Brazil and Mexico are, respectively, the top one and two largest.docx

Brazil and Mexico are, respectively, the top one and two largest
economies in Latin America in terms of GDP. Globally, Brazil
and Mexico are, respectively, the seventh- and eighth-largest
car producers and the fourth- and 16th-largest automobile
markets. Almost all of their production is undertaken by global
automakers via foreign direct investment (FDI). Audi, Fiat,
Ford, General Motors (GM), Honda, Nissan, Renault, Toyota,
and Volkswagen (VW) have assembly factories in both
countries. In addition, Hyundai, MAN, and Mercedes- Benz
produce in Brazil; and BMW, Chrysler, Isuzu, Kia, and
Mitsubishi operate assembly plants in Mexico. For
multinationals striving for ownership, location, and
internalization (OLI) advantages, their efforts in leveraging O
and I advantages are similar in both countries. However, these
two countries have pursued location (L) advantages in different
ways. Brazil attracts FDI primarily due to its largest domestic
market, while Mexico pulls in FDI due to its proximity to the
United States. As a result, only 13% of Brazil’s vehicle
production is exported (67% of such exports go to its neighbors
in Mercosur—a customs union with Argentina, Paraguay,
Uruguay, and Venezuela). In contrast, 64% of Mexico’s vehicle
production is exported to the United States, and all together
82% of its output is exported. Brazil main- tains high import
tariffs on cars and auto components (except when 65% of the
value is imported from one of the Mercosur partners or from
Mexico—with which Brazil had a bilateral free trade deal in
cars and auto components). As a result, only 21% of the content
of Brazil’s exports is imported. This ratio of imported content
among exports is 47% for Mexico, indicating a much more open
and less protectionist environment in which automakers can
import a great deal more components tariff-free and duty-free.
The differences in the production, export, and import patterns,
of course, are not only shaped by the resources and capabilities

of multinationals, but also by government policies in both host
countries of FDI. Whether Brazil or Mexico gains more is
subject to intense debates in these two countries and beyond.
One side of the argument posits that Mexico is only leveraging
its low-cost labor and has not fostered a lot of domestic
suppliers. Indeed, most first-tier suppliers in Mexico are foreign
owned and they import a great deal of components to be
assembled into final
products. As a result, most final assembly plants are
maquiladora type, otherwise known as “screw driver plants.”
With little technology spillovers to local suppliers, the
innovation ability of the Mexican automobile industry is thus
limited. Brazil, on the other hand, has pushed automakers to
work closely with domestically owned suppliers or with
foreign-owned suppliers that have to source locally. With a
domestic focus, Brazilian subsidiaries of multinational
automakers, aided by suppliers, have endeavored to search for
solutions to meet unique local demand, such as ethanol fuel.
Brazil is a world leader in ethanol—a sustainable biofuel based
on sugarcane. By law, no light vehicles in Brazil are allowed to
run on pure gasoline. Led by Volkswagen’s Gol 1.6 Total Flex
in 2003, the Brazilian automobile industry has introduced
flexible-fuel vehicles that can run any combination of ethanol
and gasoline. All the multinational automakers producing in
Brazil have eagerly participated in the flex movement. Starting
with 22% of car sales in 2004, flex cars reached a record 94%
by 2010. By 2012, the cumulative production of flex cars and
light vehicles reached 15 million units. Advocates of Brazil’s
policy argue that such success has generated opportunities to
involve locally owned component producers, local research
institutions, and smaller suppliers, which have specific
knowledge not available elsewhere in the world. The other side
of the debate points out Mexico’s shining accomplishments as
an export hub with a more open trade and investment regime.
Mexico has successfully leveraged its NAFTA membership and
its free trade agreements with more than 40 countries. While

such institution-based boosters are helpful, at the end of the
day, Made-in-Mexico vehicles—from a resource-based
standpoint—have to be valuable, rare, and hard-to-beat on
performance and price in export markets. This is largely
attributed to Mexico’s persistent efforts to keep its wage levels
low, its labor skills upgraded, and its infrastructure modernized.
Brazil, on the other hand, suffers from the legendary (and
notorious) custo Brasil (Brazil cost)—the exorbitant cost of
living and doing business in Brazil (see Emerging Markets 2.1).
Since President Dilma Rousseff took office in 2011, she has
imposed new tariffs on shoes, textiles, chemicals, and even
Barbie dolls. In the absence of protectionism, the Brazilian
automobile industry, according to critics, simply cannot stand
on its own. Brazil even threatened to tear up the agreement with
Mexico that allowed free trade in cars and components, because
Brazil—thanks to its uncompetitive automobile industry—
suffered from an embarrassing trade deficit. In 2012, Brazil
renegotiated the deal with Mexico, imposing import quotas on
Made-in-Mexico cars and components. More recently, the
Brazilian government has introduced Inovar Autos, a new
automotive regime for 2013–2017, which is intended to
encourage firms to hit specific targets in localization of
production and R&D incentivized by additional tax benefits.
Critics argue that this is just one more round of protectionism
and government meddling that is ultimately counter-productive.
Reproduced with permission of the copyright owner. Further
reproduction prohibited without permission.
Equity Financing and Capital Market Funding Policies to
Support ...
Wonglimpiyarat, Jarunee
The Journal of Private Equity; Fall 2012; 15, 4; ABI/INFORM
Collection

pg. 10

8th International Scientific Conference on Economic and Social
Development and 4th Eastern European ESD
Conference: Building Resilient Economy, Zagreb, Croatia
283
INFLUENCE OF FINANCING SOURCE ON THE SMALL
BUSINESS
PERFORMANCE
Mihaela Mikic
University of Zagreb, Faculty of Economics and Business,
Croatia
[email protected]
Tomislav Novoselec
[email protected]
Dinko Primorac
University North, Croatia
[email protected]

ABSTRACT
Finding funds for financing entrepreneurial venture often
presents most difficult obstacle in
realization of entrepreneurial idea. During this process choosing
the source of financing
represent the special challenge. Although in first it may look
there is a wide selection of
source of financing as: private equity, business angels, public
finance, etc., in practice
entrepreneurs usually depend on their own assets, informal
investors and debt financing. This
paper gives detail overview of possible source of financing for
new and already existing
entrepreneurs. Based on conducted research and multiple linear
regression analysis is
defined influence of individual source of financing and small
business performance. As profit
represents the core motive for entrepreneurship, these research
findings should be
entrepreneurs’ guidelines in choosing the source of financing
their venture.
Keywords: business angels, business performance, private
equity, small business, source of
financing

1. INTRODUCTION
Like everywhere in the world, small entrepreneurship in Croatia
is the most important
generator of development, it openes new workplaces, encourag
sole proprietorships and
inovation, increase production and export, and thus create added
value. Role of this
companies is not only in ecenomical spheres of society, but also
in social, cultural and historic
spheres. Due to their contribution to employment, creating GDP
and export, sole
proprietorships represent a huge part of Croatian economy.
Small and middle sized companies
(SMEs) encompass 99.6% of total number of registered
businesses in 2012. Out of that,
98.3% are small sized and 1.34% are middle sized businesses.
Share of small businesses in
employment in 2012 recorded a growth compared to 2011 and
now stands at 67.04% (49%
are small sized and 18.04% are middle sized businesses). At the
same time, SMEs constitute
43.06% of total Croatian export, 21% are small busineses,
22.6% are middle sized businesses

(HGK 2014). Small activity in new ventures, small share of
growing companies,
administrative barriers, under-developed financial market (too
dependent on traditional
instruments) and lack of education focused on honing
entrepreneurship knowledge and skills
are main traits of small businesses in Croatia.
Financial resources are needed for realization of every idea and
inovation. Financial requests
have a tight bond with business strategy, which in interaction
with financial strategy enables
creating added value and raising the level of competitiveness.
Without financial resources it is
impossible to realize new good business ideas. When a business
is started, financial resources
are ensured from owners own sources. With growth and
development of a company,
mailto:[email protected]
284

requirements grow with them, and so possibility to finance
come from many different sources.
Each stage of a company's life cycle has different sources of
financing. In earlier phases
personal assets, loans from family/friends and micro loans
present key financing resoruces,
while in later phases they can be expended with equity funds,
business angels (as informal
investors) and public financing. Small businesses face many
barriers in they life cycle and
financing is one of most common to appear and hardest to
overcome.
2. POTENTIAL SOURCES OF FINANCING
2.1. Self-financing
When launching a business, every entrepreneur must first turn
to his own personal property.
Although entrepreneurs prefer to invest only someone else's
capital to reduce their risk, banks
and other investors require capital investment by entrepreneurs
as a sign of faith in the
venture. The largest part of their funds is personal savings
they've acquired over the years.

