Innovation, Finance and Funding in the National System of Innovation – Case Study of China

1. Innovation, Finance and Funding in the National System of Innovation– Case Study of China Jian Gao Tsinghua University, Beijing, China August 20, 2009

2. OUTLINE • Introduction • History and reform of China’s innovation financing system • The establishment and improvement of China’s innovation financing system • Financing sources for entrepreneurship enterprises • Innovation financing system’s achievements • Conclusions

3. Introduction • Definition of innovation financing system (IFS) • Innovation financing is the key part of a national innovation system • National innovation system can be restructured through financial resources allocations by different innovative ways, such as institutional innovation in financial services, infrastructures, education, and government’s governance. • This report focuses on the evolution process, construction and function of China’s financing system. Some recommendations were given on China’s financing system’s future development and what should government’s role be.

4. Introduction • Research background • Methodology & Framework • Framework • the antecedents of China’s IFS • weaknesses of the • pre-institutionalized system • the establishment and • improvement of China’s IFS • institutional evolution • NFS’s achievements • (organized by the four • financing sources) • structure of financing sources • for entrepreneurship enterprises • ( four financing sources • and their relationships ) • Conclusions • suggestions for government

5. History and reform of China’s NFS • Antecedents of China’s NFS • Financing sources • Government support in terms of technology program, innovation fund and finance input • Bank loan for technology innovation • Venture capital and capital market

6. History and reform of China’s NFS • Development of China’s venture capital system • Initiall objective: as a useful mechanism for linking scientific and technological capabilities and outputs with national and regional economic and social development. • Primary providers of support to new ventures • R&D institutes and universities: played the most important role at the start-up stage, providing both the original technology and seed capital for a venture (spin-off) • Banks: was available only at the expansion and later stages of a venture’s development, with local governments acting as guarantors • Technology zones : incubator functions, licensed the new ventures in order for them to qualify for preferential treatment under the Torch Program and other government policies, and to access funding from various sources

7. History and reform of China’s NFS • Weaknesses of the pre-institutionalized system • Over the 1980s and early 1990s, a large number of new ventures being funded in China even before an institutionalized venture capital system had emerged. • The system for funding and promoting new ventures as a means of pursuing broader national developmental objectives had reached its limits: • Not effective in pooling funds • Research institutes and universities, funded by the government, had limited financial resources for supporting new ventures. • Banks: increasing loans to inherently high-risk ventures was not yet politically acceptable or even commercially advisable

8. History and reform of China’s NFS • Weaknesses of the pre-institutionalized system • Over the 1980s and early 1990s, a large number of new ventures being funded in China even before an institutionalized venture capital system had emerged. • The system for funding and promoting new ventures as a means of pursuing broader national developmental objectives had reached its limits: • Not effective in pooling funds • Did not provide the legal, regulatory and other institutional support necessary to identify and channel available funds to new ventures effectively . • The China New Technology Venture Investment Corporation (formed in 1986), essentially, a central government agency with the mandate to support national technology venture policy objectives, rather than a profit-oriented enterprise.

9. History and reform of China’s NFS • Government attached importance to innovation financing • Decentralization of responsibility and authority of central government • Legitimized venture capital as well as private entrepreneurship Changes in government’s role • Local governments have played a much more direct role in the development of new ventures and supporting infrastructur • Created an institutional environment conducive to investment in new ventures.

10. History and reform of China’s NFS • Government attached importance to innovation financing • Government VC firms • Mainly controlled by local governments • UniversityVC firms • Began to emerge in 2000 • Weakness Emergence of new specialized actors • Foreign VC firms • 8 of the top 10 VC investors in China were foreign firms ) • Corporate VC firms • The majority of VC firms

11. The establishment and improvement of China’s NFS • Innovation financing system within the NIS • Main transitions of China’s innovation system • The transition of leading role in technological innovation from research institutes and universities to enterprises; • The transition by mainly using existing technology to improving and creating new technology; • The transition from encouraging technology transfer to technology innovation in and among enterprises, universities and research institutes.

12. The establishment and improvement of China’s IFS • Innovation financing system within the NIS • IFS triggers the acceleration of innovation: • R&D input increased dramatically in recent decades. China’s GERD was the third largest worldwide in 2006, after the United States and Japan. • Venture capital is an important factor in accelerating innovation. From 2002 to 2008, China’s VC industry expanded rapidly. From the chart below, we see capital raised by VC institutions increased from 1,298 million US$ in 2002 to 7,310.07 million US$ in 2008. The compound growth rate is 28%.

13. The establishment and improvement of China’s IFS • Innovation financing system within the NIS Capital Raised by VC Institutions between 2002 and 2008

14. The establishment and improvement of China’s IFS • Innovation financing system within the NIS Total investments in Chinese VC market between 2001 and 2008

15. The establishment and improvement of China’s IFS • Institutional evolution • Policymakers and political authorities changed their perception of venture financing from its being a type of government funding to its being a commercial activity necessary to support the commercialization of new technology. • There is a wave of founding involving government, corporate and foreign capital. • Chinese government has established high-tech zones, incubators and university science parks to accelerate innovation. • The government also revises the Patent Law in 2000 and 2008 especially for two purposes: encourage innovation and protect the intellectual achievements.

