimulus and it quickly grew to $10 million in sales with total assets valued at $2.5 million. The terms set forth in the agreement were aggressive by US standards but the company was desperate for money and agreed to the conditions. He did however, set forth a provision to buy back 2% of the equity if the overall assets reached $2.5 million. Once the agreement was signed, it took nine months to secure the funding. If forced to wait for almost a year, many US companies either would have been out of business or would have lost their competitive advantage.
In spite of the growing success, the company faced serious internal problems. The investor’s relatives were using the company as a means to promote their individual wealth. Embezzlement became rampant but complaints to the investors were unheeded. Left with no alternative, the president decided to try to buy back his shares. After much discussion, it was decided that he could purchase the 46% for $2.2 million, with a required $1.1 million deposit. However, before the deal could be finalized, he learned that the buy back contract had to be authorized by the government, which deemed it had to go to auction for the highest bidder. The founder had three options: sue the investor, wait to see who purchases the company or give up control of and start over. He took the risk and convinced a public company to sponsor him. The company was purchased by the founder for $3 million. As President took a leadership role and the company began to take off once again.
In 2001, he decided to take the company public to obtain additional funding. In the last ten years, only 1200 companies were traded on the China Stock Market. Government regulation is heavy and the process is slow and cumbersome. After 22 months and the filing of over 1000 documents, the company finally went public and was able to raise $30 million in funds.
In spite of its inherent difficulties, China’s size and fast-growing economy offers a vast array of opportunity and cannot be ignored. The entrepreneurial spirit in the People’s Republic of China is just beginning to develop. I found the untapped opportunity to be intriguing. However, the government’s control makes investment difficult and tainted with unknown risk.
After my interview I had a great appreciation for the ease and simplicity of my business experiences. Starting a company requires hard work. With that said, our access to capital and business support lessens the risk and increases our chances of success.
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Lori educates and inspires entrepreneurs. Her company Business Simply Put provides information, advice and tools to succeed in business. Whether you are starting a company or growing an existing business, these tools will define your pathway to success. For more information visit www.BusinessSimplyPut.com or send an email to [email protected]. She loves to hear from inspired entrepreneurs!