The funds presented as savings can be found at the current bank
accounts, saving bank
accounts or in the form of effective money. There's a positive
correlation between savings and
probabilities, it is a cause - effect relationship characterized by
great likelihood that a person
will start a business venture if it has a larger amount of savings,
on the one hand, and that
he/she will generate greater amounts of savings if he/she
engages in running a business, on the
other (Hurst and Lusardi, 2006). Likewise, savings (wealth) is
concentrated by
entrepreneurially active people and entrepreneurship is a
powerful factor which affects the
level of aggregate savings (wealth), and thus the aggregate
consumption (Gentry and Glenn,
2004). Surveys show that the majority of entrepreneurs in
Croatia opted for entrepreneurship
out of necessity (GEM, 2013), so an important source of self-
financing is redundancies that
can reach very high amounts. The next type of self-financing is
personal debt that can be
result of overdraft on current account or credit card. Among
these, personal loans are suitable

for setteling short-term liabilities and are sometimes used in
order to achieve tax benefits on
such loans (Grgić, Bilas and Franc, 2011).
When they exhaust their own sources of financing entrepreneurs
turn to informal investors,
friends and family. Unlike other investors family members and
friends are often more patient
and don't interfere in the way entrepreneurs conduct their
business. Also they usually do not
sign formal contracts and the contractor doesn't pay any interest
(if they exist they are
insignificant) for the borrowed funds. Information on the return
and the potential benefits are
also informal (Skrtic and Mikic, 2011). Repayment period of the
borrowed funds is often
flexible and it adapts to the undertakings' capabilities, and the
borrowing decision depends on
the personal trust in the entrepreneur as a person. Because of
the mutual relations of family
members or friends and business drivers, they will prefer to
invest in entrepreneur’s
investment than decide to hold cash or invest in other
investments (Scarborough and

Zimmerer, 2009). In this case there may be conflicts between
entrepreneurs and family or
friends, and the main causes of disagreement are usually
unrealistic expectations or
misunderstood risk by those who have invested in venture
project. In order to avoid distortion
of relations, the entrepreneur must honestly and realistically
present strengths, weaknesses,
opportunities and threats of the project and the nature of the
investing risks.
If we talk about financing of the existing company, then we
need to mention another form of
self – financing, which in this case is the most important,
financing from business retained
earnings. There are two options that a company can use if it
makes profit. One is to reinvest
the acquired funds in the business to help them achieve new
value added, and the other option
is to distribute its profits to owners in the form of dividends.

285
2.2. Debt financing
The most common form of debt financing is a bank loans. Such
financing can be shorterm or
longterm and is marked by giving collateral as insurance of
payment by entrepreneurs. It is for
this reason that this type of financing is difficult to apply to
businesses that are at the very
beginning of their life cycle. Bank wants proof of successfully
conduction of business and real
evidence of stable sales and the ability of products or services
to generate adequate cash flows
to ensure the repayment of the loan, and therefore they insist on
collateral when financing
entrepreneurial projects in early stage of development. In
assessing the requirements for
lending resources, banks focus on the ability of the company to
generate cash flows since it
will continue to serve for servicing the loan. Other forms of
debt financing include: trade
credits, factoring and leasing. Trade credit is given by the

supplier (also called loan of
manufacturer to the customer), and is implemented through the
granting of loans under a
contract for the delivery of goods with deferred payment,
usually 30 to 90 days. Suppliers
often use this type of financing to attract new customers, and
customers or contractors use it
as a way of acquiring the additional working capital. Since
these loans are often not linked to
interest payments, entrepreneurs often use it in their daily
business. Factoring, as a form of
debt financing, represents a form of shortterm financing on the
basis of sales of short, in
general, unsecured assets of enterprises (primarily trade
receivables without collateral
payments) to specialized financial organization, which is called
a factor. These financial
institutions may also provide other services, such as claims
management and underwriting
payment from the debtor. Factoring regularly represents a
shortterm rating with a large circle
of regular customers and large annual turnover and is often not
an option for small businesses.
Leasing is a form of financing that is based on the idea that it is

better to use the object of
leasing than to buy it. It allows the user to obtain any
equipment or property for use during
needed time, rather than to buy it. By leasing, SMEs can obtain
manufacturing and other
goods without spending their own funds and without taking
expensive loans in the financial
market, and allows compensation for the use of subjects on the
principle of "pay out of what
you earn." There are two types of leasing: financial and
operational. Financial leasing is a
basic contract period of the lease, in which one of the
contracting parties can't cancel, it is
designed as a "contract of full amortization," which means that
the user, during the duration of
the contract paid the full value of the service (where the costs
of maintenance and
obsolescence of subjects bears the recipient). On the other hand,
operating leasing represents a
shortterm contract for the lease that can be terminated at any
time (under the terms of the
agreement), it lasts less than the economic life of the subject,
the fee is smaller than the value
of the object, so the service is depreciated only by a portion of

their expenses and assumes the
risk of obsolescence and maintenance costs of leased items.
Also after the expiry of the lease
entrepreneur can (if the contract was concluded) redeem the
subject of leasing. In operations
of European companies leasing is mostly used for the
acquisition of transport equipment and
machinery, and technology (European Commission, 2013).
Leasing purchase of equipment
allows small businesses to keep up with technological change
and to preserve their
technological competitive advantage.
2.3. Equity capital
Venture capital funds are a form of equity financing, and
represent funds for medium and
longterm investment in companies that typically are not listed
and have high growth potential
(Cvijanovic, Marovic and Sruk, 2008). These funds are known
under the name of private
equity funds and by the Investment Funds Act of Republic of
Croatia defined as mutal venture
capital funds with a private offering (150/05). Venture capital
funds usually invest in

companies that are engaged in hightech service sectors such as
Internet, communications,
286
information technology, biotechnology, etc.. To attract capital,
company must primarily have
potential for rapid growth. The process of obtaining capital is
rigorous and requires
entrepreneur to professionally prepare project documentation
with longterm business plan.
When a venture capital fund accepts an entrepreneurial project
follows an agreement on all
relevant business issues with special emphasis on the
management team. Venture capital
funds do not buy more than twenty to forty percent ownership
of the company, since the
purchase of a large stake would reduce the enthusiasm of
entrepreneurs to manage the
company. The dynamics of investing funds in an entrepreneurial

project is not always a one
time investment; instead, if it comes to large amounts, it can be
realized in several phases.
Acceptance of this form of financing requires a waiver of part
of ownership by the
entrepreneur, and sometimes loss of control over operations.
Business angels are individuals
or groups that provide capital for financing new business
projects. Most often these are
wealthy individuals who are looking for entrepreneurial
ventures (projects) in which they
would invest their own resources in exchange for the acquisition
of shares of those companies
(Garaca and Marjanovic, 2010). This is an informal form of
investment whose holders are
highly educated business people who invest their funds in start
up projects with high potential
of growth. This implies that angels expect a high annual return
on investment and a multiple
increase of the initial investment after a few years when they
decide to retire from the
business (Figar, 2010). The reason why they are willing to
accept such a degree of risk is that
one investment is only a tiny fraction of the total portfolio of