16. The establishment and improvement of China’s IFS • Institutional evolution • The innovation financing system that has emerged so far is highly complex in terms of the variety and number of organizational actors, as well the multiple dimensions on which these actors are linked (see the next figure) • This complexity is increased because all of the organizational and institutional elements are themselves changing in response to policy, technological and other developments.

17. The establishment and improvement of China’s IFS Actors and flows in China’s innovation financing system

18. Financing sources for entrepreneurship enterprises • Institutional evolution special fund from central government 2 incubators 1 four basic financing sources university Science Park 3 4 high-tech zone

19. Financing sources for entrepreneurship enterprises • Institutional evolution 1 special fund from central government • Policy guide fund , was established by China ministry of science and technology in May, 1999 • From year 1999 to 2005, the innovation fund accepted 30,623 applications and approved 7,962 projects. • Applicant qualifications for innovation fund are: • Independent business entity • Involving in high-tech R&D, production/services • R&D investment/sales > 5% • Technological personnel/total employees > 30% • Various ownership (Chinese equity 50% up) • Less than 500 employees

20. Financing sources for entrepreneurship enterprises • Institutional evolution 1 special fund from central government Innovation fund: filling the market gap

21. Financing sources for entrepreneurship enterprises • Institutional evolution 1 special fund from central government innovation fund projects 1999-2004

22. Financing sources for entrepreneurship enterprises • Institutional evolution 2 3 High-tech zones & Incubators • By 2000, the number of new ventures in these zones had exceeded 20,000 • These zones have generated benefits in two areas (Chen,2002)； • they have provided the structure in which local governments can express their creativity by adopting and improving the policies and activities related to these zones. • They have contributed significantly to the commercialization of China’s science and technology (S&T) outputs by non-government S&T firms, as well as by serving as an important base for training and education.

23. Financing sources for entrepreneurship enterprises • Institutional evolution innovation process supported by incubators

24. Innovation financing system’s achievements China’s innovation improvement from 1987 to 2005 under innovation financing system

25. Innovation financing system’s achievements Innovation fund • Of the total early-stage Companies supported by the fund, 31% are Start-up companies (<18 months), 60% are Companies with less than 100 people, 41% are Companies with less than 50 people. • There are 4946 projects funded during 1999-2003 and 17% of the projects hold IPR, which indicates the innovation fund promotes innovation. • The direct social welfare brought by the innovation fund is the employment increment. The data shows that 63 new jobs created by one project on average.

26. Innovation financing system’s achievements High-tech zones, Incubators and University Science Park • There are totally 53 high-tech zones, 41990 tenant enterprises with 5.212 million employees. The enterprises create 3441.56 billion revenue, 111.65 billion exports and 32.19 billion taxes. • different industries: Electronics and Information; New Materials; Optical, Mechanical and Electronic Integration; Biotechnology; New Energy; High Efficient and Energy Saving Technology; Environment Protection Technology. • R&D/Revenue ratio of the zones’ enterprises reached at 2.3%, account for one third of total national R&D expenditures. • There are 6222 Invention Patent Applications and 3962 of them are granted. The amount of invention patents granted account for 27.2% of the whole invention patents granted.

27. Innovation financing system’s achievements Venture capitals In 2007, there are 428 successful deals and the amount invested reached US$ 3.18 billion.

28. Innovation financing system’s achievements Venture capitals The venture capital investment are distributed in the whole country and the most three areas are Beijing, Shanghai and Shenzhen. VC-geographical distributions

29. Innovation financing system’s achievements Venture capitals VC exits by industry & case number in 2008 VC exits by options & case number in 2008

30. Conclusions • The four kinds of funding sources provide capital for a company in different stages: • Innovation fund, High-tech zones, Incubators and University Science Park enters in the earliest period-seed stage • Venture capitals invest company in the second period-start-up stage • Bank financing, is available only at the expansion and later stages of a venture’s development

31. Conclusions • Two factors suggest that the role of government in developing venture capital systems such as China’s will continue to be significant and extend beyond simply creating appropriate institutions. • First, the government has a strong paternalistic view of the economy, and assumes that it both should and is able to provide direct guidance to emerging actors • Second, the lingering role of the government as itself an economic actor is still strong, as evidenced by the still significant number of enterprises held by local government holding companies.

32. Conclusions • Two factors suggest that the role of government in developing venture capital systems such as China’s will continue to be significant and extend beyond simply creating appropriate institutions. • First, the government has a strong paternalistic view of the economy, and assumes that it both should and is able to provide direct guidance to emerging actors • Second, the lingering role of the government as itself an economic actor is still strong, as evidenced by the still significant number of enterprises held by local government holding companies.

33. Conclusions • The government still has much work to do in strengthening and clarifying the regulatory, legal and other elements of the institutional systems that have an important impact on the venture capital system. • Issuing relevant laws regulating venture capital firms • Carefully considering the types of policies for promoting venture capital and new ventures. • Increasing coordination among government bureaus and reducing dysfunctional competition between, for example, MOST and the State Planning Commission.

34. Thank you for your attention