Huseynzade Farahim [1]

Annotasiya

İnnovasiyaların maliyyələşmə yolu qlobal səviyyədə daim dəyişikliyə uğramaqdadır. Vençur kapital sənayesinin inkişafı bir sıra yeni inoovativ ideyaların və bunun məntiqi nəticəsi olaraq da, yeni startap şirkətlərin yaranmasına gətirib çıxardı. Buna baxmayaraq, vençur kapital hər zaman investorlara risksiz başa gəlmir. Zəruri informasiyanın yalnız bir şəxsə məlum olması, eləcə də kapitalın lüzumsuz dərəcədə artıq xərclənməsi kimi maneələr investorlar üçün narahatlıq doğuran məsələlərdəndir. Çin Xalq Respublikası kimi bəzi ölkələr “kütləvi sahibkarlıq” modelini əsas konsepsiya kimi nümunə götürdüklərindən dolayı yeni innovasiyaların və startapların maliyyələşdirilməsi üçün dövlət tərəfindən subsidiyalaşmaya üstünlük verir. Çinin demək olar ki bütün ərazisində artmaqda olan tendensiyanın məntiqi nəticəsi olaraq yeni “Çin Silikon Vadiləri” yaranmaqdadır.Bu məqalədə innovasiyaların maliyyələşməsində vençur kapital və dövlət tərəfindən ayrılan vəsaitin hansı dərəcədə zəruri olması təhlil edilir və ən effektiv modelin yaradılması barədə təkliflər irəli sürülmüşdür.

Abstract

The pattern of innovation financing in all over the world is regularly fluctuating. The escalation of the venture capital industry has steered to the dawn of some innovative ideas and consequently, new start-up corporations founded. However, venture capital is not occurring without risks to the investors, always. Some obstacles such as holding information only by one person and heavy spending of capital are becoming one of the main concerns for investors. Since some countries like China takes the “mass entrepreneurship” as a main concept they give priority to the government subsidies to finance new innovations and start-ups. This tendency is going rise almost all parts of China and accordingly brand new “Chinese Silicon Valleys” are emerged. This article analyzes the volume of necessity of venture capital and government funding to finance innovative ideas and attempts to suggest solution to create the most effective model.

Keywords: Venture Capital, investment, government, start-ups, agency cost, information asymmetry, China