personal investments that angels
make (Vasilescu, 2009). On capital market business angels fills
the gap between the founders,
family and friends on one side and the venture capital funds on
the other, and therefore have a
key role in the financing of SMEs, particularly innovative
businesses and businesses with high
growth potential. In some cases, firms choose to raise capital
through the public sale of shares
in the capital market, so called going public. By analysing the
strengths and weaknesses of
public offering, we can conclude that going public primarily
allows the entrepreneur to collect
large amounts of capital, but not without consequences. For
some businesses, the
consequences are too big. Most entrepreneurs enter
entrepreneurship with the goal of
independence and creating something of their own, so the loss
of independence in decision
making and conducting business, shared ownership and a sense
of "accountability" are simply
too big sacrifice that most entrepreneurs are not ready to make.
For those entrepreneurs who
enjoy the fact that their company outgrew themselves and who

want to try some other
challenges, public offering is a good way to achieve that dream.
Once an entrepreneur, a small
business owner, weighs all the pros and cons and decides for
public offering he will meet with
the formal problems. Today in the world there are only a few
specialized stock exchanges for
SMEs, of which the most important for Croatian entrepreneurs
is AIM (Alternative
Investments Market) in London. AIM London is the largest and
most liquid world market for
growing SMEs, and its biggest advantage over other stock
exchanges is that it belongs to the
London Stock Exchange which brings listed companies many
advantages and great number of
competitors as well.
3. CHOOSING THE SOURCE OF FUNDING
Raising funds for launching an entrepreneurial project is a big
challenge for every
entrepreneur. Constant changes on the market only make the
mentioned challenge more
difficult. When selecting sources of financing entrepreneurs
need to consider the following

factors (Stokes and Wilson, 2010):
nterprise life cycle
287
Companies with more complex legal forms of conducting
business, such as public limited
companies, will have an increasing number of opportunities
related to funding the company,
while those with simpler legal forms (sole traders) will be much
more limited in terms of the
diversity of funding sources. Thus, for example, sole traders
can't get access to equity capital
because there is no possibility of selling shares of the company.
At different company life cycle stages (start up, growth,
differentiation, consolidation,

liquidation) company will require increasing amounts of
resources for growth and prosperity
of business. The needs for financial resources of a recently
founded company and one that has
a long tradition of conducting business are not the same. It is
essential that strategy and
structure of the company are changing along with the changes in
the life cycle and therefore
business conditions, and indirectly the needs for financial
resources will also change. Funding
problems are encountered mostly by entrepreneurs who are at
the very beginning of their
entrepreneurial adventures, so at the very beginning, funds
come from entrepreneurs, friends,
relatives, business angels. Banks are reluctant to finance new
business ideas for entrepreneurs
usually can't provide adequate collateral. On the other hand, the
venture capital funds are
usually not interested in these investments because for them the
amounts of profit are very
low. In the next stage, the resources are needed for the
development of the business idea and
its expansion, so for the entrepreneur, through well developed
business plan the possibility of

using others financing resurses is opening up. When a company
occupies a certain market
position through quality business it will have a full range of
possible sources of funding
available.
In the case of fixed resources, financing is mostly carried out
through owner’s equity, and
funding source is most often seen in the proportion of
entrepreneur’s ownership (in the form
of shares) in the company or personal loans of entrepreneurs or
their partners. This serves to
cover the initial operating expenses or new product development
in the stage of development
and expansion. Unlike fixed assets, current assets are covered
by shortterm financing and are
used to cover operating costs and often the procurement of
rolling stock. Financing assets
carried out through medium and long term financing (3 – 10
years) is used for the acquisition
of plants, machinery, equipment, while making sure that credit
conditions correspond to life
expectancy (or shorter) of the underlying assets. In financing
sources entrepreneur should pay
attention to the potential problems that are presented by

exchange rate fluctuations,
requirements and safety charges.
5. SMALL BUSINESS FINANCING IN CROATIA
5.1. Methodology
Population of this research is all Croatian small businesses.
Small business has maximum of
50 employees and size data are available in the register of
business entities at Croatian
Chamber of Economy. Research sample consists of 350 small
businesses from various
business activities: manufacturing, construction, wholesale and
retail sale, repairs of motor
vehicle and motorcycles, and objects for personal consumptions
and households,
transportation, storage and communications. Research was
conducted via electronic mail, and
rate of return is 11.71%. Regardless relatively small percentage
of return, given sample is
sufficient for relevant analysis and impact assessment of
choosing financing source on small
business performance. Questionnaire was answered by owners
of small business, ie small

entrepreneurs.
Determining financing sources was done by using five-level
Likert item scale. Financing
sources include: self-financing by entrepreneur, informal
investor (3F), venture capital funds
and business angels. This research was based on acquisition of
self-selected, subjective
answers about the financial and non-financial performance of
the firm from the entrepreneurs
288
of the retained sample companies with an effort to reflect its
multi-dimensionality. Business
performance was operationalized accordingly by Gupta and
Govindarajan (1984) where the
respondents were asked to rate the extent to which stated
financial and non-financial
indicators are important for their business, and subsequently, to
assess the extent of

satisfaction with the achieved performance of these indicators.
For this purpose three financial
and three non-financial indicators were used; each of the
indicators was measured with three
questions using a five point Likert scale. Financial performance
represents the key of business
effectivity and it is considered important, but not self-sufficient
for defining business
performance (Murphy et al., 1996). We used these indicators of
finance performance:
OA
Business performance represents market oriented components
and includes indicators of total
revenues and market share. This definition was subject in
numerous researches (Koufopoulos
et al., 2010; Postma, Zwart, 2001)
Multiple linear regression method is used for the prediction of
the dependent variable on the
basis of the insights that can be obtained from a number of
independent variables and for
determining the nature and relationship between these variables
and the variables used to

measure the quantitative scale. Standard methods of multiple
linear regression is used and all
independent variables entered into the regression equation
simultaneously in order to explore
the relationship between the entire set of independent variables
and the dependent variable.
For the evaluation of the strength of relations among variables
the regression coefficients and
t-test is used.
5.2. Sample characteristics
We gathered responses from 41 small business. The biggest part
of questioned business is
from construction 37% and wholesale and retail sale 29%
(Figure 1). The majority was
founded in period of 1990 to 2000, average year of foundation
is 1996, and the modal year is
1991.
Figure 1: Distribution of the business according the business
activity
37%

29%
17%
17%
Construction
Wholesale and retail sale
Transportation, storage
and communications
Manufacturing
289
As main reason for using self-financing entrepreneurs stated
completely ownership over the
resources 24%, no interest rates and monthly payments As main
reason for using self-
financing entrepreneurs stated completely ownership over the
resources 24%, no interest rates
and monthly payments 23% and independence in disposing

resources 22% (Figure 2).
Figure 2: Reasons for using self-financing
Most common source of self-financing is savings through the
years 34%, and from other
sources inheritance and selling of the personal property (Figure
3) Personal debt financing and
current account overdraw are least represented, which can be
interpreted as willingness of
entrepreneurs to stay independent in disposing resources
without attachments to interest rates
and terms as in the case of bank loans.
Figure 3: Source of personal property
As for the entrepreneus who used the loans to family/friends to
finance busienss equity, 65%
of them stated these reasons for using this form of financing: no
detachment deadlines and
high interest rates and the fact that family members/friends will
not interfere with their way of
doing business. Interesting is that the 35% of the sample did not
use any borrowings from

family/friends to finance equity (Figure 4).
22%
24%
23%
18%
Independence in
disposing resources
Completely ownership
over the resources
No interest rates and
monthly payments
Signaling to investors faith
in investment
34%
14%
11%
10%
15%
Savings throug the years
Personal loan

