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SMEs Need to Have More than Courage

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US-trained chemist Wang Xiaochuan's Sundia MediTech Company Ltd - a private, Shanghai-based clinical research firm - enjoys brisk business even during tough times, thanks to a continuous flow of contracts from renowned drugmakers, partly boosted by the recession-proof pharmaceutical sector.

What was started six years ago by a group of Chinese returnees who are medical practitioners - and was once considered ambitious, new and daring in China - is now a much sought-after business model.

Global drugmakers are known for outsourcing research for drug discoveries to contract research organizations. As a contract research organization, Sundia's services help drugmakers slash costs up to three-fold when compared to their peers in the United States, Wang claimed.

Stronger-than-expected growth of new clientele ensured Sundia's revenue to jump 50 percent this year alone, up from its annual average of 30 percent. Currently, Sundia employs 500 skilled workers, has low staff turnover, is debt-free, enjoys robust orders from its multinational clients and has a strong, professional management team from diverse backgrounds, Wang claimed.

Figuratively speaking, this success story from a small company is one in a hundred in China.

How much is enough?

To date, China has over 50 million small- and medium-sized enterprises (SMEs), which account for 80 percent of the country's jobs, 60 percent of gross domestic product (GDP) and half of the national tax revenue, according to the Ministry of Commerce.

One of the important factors for businesses' survival is the availability of a healthy cash flow. Yet for SMEs, maintaining a positive cash flow is often far from their reach.

Despite government measures to assist SMEs, the amount of funding and further tax reductions continue to nag officials.

Take for example the well-known 7 billion yuan (US$1.03 billion) Torch Project and InnoFund set up by the Ministry of Science and Technology to help technology-based SMEs develop and commercialize new technologies.

"The size of the fund is clearly too small for this huge country with millions of qualified technology-based SMEs," said Ge Dingkun, assistant professor of strategy and entrepreneurship at the China Europe International Business School (CEIBS).

He suggested a common practice among foreign private equity firms and venture capitalists. "The government could have funds for different technological fields, for different industries and for different development stages."

However, the key challenge is to ensure the effectiveness and efficiency of the usage of these funds by SMEs.

"I have locally developed technologies that are cheaper and can rival the quality of foreign companies, and I provide employment to China's best," said He Yuanping, chief financial officer at Beijing OriginWater Technology Co Ltd, a water treatment services SME listed on the Shenzhen Stock Exchange.

"Government support usually goes to State-owned enterprises, universities and research institutes. But who is really at the forefront of the economy?" he asked.

Beijing enacted a slew of expansionary fiscal and monetary policies last year to counter the impact of the global financial crisis, including generous tax reductions for SMEs, making it easier for them to get loans.

All these measures seem to have brought China through the impact of the global financial crisis as the country recorded GDP growth of 11.9 percent in the first quarter this year after 8.7 percent growth in 2009.

Hidden gems

While the majority of the SMEs are in the service sector, the downside is their difficulty in obtaining loans from banks.

Due to the nature of the service sector - that thrives on talent, innovation and being asset-light - SMEs in this important sector couldn't possibly show strong collateral, such as fixed assets, to banks.

"Being asset-light is good for efficiency but not good for loan approval," said Patrick Chovanec, associate professor of the International MBA program at Tsinghua University.

"Ironically, it's like punishing those who are innovative and efficient when a lot has been spoken about the need to improve the service sector," he added.

"The least efficient businesses usually get funding because of their heavy assets."

Many SMEs blame Chinese banks for acting like government agencies, pushing them to become more market-driven commercial entities.

But China Europe International's Ge thinks otherwise: Lending to SMEs poses much greater risk of loan defaults for banks. "The solution (is to) improve the lenders' knowledge, skills and ability to discover, assess, price and manage risk inherent in making loans to SMEs," he said.

Chovanec said partnering with foreign banks will help Chinese lenders improve their product range, develop local skills, improve credit ratings and become more commercially-driven.

On the flip side, SMEs' financing problems have a boom in investment opportunities for foreign private equity firms and venture capitalists.

These firms are trying to deploy as much money as possible in China because of the growth opportunities. And discovering businesses that have good growth potential is key in the private equity and venture capital businesses.

Major private equity firms such as Kohlberg Kravis Roberts & Co recently said it aims to raise US$800 million to invest in Chinese companies. Texas Pacific Group invested over US$30 million in ShangPharma Corporation, a Chinese pharmaceutical and biotechnology research and development outsourcing company.

In February, Carlyle Group partnered with one of China's largest conglomerates, Fosun Group, to form a yuan-denominated fund to invest in emerging Chinese companies.

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