Since the innovations and start-ups give results to the growth of the economy of states, governments seek to nurture them. Despite there are many obstacles for young people about funding, day by day new ideas arise. Especially, the internet, artificial intelligence (AI), robotics and information technology (IT) sector still rules Venture Capital investment. Of course, the governments and private entrepreneurs have own interests for this ongoing trend.
Some critics think that economic growth only comes from entrepreneurs who are risking their own money for the market, there is no need for politicians in the marketplace who are risking people’s money. But some argue that the government is the only body ensure that services are safe fair and accessible every time. And in the startups regarding with housing, education and other social fields, the government can make them real or break. So, the development of many ideas highly depends on the government. For my understanding, since it warrants economic stability and full occupation of resources, economic development highly depends on key actor such as government. At this point, the difference between private and government funding shows itself in innovation as well.
Private enterprises generally do not undertake investments in social expenses. The main reason why they make an investment is to get material benefit from it and do it as soon as possible. It means that the satisfaction of social needs is not the main concern of them due to it takes a long time period to achieve. However, the government makes an investment for the reason that it aims to focus on social necessity, like to open workplaces, to enhance the life condition of population and etc. Its contribution to innovation is not financially rewarded. Surely, the financial benefits of government would be increases in tax outcomes after the creation of new companies upon start-ups grow based on which are time taking processes and bear reasonable risks for private companies.
Another issue is that the efficient allocation of limited resources through central planning can only be done by the State. The State is in a far better position to find the necessary resources through taxation borrowing and deficit-financing sources not open to private enterprise. So depending on risks and financial resources, private firms often capitalize on ideas after innovations have already become known and researched by the government. Naturally, the private investment is done when these ideas already turned into reality. To conclude abovementioned ones, no one can exactly predict that how much outcome can the society and state get from the innovations if they would be financed by the private firms in spite of government funds. And while talking about the government fund and its achievements we can show China, USA and some of the European states as a perfect model. Surely, there are external factors affect this issue, such as the stability of the country, financial resources, and willingness of the government to do that. So we can’t make a general conclusion for this specific matter for all cases.
The role of government is not limited to only to spend money for the innovations, however, it also covers the new incentives such as tax breaks, free interest loans, free rents, highly official and technical support. The government makes these incentives through two ways: either tax breaks while decreasing government incomes without spending or issuing grants raising spending without decreasing any direct income. Actually, those tax breaks, free rents, loans, as well as cut-price access to assets give many opportunities to the innovators even after the establishment of huge companies. And sometimes, the government itself makes some incentives to attract private investors or venture firms to support start-ups. One of the main examples for this is the announcement of the Ministry of Finance of China on benefit for venture capital firms. It stipulates that investors or investment firms that pick up a stake in a tech startup at an early stage and stay invested for two or more years would be subject for deduction 70 percent of startup investment from their taxable investment. This fact itself shows the interest of the government to encourage venture firms. Of course, the government is not interested to take all investment burden for itself, since it can cause exclusion of venture capital firms from market and disaster for the whole economy.
But for all occasions, we cannot avoid the self-interest from governmental agency or decision-maker intentionally and lack of his knowledge about investment and economic issues. Actually, the spending of money on innovation from government fund means usage from state budget which demands necessary attention to do that. Human factor like relations with political authorities should be considered as well. Moreover, the main concern is related to the lack of professionalism, evaluation of the market properly and bureaucratic obstacles. So the persons who have the right to make a decision may not understand current market economy, realize the future outcomes of a specific innovative idea and it may bring loss of lots of money from a government fund. 
 Another problem is funding innovations from the government sources, of course, can bring many risks with it. The private firms are less likely financing the innovations since its risks. They prefer to do this after the “early stage”. For a good idea, the government subsidies them, even it has huge risks about lack of performance as planned. Regardless, there are many critics about some failure of a government fund for some “unlucky” start-ups in China and USA (“Solyndra” case), in my opinion, failure is default mode which means expect to fail, at least. Funding innovation bears a risk always.
Furthermore, even some businesses face failure, we cannot say that they are totally failed. At least, the government gives a contribution by creating a real value for the community to create a job and the failure does not mean that the one will fail again in a future business environment. It is actually better to do that, in spite of picking “winners” from the community. To sum, even it can cause corporate governance problem, the aim of government is achieved, for my understanding. 
Secondly, another problem that may arise is related to “information asymmetry”. Generally, being the subject of the intellectual property right of innovators and entrepreneurs, investors usually cannot get access appropriate information for some start-ups. So, time by time, even the idea is very well, lack of deep understanding about exact innovation put investor at the disadvantageous situation.
At this point, I would mention one of the problematic issues about the real problem, which is “agency cost”. Generally, this problem arises when entrepreneurs or investment grantors are going to maximize their own and they sometimes don’t care about the investment they got from the government. The lack of timely intervention, attentive approach, and monitoring activities by investor and also generally understanding not obtaining the revenues of investment for a long time can cause failure of total investment finally. But, the investors can decrease this occurrence by including an analysis of the costs, revenues, expenditures timely and creating proper authoritative remedy to prevent this.
I would like to mention one initiative by Shanghai government which drew my attention most. According to the “Provisional Measures on Managing Shanghai Angel Investor Risk Compensation” the government gives 3 million RMB per unsuccessful investment. It compensates investment firms for losses incurred while investing in early stage funded tech startups. Ken Xu, a Partner at Gobi Ventures mentioned in his speech that, startups are characterized by their potential for explosive growth and the factors of uncertainty within them, there’s no simple guide to their success. In any case, China’s citizens are not happy with Shanghai’s “risk compensation” policy. They think that the taxes they pay will flow to the investment firms.
To solve the core problems of corporate governance and minimize the loss arising from the failure of innovations, the Spanish model can be studied. The establishment of a common fund by both private firms and government with very strict rules such as last years’ statistics of companies’ investments and transactions can be considered as a way. It will prevent bad spending or tech industry bubble, so the state money should flow to that fund with private investment firms. In general understanding, for minimizing Corporate Governance problem, before making the investment the decision-maker has to make analytical research for future outcomes and profits of the innovation. Moreover, the governmental bodies have to create the good legal infrastructure to strengthen legal remedies, especially for liability of managers and owners, non-compete agreements and their realization mechanisms, bankruptcy cases and liability of debtors upon the creditors and improve supervision on those matters.

1] Farahim Huseynzade, LLM in Chinese Law, at School of Law, Renmin University of China, Beijing, China; at School of Law , Renmin University of China, Beijing, China; The author is grateful to the Dean of Baku State Univerrsity Law school , Prof. Dr. Amir Aliyev and Academic Coordinator at Harvard University, SJD Prof. Rui GUO for suggestions on the work; Contact: farahim.huseynzade@outlook.com

 

References

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The articles on this blog are not, nor are they intended to be, legal advice. You should consult a lawyer for individual advice or assessment regarding your own situation.