Current account overdraw
Redundancy
Funds from selling
property
290
Figure 4: Reasons for using funds form family/friends
The other interesting finding is that 44% questiond
entrepreneust said that the concept of
venture capital is completely unknown to them. Only 41% of
respondents answered that they
have heard of venture funds, but are not familiar with
possibility of using their finance
resources (Figure 5).
Figure 5: Familiarity of venture capital funds

Even worse indicators relate to knowledge of the term of
business angels and their advantages
and disadvantages. Only 15% of respondents is fully aware of
business angels (Figure 6). At
the same time, to 59% of entrepreneurs business angels are
completely unknown concept. The
above shows an extremely negative trends of Croatian SMEs,
and states the area within is
necessary to conduct additional training of entrepreneurs in
order to improve these negative
trends.
18%
17%
15% 15%
35%
Detachment to return
deadlines and high interest
rates
Family members/friends
do not interfere with their
way of doing business
Not obligatory to report
business performance
details

Do not have enought own
funds
Did not used this financing
source
44%
41%
15%
Do not know
Heard, but do not know
the details
Fully understand
291
Figure 6: Familiarity of business angels
As conclusion it can be stated that the Croatian small businesses
or entrepreneurs show a more

traditional approach to finance business equity. Majority of
financing is based on their
personal property and only a small part on the borrowed funds
from family/friends or informal
investors.
5.3. Results of multiple linear regression
Regression equation is:
Y = α + β1X1 + β2X2 + β3X3 + ei
Y = business performance
X1 = entrepreneur's savings
X2 = funds form family/friends
X3 = bank loans
In the above regression equation venture capital funds and
business angels are exempt as
previously mentioned results show that questioned
entrepreneurs did not use their funds for
financing their business venture.
The business performance(Y) is the dependent variable and is
measured as a weighted average
which is obtained through multiplying the importance and

satisfaction for each individual
criterion. Criteria used are: (1), Financial performance:
company total profit, profitability of
total assets (ROA) and return on equity (ROE); (2) Business
performance: total revenue and
market share. The independent variables in this model represent
the types of financing that
take three modalities: personal property of entrepreneur, fund
from family/friends and bank
loans.
The outcome of a multiple linear regression using method of
least squares (Table 1)
show estimated equation model of the impact of financing
source on small business
performance as follows:
Ŷ= 0,14 + 0,67X1 – 0,37X2 + 0,49X3
58% 27%
15%
Do not know
Heard, but do not know
the details

Fully understand
292
Table 1: The outcomes of the multiple linear regression
(financing source/small business
performance)
N=41
Coefficient Standard deviation t(41) p-level
α 0.136546624 0.769284092 0.177498 0.860085165
X1 0.66667436 0.120485453 5.533235 0.0000026921391
X2 -0.369496985 0.251370055 -1.46993 0.150032975
X3 0.489712921 0.128733438 3.804085 0.000516709
Statistics Value
Multiple R 0.698670101

Multiple R
2
0.48813991
Adjusted R
2
0.44663774
F(3,37) 11.76179259
p 0.0000147744
Contribution of financing sources to explanation of business
performance is satisfactory
because it explains 48.81% of variance, on the whole population
is 44.66%. This data is
significant as a source of financing is one of the most
influential factors of business success -
but not the only one. There are many other factors that affect
business performance - both on
the internal as well as external level, which in this analysis was
not included. Regardless of
the high coefficient of multiple linear determination, the impact
of the financing source on
small business performance is highly significant (p <0.01.).
Personal assets of entrepreneur has a positive impact on

business performance (β1 = 0.67, p
<0.01 - significant at 1%). The above result was expected
because when investing their own
funds entrepreneurs are acting and making decisions more
prudently. As an entrepreneur
invests his savings accumulated for years, thereby risking the
financial stability of your
family, it is logical that he will be managing it more responsibly
while avoiding investment in
high-risk activities. In this case, we can say that the
entrepreneur takes reasonable assumption
of risk when making business decisions.
And financing through bank loans has a positive impact on
business performance (β3 = 0.49,
p <0.05 - significant at 5%). The reason for this can be found in
the complex procedure of
loan approval which credit institutions protect against bad
loans. When applying for funds,
entrepreneurs are responsible for providing high quality and
systematically developed a
business plan which covers all areas of the business in order to
reduce potential operational
risks to a minimum. By doing so, companies are obliged to
comply with the plan. At the same

time, the bank will only approve funding for promising projects
that have a certain economic
potential. In this way the bank invests only in ventures that
promise a return, so it is logical
that between bank loans - as a form of business financing - and
the business performance we
have a positive link.
Interesting results showed that analysis of the impact of funds
from family/friends on small
business performance. Results of the analysis indicate a
negative relationship (β2 = -0.37, p =
15 - significant at 15%). This is explained with very informal
relationship that exists between
entrepreneurs and investors mentioned. As the landing of the
funds is usually based on
acquaintance and relationship with the entrepreneur, or trust, all
the information about the
entrepreneurial venture and the potential returns are usually
verbal. The lack of formal
developed business plan that will provide an objective picture
of the business venture
potential may lead to worse malpractice risk management
operations, thereby to achieving

293
poorer financial results. Also, entrepreneurs are often turning to
family and friends when they
exhausted all their own available funds or personal property and
at the time when they can no
longer get any bank loans. The most common reason is high-risk
from non-viability of a
business project or already high indebtedness of entrepreneur.
The research results bring answers to many questions related to
the Croatian small businesses
and ways to finance it, but also many questions remain open for
further research. Additional
limitation is the scarcity of data on business performance in the
Republic of Croatia so the
quality of doing business is still incomplete. A small sample
represents a kind of restriction
regarding the use of inferential statistics and advanced
statistical models for more detailed and

better analyses.
5. CONCLUSION
Finding and selecting sources of financing is a significant
problem in implementation of
Croatian entrepreneurs' ideas. Although they have available
many sources of financing, as
shown in this paper, they usually use only three types: personal
property of entrepreneur (self-
financing), informal investors (family and friends) and bank
loan. The reason for this lies in
the lack of knowledge of other forms of financing that are at
their disposal, such as venture
capital funds and business angels. Also, stated unwillingness of
investors to finance
entrepreneurial ventures in the initial phase of the life cycle or
to finance such "small" amount
does not help. The limiting factor in finding funding represents
a legal form of business,
which entrepreneur is not usually aware of when starting a
business.
The empirical research has shown that there is a positive
relationship between self-financing
of the entrepreneurial venture or investment of his personal

property, and small business
performance, and above is explained by the fact that such firms
conduct much more sensibly
risk management. Entrepreneurs are investing savings gathered
through the years and
inherited assets, the reason is completely ownership over the
resources, no interest rates and
monthly payments and independence in disposing resources The
reverse situation is present
when borrowings from family/friends. Results of multiple linear
regression show a negative
correlation between this form of financing and business
performance. The main reason for
borrowing from family/friends is detachment to high interest
rates. The fact that family
members/friends do not interfere in doing business, is the
second most common reason for
using this type of financing. Financing through bank loans
positively affects the achievement
of successful business results, and one of the reasons is
systematically and holistically
developed a business plan that is needed for obtaining bank
funds. Croatian small businesses
show a more traditional approach to funding equity, the

majority of funding is based on the
personal assets of the entrepreneur (in 2012 the average
proportion of self-financing was
80.14%), and only a small part is based on the borrowed funds
from family/friends and bank
loans. Precisely for this reason, the Croatian entrepreneurs
should through education for
entrepreneurship, improvement of technical and technological
knowledge and skills, and
international entrepreneurial practices adopt the best European
(global) trends in
entrepreneurship so their work and business efforts could result
with a long term national and
international competitiveness.
LITERATURE
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m
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content/blogs.dir/1/files_mf/gospodarska_kretanja_6_201421.pd
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out of Entrepreneurship,
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Small Business Strategy, 12 (92), p. 52.-64.
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Business Management,
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novine: klasa: 402-09/05-01/03
*******
http://hrcak.srce.hr/practicalmanagement
reproduction prohibited without
permission.

Challenges of SMEs innovation
and entrepreneurial financing
Jarunee Wonglimpiyarat
College of Innovation, Thammasat University, Bangkok,
Thailand
Abstract
Purpose – Today, the financing mechanisms to support small-
and medium-sized enterprises (SMEs)
development have been a subject of great interest and a
challenge to policy makers as SMEs are
regarded as an important sector contributing to economic
growth and stability. This paper is
concerned with the bank financing policies to support SME
development in China. The purpose of this
paper is to examine the governmental financing policies and the
innovation financing system of China.
The discussions are focused on the bank financing policies to
support SME development in China.
Design/methodology/approach – This study is a qualitative
research with the use of case study
methodology (Eisenhardt, 1989; Yin, 2003). The research is
focused on the policy perspectives of bank
financing to support SME development in the case of China, the
world’s fastest-growing economy.
To explore 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 analyses are undertaken to
answer the key questions of: What are
the Chinese government’s strategies to support the development
of SMEs? To what extent the
government policies in bank financing can support SMEs and
promote the development of an
innovative economy?
Findings – The empirical study has shown that despite the
introduction of the 12th Five-Year
National Economic and Social Development Plan to support
SMEs development, China still needs to
improve regulatory policies in support of innovative businesses
which would help its transition to an
innovation-driven economy. The study provides lessons and
policy guidelines to improve the
competitiveness of SMEs in China. The insights from this study
can also be applied to other developing
and emerging economies attempting to understand the role of
financing mechanisms in building an
innovative economy.
Originality/value – The study has addressed the policy
challenges to support SME development in
China, a major Asian emerging country and one of the fastest-
growing economies in the world
(with averaged growth rate of 10 percent per annum). The
empirical study of policy challenges was
undertaken in Beijing and Shanghai, major financial centers in
China. The study offers insights which
can be applied to other developing and emerging economies
attempting to understand the role of SME
financing policies and mechanisms in building an innovative
economy.
Keywords Sustainable development, SMEs
Paper type Research paper

1. Introduction
China is one of the fastest-growing economies in the world
(with averaged growth rate of
10 percent per annum). In 2014, China was placed in 23rd
position according to the
International Institute for Management Development world
competitiveness ranking and
28th position by the World Economic Forum. After joining
World Trade Organization
(WTO), China has adopted trade liberalization policies and
various government policies
to drive its economy. Small-and medium-sized enterprises
(SMEs) play a significant role
in the economy of China as they are the thrust sector that
account for 60 percent of total
World Journal of
Entrepreneurship, Management
and Sustainable Development
Vol. 11 No. 4, 2015
pp. 295-311
© Emerald Group Publishing Limited
2042-5961
DOI 10.1108/WJEMSD-04-2015-0019
Received 23 April 2015
Revised 9 June 2015
Accepted 16 June 2015
The current issue and full text archive of this journal is
available on Emerald Insight at:
www.emeraldinsight.com/2042-5961.htm

The author is thankful to Dr Pravit Khaemasunun, Yanathip
Techawiset, Professor Shufen Dai,
Kesrin Ariyaponges and China Thai Chamber of Commerce for
all research advice and support.
295
SMEs
innovation and
entrepreneurial
financing
industrial outputs and 80 percent of jobs created in China. The
Chinese government thus
realizes the importance of building an innovative economy
through enhancing SMEs’
capabilities. In building an innovative economy, the Chinese
government has introduced
the 12th Five-Year National Economic and Social Development
Plan to support SMEs
development. This paper attempts to understand the challenge of
financing innovative
economy through SME development in China.
The paper is organized as follows. Section 2 reviews the
theoretical framework on
the banks, financial institutions and their role in innovation. It
also reviews the
literature on venture capital (VC) financing to support SME
development. Section 3
describes the research design and methods. Section 4 discusses
the analyses of findings

with a focus on the bank financing policies to support SME
development in China.
Section 5 concludes the paper by drawing lessons and insights
that can be used as
policy guidelines to improve the competitiveness of SMEs.
2. Theoretical framework
SMEs are the economic sector making a significant contribution
to economic growth
and job creation. However, they often face significant
difficulties in accessing the kinds
of financing they need for growth (Pissarides, 1999; Hyytinen
and Toivanen, 2005).
Although the studies on traditional sources of finance for start-
up are already
voluminous (e.g. Moore, 1993; Gompers and Lerner, 1998,
1999, 2001; Mani, 2004), there
is a gap of research linking the study of entrepreneurial
financing to the aspect
of public policies in developing countries. Therefore, this study
attempts to fill a gap in
existing research by exploring the bank financing and VC
financing to support
entrepreneurial activities. Table I lists the types of financing
and sources of capital to
support SMEs.
In filling the research gap, this study will make a contribution
to the body of
knowledge in SMEs innovation and entrepreneurial financing.
Thus, the structure of the
theoretical framework section will be divided into two parts:
(1) Banks, financial institutions and their role in innovation.
(2) VC financing to support SME development.

2.1 Banks, financial institutions and their role in innovation
Banks and financial institutions play an important role in terms
of providing credits to
support the economic growth. Bank financing is critical to the
functioning of the
economy since it is an important source of funding to support
SMEs development.
Nevertheless, banks and financial institutions are reluctant to
provide credit lending to
Investor Goals
Family Success, payback
Friends Payback, friendship
Credit cards Payment
Suppliers Payment relationship
Business angels (private investors) Payback, returns, control
Venture capital Fast growth, multiple returns, ownership
Banks Payback, collateral
Source: The author’s design
Table I.
Types of financing
and sources
of capital
to support SMEs
296
WJEMSD
11,4
SME sector due to the riskiness of early stage ventures in terms

of insufficient assets,
having no proven track record and low capitalization (Berger
and Udell, 1998, 2006;
Black and Gilson, 1998; Wonglimpiyarat, 2007; Menkhoff et
al., 2012; Fredriksson and
Moro, 2014). As a result, they do not see this sector as a
profitable business. In other
words, they do not see worthwhile returns on SME investments
or whether such
investments would provide a potential pay-off.
Figure 1 portrays the valley of death (or the funding gap), the
difficulties
encountered by all SMEs in accessing the needed capital to
grow their businesses.
The valley of death refers to the period before a company can
generate revenues,
making it difficult to get the finance it needs to grow a business
in the start-up period
(Ehlers, 1998). Table II shows the target returns by investment
stages (Bygrave
et al., 1999). It can be seen that the high level of risks in early
stage investment requires
the highest return (internal rate of return over 50 percent) to
compensate the risks that
are higher than those in other stages.
Looking from an economic development perspective,
Schumpeter (1939, 1967)
argues that finance and financial institutions are the mainstream
of innovation
system as well as crucial determinants of the entrepreneurial
ability to develop
the new economy. The entrepreneurial firms are seen as playing
a crucial role to
the economy in terms of creating jobs contributing to economic

growth and stability.
Realizing the high risk nature of SMEs, many governments have
tried to bridge
the valley of death and improve SME capability. They see the
valley of death as
a challenging task in terms of introducing policies to manage
the financial risks that
Basic
Research;
Invention
The Valley of Death
Political picture
of the “gap”
“Valley of Death”
Applied
Research;
Innovation
Source: Ehlers (1998)
Figure 1.
The valley of death
faced by SMEs
Investee development phase
Expected return represented by internal rate of return (IRR) %
per annum
Early stage (Seed/Start-up) IRRW50
Expansion and growth 40WIRRW35

Maturity stage (Bridge, Management
buyout) IRRW30
Source: Bygrave et al. (1999)
Table II.
Target returns by
investment stages
297
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
a
te
o
f
g
ro
w
th
Risk profile
Source of funding
Source: Wonglimpiyarat (2007)
Figure 2.

Funding requirement
along the life cycle
of SME development
298
WJEMSD
11,4
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
299

SMEs
innovation and
entrepreneurial
financing
Commerce in China. The interviews were conducted with banks,
financial institutions
and government agencies as shown in Table III.
In carrying out fieldwork research, the study aims to elicit
views on the government
policies and strategies to support SMEs and innovative
businesses, the backbone of the
Chinese economy that can lead to improved national innovative
capacity. The key
questions guiding the research are:
RQ1. What are the Chinese government’s strategies to support
the development of
SMEs?
RQ2. To what extent the government policies in bank financing
can support SMEs
and promote the development of an innovative economy?
In order to provide a cross-check on internal validity, interview
data are supported by
an examination of secondary data. The conduct and analysis of
the case study
have enabled the development of conclusions and
recommendations for the research.
The analyses provide lessons and insights which would be

useful for other emerging
economies to use the policy guidelines in supporting SME
development.
4. Analyses of findings
4.1 The economy of China and government strategies to support
SME development
China is the fastest-growing major economy in the world with
an average gross
domestic product (GDP) growth rate of 10 percent. The
overview of economic and
innovation performance of China is shown in Table IV.
Currently, the Chinese
government mainly uses the open door policy in attempts to
remodel itself from an
agriculture-based economy towards an innovation-driven
economy. Taking into
account the policies to support SME development, the Chinese
government has
launched various innovation policies to catch up with leading-
edge countries after it
joined the WTO in 2001. Specifically, the 12th Five-Year
National Economic and Social
Development Plan is a major government policy that places a
specific emphasis on
Name of institutions Characteristics of institutions
1. Bank of Beijing Bank owned by the local government
2. Huaxia Bank Bank owned by the central government
3. China Citic Bank Bank owned by the central government
4. United Overseas Bank or UOB Foreign bank
5. Bank of China Bank owned by the central government and
one of the Big Five
6. Bank of Shanghai Bank owned by the local government
7. Bangkok Bank China Co., Ltd. Foreign bank

8. Siam Commercial Bank Public
Company Limited
The bank is currently planning to open a representative office in
China
9. Thai Chamber of Commerce in
China
An agency promoting economic relationships between Thailand
and China
10. Bank of Thailand Bank of Thailand – the Department
dealing with investment and
trade relations with China
11. The Securities and Exchange
Commission
The Securities and Exchange Commission in Thailand with
specific research department providing advice on China’s
financial and monetary policy
Source: The author’s design
Table III.
List of institutions
providing research
interviews
300
WJEMSD
11,4

supporting SMEs in terms of creating an environment conducive
to entrepreneurship
and innovation for SMEs.
In China, SMEs are defined as follows according to the 12th
Five-Year National
Economic and Social Development Plan 2011-2015 by the
Ministry of Industry and
Information Technology:
(1) Small-sized enterprises: companies that employ fewer than
300 people and earn
less than 20 million RMB Yuan in annual sales revenue.
(2) Medium-sized enterprises: companies that employ 300-1,000
people and have
annual sales revenue of 20-400 million RMB Yuan.
In 2010, the number of registered SMEs in China is
approximately 11 million, contributing
to employment creation of more than 44 million people.
Therefore, SMEs are important in
driving China’s economic growth that the government cannot
afford to overlook. Table V
gives an overview of indicators to support entrepreneurship in
SMEs according to the
Global Entrepreneurship Monitor Report 2013, a global report
which provides an annual
survey of entrepreneurial activities worldwide. The first column
lists the indicators that
influence entrepreneurial activities in various dimensions. The
highlighted box shows the
performance of China compared to the average performance of
Asia Pacific and South
Asian countries which include China. It can be seen that the

performance of China in
supporting entrepreneurship in SMEs is likely the same as the
average performance in
North America and the Asia Pacific and South Asia (except that
China is relatively weak
in entrepreneurship education with the score of 1.6 but performs
better than other
countries in terms of physical infrastructure with the score of
4.0). These scores reflect the
government attempts to support entrepreneurial development in
China. They also reflect
the importance of entrepreneurship in building China’s
innovative economy.
Realizing the importance of SMEs in economic development as
they constitute more
than 90 percent of all firms in China, the Chinese government
has placed importance on
SME development to drive the national economy. Figure 3
depicts major institutions and
players providing support to SMEs as well as high-growth
innovative SMEs in China.
Indicators Year Important figures
Population (million) 2014 1,393
Gross domestic product (GDP) (USD billion) 2014 1,253
GDP growth (%) 2014 7.4
IMD world competitiveness ranking 2014 23
WEF competitiveness ranking 2014 28
Knowledge Economy Index (KEI) Ranking 2012 84
KEI Index 2012 4.37
% of R&D expenditure to GDP (approximate) 2014 1.95
No. of patent applications
Residents 2012 535,313

Non-residents 2012 117,464
Amount of venture capital (VC) investments (USD billion) 2013
3.5
Sources: The author’s design, based on the World
Competitiveness Scoreboard (various years) by
International Institute for Management Development (IMD),
World Economic Forum (WEF) Global
Competitiveness Report, World Bank, United Nations
Conference on Trade and Development
(UNCTAD), OECD Main Science and Technology Indicators
and Dow Jones Venture Source 2013
Table IV.
Overview
of economic and
innovation
performance
of China
301
SMEs
innovation and
entrepreneurial
financing
The government plays an important role in developing policies
and strategies to support
the transition to an innovation-driven economy. For example,
the Decision on Developing
High-Tech and Realizing Industrialization (CCCP) sets forth the

tenth plan (2001-2005) to
promote innovation commercialization. The Guideline for
Developing National
University Science Parks provides a plan to promote the
development of university
science parks. The government policy in encouraging R&D can
be seen a result of
adopting Deng Xiaoping’s open door policy to encourage
foreign investments and attract
new technologies. The major policy of the Ministry of Science
and Technology includes
the guidelines on national medium-and long-term program for
science and technology
development during the period of 2006-2020.
China’s Ministry of Science and Technology plays a significant
role in the design
and implementation of national innovation policies. The special
economic zones
and science parks were established to foster new technology
development.
In particular, the Torch program was developed to support the
creation of industrial
clusters. The national Science and Technology Industrial Parks
(STIPs) were
established to support high-technology enterprises. Up to now,
there are 54 national
STIPs established by the Torch program to promote the
development of innovation
clusters and advance upgrades in high technologies.
Currently, the government policy has placed a greater emphasis
on strengthening
clusters of special economics and high-technology zones as the
government
realizes their important role in offering infrastructure for

implementing the
innovation strategies. The government has also reduced the
corporate income tax
rate and value-added tax to promote high-technology
enterprises. Recently, the
Rating scores based on a five-point Likert scale
Indicators of entrepreneurship
North
America
(Average)
Europe
(EU)
(Average)
Asia Pacific and South Asia
including China (Average) China
Entrepreneurial finance 2.4 2.6 3.0 2.5
Government policy to support
entrepreneurship 2.7 2.6 2.8 2.7
Government policy to support
new SMEs 2.0 2.4 2.6 2.6
Government programs to support
entrepreneurship 2.6 2.8 2.7 2.6
Entrepreneurship education at
basic school 2.0 2.1 2.2 1.6
Entrepreneurship education at
post-secondary levels 2.9 2.8 2.9 2.7
R&D transfer 2.3 2.5 2.6 2.5
Commercial and legal
Infrastructure to support SMEs 3.1 3.2 3.1 2.6
Regulations related to market

dynamics 3.1 3.1 3.6 3.9
Regulations related to market
openness 2.6 2.6 2.7 2.6
Physical infrastructure 3.8 4.0 3.8 4.0
Cultural and social norms that
encourage business activities 3.2 2.6 3.2 3.0
Source: The author’s design, based on the Global
Entrepreneurship Monitor (GEM) Report 2013
Table V.
Entrepreneurship
overview of China in
various indicators
302
WJEMSD
11,4
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Major institutions
and players to
support SMEs and
high-growth
innovative SMEs
in China

303
SMEs
innovation and
entrepreneurial
financing
Ministry of Science and Technology has proposed State Council
of 2009 to strengthen
the science, technology and innovation system.
Interestingly, innovation is one of the policy aspects (the
Chinese dream) that
President Xi Jinping emphasizes: patriotism (aiguo); innovation
(chuangxin);
inclusiveness (baorong) and; morality (houde). The financial
policies under the
political leadership of President Xi Jinping can be seen as a
continuation of using an
open door policy to improve financing mechanisms and provide
financial funds to
support SMEs. The Chinese government provides grants, loans
and other incentives
(such as tax incentives for R&D, low income tax rates for high-
technology enterprises)
to drive innovation and growth. The SME financing policies can
be seen as a result of
government intervention in the financial market to fill SME
financing gap.
4.2 Challenge of the government policies in bank financing to
support SMEs
Financing constraints of SMEs are one of the major difficulties

faced by entrepreneurs
in China. The central government attempts to improve SME
access to finance by
introducing the 12th Five-Year National Economic and Social
Development Plan.
In China, the Big Five banks providing a major source of credit
for SMEs in China
are Industrial and Commercial Bank of China, Agricultural
Bank of China, China
Construction Bank, Bank of China and Bank of
Communications. Table VI shows the
performance of the Big Five accounting for 47.3 percent of total
market share.
As a result of the 12th Five-Year National Economic and Social
Development Plan,
the Beijing Municipal Government supports Chinese financial
institutions in setting up
SME credit departments. The policies of Beijing municipal
government put greater
emphasis in upgrading small scale financial institutions into
commercial banks so as
to facilitate SME access to finance. Table VII shows the granted
credits in China. As a
2008 2009 2010 2011
Credits granted to USD % USD % USD % USD %
Small enterprises 0.71 21 0.93 22 1.20 24 1.74 24.7
Medium enterprises 1.12 32 1.40 33 1.66 33 1.79 25.3
Large enterprises 1.61 47 1.90 45 2.16 43 3.53 50
Total 3.44 100 4.23 100 5.02 100 7.06 100
Source: China Monetary Policy Report
Table VII.
Credits granted in

China (units in
USD billion)
Total assets
Operating
income Total loans
Growth
rate per
annum
Bank 2010 2011 2010 2011 2010 2011 2010 2011
Industrial and Commercial
Bank of China 2,195,534 2,524,775 62,124 76,770 1,107,750
1,270,619 22.68 23.32
Agricultural Bank of China 1,686,363 1,904,988 47,676 61,950
781,078 880,728 22.23 20.26
China Construction Bank 2,003,562 1,763,510 52,771 64,778
901,472 1,031,842 22.45 22.36
Bank of China 1,706,340 1,929,864 45,158 53,534 903,387
1,011,931 18.68 18.10
Bank of Communications 644,632 752,231 17,004 20,711
364,915 417,904 20.08 20.49
Source: China Securities Regulatory Commission
Table VI.
Performance of the
Big Five
(USD million)
304
WJEMSD
11,4

result of the implementation of this credit policy, it can be seen
that the total loan
amounts granted to SMEs account for approximately USD3.53
billion (from total
credits granted of USD7.06 billion in 2011). It is argued that
the 12th Five-Year National
Economic and Social Development Plan reflects the efforts of
the Chinese government
to help SMEs cross the valley of death (according to the study
by Ehlers, 1998). Clearly,
the SME financing policies play an important role in helping
alleviate SMEs’ financial
constraints (in line with the studies by Mani, 2004; Hyytinen
and Toivanen, 2005; de la
Torre et al., 2010).
In China, the majority of the banking sector is owned by the
central government.
The credit granting system of each bank therefore has to follow
the prescription policy
from the central government. In credit granting, most of the
banks prefer to grant loans
to large enterprises since granting credits to SME is more risky.
Understanding
the problems of SMEs, the Chinese government, through the
People’s Bank of China and
the China Banking Regulatory Commission (CBRC), has
encouraged banks to increase
access to credits and supports to SMEs. The government would
assess the performance
of policy implementation or the effectiveness of banks’ credit
granting system from the
non-performing loans (NPLs) rate. It is interesting to note that
the proportion of NPLs to

GDP in 2010 is 2 percent compared to 25 percent in 2000. The
reduction in loan losses is a
result of the government’ s policy in taking steps to control
NPLs, an attempt to build
solid economic footing in China’s banking system (World Bank,
2012).
Table VIII summarizes reflections from the interviews with
regard to the government
policy on SME financing and the extent of bank financing to
support SMEs. Most banks
state a consistent view that the introduction of the 12th Five-
Year National Economic and
Social Development Plan does have influence on the banks’
lending policy in terms of
increasing SME loans as the banks are under control by the
government (via the CBRC).
They view that the 12th Five-Year National Economic and
Social Development Plan is an
overarching strategic plan defined by the government. However,
in practice the policy
implementation differs across the banks depending on the
policies of each bank and the
extent of credit risks that each bank can bear (risk exposure).
At present, most SMEs depend on informal loans outside the
banking system which
bear relatively high interest rates (charging the high interest
rates of 18-20 percent)
and thus constrain the SMEs’ ability to grow. Therefore, the
Chinese government
attempts to terminate this informal lending system so as to help
SMEs. Interviewees
stated that the introduction of the 12th Five-Year National
Economic and Social
Development Plan has not only increased SME lending but also

placed emphasis on
capital market financing to build an innovative economy since
the 12th Five-Year
Plan encourages the opening up of the capital markets for
technology-based firms to
improve the capability of the economy to innovate. The
interviewees expressed their
views that the introduction of the 12th Five-Year Plan has
changed banks’ credit
direction from lending to heavy industries to new industries like
information
technology, renewable energy, biotechnology and other high-
tech sectors.
According to the interviews with banks in China, one of the
banks stated that: “[…]
the 12th Five-Year Plan can be seen as the government’s
command that we have
to follow by setting up SME special unit to provide SME
financing. Although the policy
is not mandatory, in practice we must comply with these
directives. Otherwise,
the future of our business relations with the government will be
not easy […]”. Most of
the interviewees stated that as the 12th Five-Year Plan denotes
the policy signals that
policy makers attempt to favor SMEs, the banks have to comply
with the policy.
Nonetheless, by complying with the 12th Five-Year Plan, the
banks expressed concerns
305
SMEs
innovation and
entrepreneurial

financing
Policies/strategies of
SME financing
Enabling
policies/
strategies Description
1. Government policies/
strategies to support
SMEs
x The policies from the central government not only
influence the small banks having a high proportion of
SME clients but also the Big Five commercial banks. The
Big Five need to comply with the government policy by
increasing SME lending portfolio despite their reluctance
to lend to SMEs
The government provides incentives for banks to
increase SME financing. If the banks follow the
government policy guidelines on SME lending, they
would receive positive consideration and support in
terms of getting approval on opening more branches
Despite the government policies to support SMEs, they
still face difficulties in accessing finance. Most SMEs
turn to informal lending outside the banking system
(most SMEs still rely on black market lending)
2. Bank credit policies x Even though most banks view that the
intellectual
property (IP) assets such as patents, copyright,
trademarks, trade secrets should play an increasing role

as lending criteria for innovative businesses, this is not
the case in practice. Almost all banks argue that the
lending decisions still depend on the collateral value and
the borrower’s credit worthiness
Foreign banks in China are constrained by the limit that
they can give out credit loans. Consequently, foreign
banks operating in China tend to focus on providing
financial services to serve their own customers doing
businesses in China (rather than serving the Chinese
businesses)
Due to the difficulties in valuing IP assets, they are not
the preferred collateral (loan security) for banks. The
valuation of these types of assets requires IP valuation
experts to assess their actual economic value
3. Bank financing
programs to support
SMEs
x Banks assist SMEs to save on bank charges by waiving
fees or charges related to SME transactions. Banks also
help SME businesses in terms of lowering upfront fees,
commitment fees to reduce SME financing costs
Banks see that the policy from the central government
has greatly influenced their decisions in setting up the
SME Special Unit to provide SME financing, for
example, HuaXia Bank’s Dragon Boat Program to
provide small business financing
Banks are still conservative in providing loans or
credits to SMEs to maintain lower loan to deposit ratios
(75% loan to deposit ratio limit for all commercial banks
according to China’s Commercial Bank Law), for
example, China Citic Bank, one of the banks established
during China’ reform said that the bank could allow SME
loan losses by only 2-5%

(continued)
Table VIII.
Summary of
interview results on
the government
policies of bank
financing to support
SME development
in China
306
WJEMSD
11,4
about the high credit risks of SME financing which would result
in high incidents
of NPLs. Many banks have emphasized the importance of credit
risk management in
terms of laying the procedures to limit loan losses to 2-5
percent of the SME lending
portfolio. The banks stated that, they try to limit loan losses not
to exceed 2 percent of
the SME portfolio in the actual practice. Otherwise, they would
be under scrutiny over
their policies on SME lending/bank lending standards. The
banks also stated that the
introduction of the 12th Five-Year Plan seems problematic since
the government
expects that there should be no loan losses from SME lending.
Taking into account of VC financing, another important
mechanism to support

innovative SMEs, the VC industry in China is not well
developed and limited in scale
due to regulatory restrictions of fund-raising. The China
Venture Capital Association
was established in 2002 to promote government policies
conducive to the development
of VC industry. The Government-financed Venture Capital
Funds was established in
1993 in Guangdong, Jiangsu, Zhejiang and Shanghai together
with the formation of
University-backed Venture Capital Funds to provide university
incubating services
and encourage the process of technology commercialization. At
present, the VC
industry is dominated by international VC funds. The
international VCs have helped
build the high-tech industries of internet, networking as can be
seen from the successful
enterprises like Lenovo and Huawei Technologies.
Figure 4 presents comparative VC investments in China and
other countries
during 2006-2012. It has shown that China’s VC industry is not
fully developed. The
major obstacle to VC development in China is a lack of policies
to induce VC
investments, a lack of credibility and transparency in China’s
capital markets and
legal system. Moreover, the industry also suffers from a lack of
skilled professionals
Policies/strategies of
SME financing
Enabling
policies/

strategies Description
4. Policy aspects to support
innovation
x Although most banks implement the 12th Five-Year
Plan to support SMEs by setting up specific units to
increase the supply of SME financing, most of them do
not operate VC investment units to support high-tech
SMEs. At present, China’s VC industry is not fully
developed and still needs incentive programs to foster
the VC industry
Concerning credit lending, if the borrowers are
technology-based firms in Beijing’s Zhongguanchun
Science Park, they would get financial support from the
government in the form of fee refund.
China has the formal business angel market but its
business angel community is still small
The government has launched the national strategy to
promote Shanghai Free Trade Zone by providing tax
incentives to encourage investments and trade. In
promoting an innovative economy, the government also
gives tax breaks as an incentive to importers and
exporters in this zone
Note: x, category of policies/strategies as enabling
policies/strategies
Source: The author’s design (summarized from interview
results) Table VIII.
307
SMEs
innovation and
entrepreneurial

financing
with experiences in VC management. The government has
increasingly recognized such
difficulties and tried to improve regulatory policies so as to
support the growth of VC
investments in China. For example, at present, China’s Ministry
of Commerce has issued
regulations allowing foreign-invested VC firms to invest in
China. The Ministry of
Finance has also eased the regulations regarding the capital
requirements of
international VC firms – lowering the capital requirement by
USD10 million as well as
easing stringent regulations of foreign VC structure.
Nevertheless, the venture capitalists
still have difficulties in exiting their investments in the VC
market. Currently, the
development of VC industry in China is still at the initial
development stage. In
transitioning to an innovative economy, the country needs the
policy supports in terms of
VC financing, private equity funds, capital markets for
technology-based firms.
Most of the VC investments are in the sectors of internet, clean
technology, electronics
and optoelectronic equipment, telecom and value-added
services. The centers of VC
industry are Beijing, Shanghai, Chengdu and Shenzhen. In the
growing VC industry,
Zero2IPO Capital is the major VC corporation among others
(such as Accel Partners-
Beijing, Redpoint Ventures-China, Sequoia Capital-Beijing,

GSR Ventures-Beijing-China,
Eastern Bell Venture Capital, Walden International-Shanghai-
China, Warburg Pincus-
Beijing-China, VantagePoint Venture Partners-Beijing-China,
Vivo Ventures-Chengdu-
China) targeting investments in high-potential an high-growth
companies.
5. Conclusions
This paper explores the challenges of SMEs innovation and
entrepreneurial financing
in China. The empirical research is focused on the impacts of
the 12th Five-Year
National Economic and Social Development Plan, the main
policy function
after China joined the WTO, on SMEs development and
entrepreneurial activities.
The findings have shed light on the impacts of the 12th Five-
Year Plan over the bank
financing sector – its influence over the banks’ policy in terms
of increasing SME
lending. In adopting the 12th Five-Year Plan, the results of this
study have shown
that banks tend to focus only on SME financing (bank loans) but
not VC financing.
However, the extent of credit lending differs among banks
depending on each bank’s
credit policy.
0
5
10
15

20
25
30
35
40
2006 2007 2008 2009 2010 2011 2012
USA Europe Israel China India
Source: Dow Jones Venture Source 2013
Figure 4.
VC investments in
China compared to
other countries (units
in USD million)
308
WJEMSD
11,4
At present, the government has emphasized the aspect of
innovation strategy
according to President Xi Jinping statement on the Chinese
dream (focusing on
patriotism, innovation, inclusiveness, morality). However, the
VC policies, the financing

mechanism that can contribute to the build-up of national
innovative capacity, are still
weak. The study has shown that the Chinese economy is driven
by the government
intervention policies. The analysis also points out the challenge
of the Chinese
government in improving regulatory policies to support
innovative businesses. It is
argued that building national innovative capacity is highly
regarded as an important
factor to strengthen China’s position in the global competitive
landscape. Thus, the VC
financing should play an increasing role in supporting high-tech
and innovative SMEs
in the future since China’s VC industry is not yet fully
developed at present. For the
long term policy perspective to increase and sustain national
competitiveness, it is
necessary that the government policies should encourage the
private sector to provide
more VC and business angel investments to support high-tech
business start-ups and
SMEs. Arguably, effective financing mechanisms would
increasingly open up new
investment opportunities to support the rise of China in the
world economy.
The findings in this paper suggest important implications for
practice in that for
the developing countries with scarce resources and budgetary
constraints, it is the
government (not the private sector) that should play a major
role in encouraging the
provision of SME financing. However, the government
financing should not crowd out
private investments. The present study offers interesting avenue

for future research in
exploring the effectiveness of the government’s policies to
support SMEs’ growth.
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Corresponding author
Dr Jarunee Wonglimpiyarat can be contacted at:
[email protected]
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INTERNATIONAL JOURNAL OF BUSINESS, 14(4), 2009
International Comparison of Entrepreneurial
Sub-Cultures within Cultures: Effect of Territory
on Entrepreneurial Strategies for Fundraising
Katariina Rantanen
a
and Michel Bernasconi
b
a
Ph.D. Student, Swedish School of Economics and Business
Administration,
Helsinki, Finland
[email protected]
b
Professor, CERAM Business School, Sophia Antipolis, France
[email protected]
ABSTRACT
Two technological hotspots: Silicon Valley (USA), and Sophia
Antipolis (France) have
been assessed for differences in entrepreneurs’ fund raising
strategies. The study
analyzed different stages in the venture capitalist’s (VC)
investment decision process
from the entrepreneur’s perspective, not from the frequently
examined VC’s viewpoint.

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