A BRIEF INTRODUCTION TO GROWTH ENTERPRISE MARKET OF HONG KONG:  WITH SPECIAL REFERENCE TO PARTICIPATION BY SMALL AND MEDIUM-SIZED BUSINESS IN CHINA

by

Albert P.K. Lau

Vice-chairman

Hong Kong Small and Medium Enterprises General Association

It is my great honour to attend ??The First West Lake International Conference on Small and Medium-sized Business.??  In early August 1999, Hong Kong Small and Medium Enterprises General Association played host to a study mission from Hangzhou, which had just completed a market study on Egypt, South Africa and Hong Kong.  Some delegates of the mission told me that their companies were interested in seeking listing on the Growth Enterprise Market (hereinafter referred to as the ??GEM??) or commonly known as the Second Board. In response to their intention, I am pleased to give you an introduction to the GEM and put forward the preparatory steps to be taken by the small and medium-sized business (hereinafter referred to as the ??SMB??) in China, which wants to cash in on this new stock market. 

A Brief Introduction to the GEM 

The objective of the GEM is to provide an SMB with an unrivalled opportunity for financing and venture incubation.  Unlike the Main Board, the GEM aims at growth companies without any impressive track record of business.  They cannot meet the basic requirements currently imposed on an applicant for listing on the Main Board:  a minimum market capitalization of HK$100 million and a minimum aggregate profit of HK$50 million over the last three years.  The hopefuls with growth potential are blessed with more lenient requirements to be enforced by the GEM. 

The following are the highlights of the listing and disclosure requirements to be met in the GEM (updated to 22 July 1999 and published by The Stock Exchange of Hong Kong):

The applicant must be incorporated in one of the four domiciles: China, Hong Kong, Bermuda and Cayman Islands;
The applicant is to specialize in a single line of business while the major shareholding is vested in the management; financial statements for at least two years are to be submitted but not necessarily in the black;
A sponsor is to be appointed by the applicant for documentation and compliance with listing regulations; the appointment is tenable for two more years after successful listing;
During the initial public offering, the public must have subscribed for a minimum float of HK$30 million or 25% of the total issued capital ( 20% is also acceptable provided that the percentage is to be raised to 25% in due course);  underwriting is not compulsory; the number of the public shareholders is not less than 100;
At the time of application and after successful listing, executive directors with high calibre and experience are to be appointed along with at least two independent non-executive directors; a qualified accountant is required to monitor financial matters; quarterly and half-yearly financial reports are to be published (not necessarily audited).
The applicant has to disclose its business objective for the subsequent two years after being listed and make comparisons with the actual performance. 

Listing on the GEM: Pros and Cons

By all means, the GEM gives the SMB a shot in the arm, in particular, the hi-tech growth company.  In addition to a source of financing and incubation, the company is also identified with a vigorous and emerging corporate image.  This intangible benefit accounts for the phenomenon that a few US mega-corporations, such as Microsoft, Yahoo and Intel, which have been initially listed on the NASDAQ (equivalent to the Second Board in the US) and should have been upgraded to the NYSE (equivalent to the Main Board in the US), still ??squat?? the NASDAQ so that they can retain a hi-tech and growth image.  After all, it is not that every company listed on the second board eventually reaches for the brass ring.  For example, the success rate for the NASDAQ is, on average, less than 2%. 

Currently, there are 10 million business entities classified as SMBs in China, or 99% of the total. They also account for 70% of the labour force at national level.  Although they make substantial contribution to the China??s economy, they are at their disadvantage for lack of capital funds.  At the end of 1998, the big four state-owned commercial banks advanced loans of RMB?D300 billion or 5% of the total to private businesses, mainly the SMBs.  As at the end of June, 1999, there are 901 stocks listed on Shanghai and Shenzhen Stock Exchanges and only 3% are privately owned.  As a matter of fact, the GEM in Hong Kong can play an important role in raising capital for SMBs from China.  However, it is estimated by a financier in Hong Kong that the total expenses for seeking listing on the GEM could cost to the tune of HK$5 million.  If a company can only raise the minimum public float of HK$30 million, the listing expenses, which eat considerably into the public float, are worth serious consideration. 

Hong Kong, located in the region of Greater China, is equipped with state-of-the-art transportation and telecommunications network.  Hong Kong also teems with top-notch financiers and other professionals.  If an SMB from China is successfully listed on the GEM, it gains access to the market update and other information exchange from over the world under a growth corporate image.  Concurrently, its corporate structure and accounting system are increasingly complying with the international standards. 

How Should SMBs Prepare Themselves ? 

For the SMBs with the intention to seek listing on the GEM, what preparatory steps should they take to achieve this end?  I propose the following:

Apart from securing the approval by the GEM, the applicant is required to be pre-screened by China Securities Regulatory Commission, in a similar fashion as to the H-shares currently listed on the Main Board.  The bottom line is that the applicant should adopt a financial and accounting system in accordance with that in force in Hong Kong so as to meet listing and disclosure requirements.  In this connection, I recommend that a qualified accountant from Hong Kong be commissioned as a consultant to audit and rectify a prospective applicant??s accounting system prior to the application procedure.

It is expected that twenty growth companies are to be approved for listing on the GEM in October 1999.  The first lot has to go through more rigorous requirements as a means to bestow the GEM a sound standing during its inception of operation.  After some time, the vetting procedure will be given more leeway provided that these listed companies are managed on the right track.  If a prospective applicant can wait and in the meantime improves its financial status as well as performance, the odds of successful listing are in its favour.

In the US, an emerging company, which merely has an idea but without any proven track record of business and a prototype, depends on start-up capital or seed money to kick off the R & D efforts and produce its prototype.  A growth SMB in the similar situation should look for venture capital as seed money to materialize its brainchild before making application to the GEM.  Until recently, the venture capital has not been available in China.  Shanghai is reportedly the first city in China to launch the venture capital up to RMB?D600 million.

The hi-tech industries, among others, include computer hardware and software, telecommunications and Internet-based business, such as E-commerce and website hosting.  These hi-tech industries are keenly competitive and highly risky.  To shun cut-throat competition, some so-called medium-tech industries are money-spinners if their products and services are value-added with innovative and multi-functional features.  The industries with promising prospects include Chinese herbal medicine, eco-friendly products and health food. The niche market for these industries, which is characterized by individual taste and small output for consumption, is easily tapped by an SMB.

As usual, an emerging company starts from some ideas without any operation.  What is the selling point for this company?  In the business circles, there is a saying: ?? No failure in business but management.?? Therefore, the academic qualifications, experience, entrepreneurship and successful track record of the management become the backbone of a start-up.  In addition, any patents, trade secrets and R & D results, which are crucially intangible assets of a growth company, can only be achieved by the capable management.  The SMB under the management of highly qualified entrepreneurs is likely to succeed in seeking listing on the GEM if it is also backed up by workable and not whimsical ideas.

To date, many hi-tech growth companies from China are stepping up their efforts to take advantage of the GEM in Hong Kong.  A case in point is Xian New and High Technology Industrial Park, which has commissioned a sponsor in Hong Kong to complete listing application for thirty companies stationed in the park.  The mission is to raise a total capital fund of US$200 million.  I sincerely hope that the SMBs from China will actively participate in this new stock market of Hong Kong.          

Bibliography:

Careers in High Tech. Nicholas Basta. NTC Publishing Group. 1997

Cases on Hong Kong??s Entrepreneurs. Chan Kwong Fai, etc. Joint Publishing (HK) Co., Ltd. 1999

Consultation Paper: On A Proposed New Market for Emerging Companies.

The Stock Exchange of Hong Kong. 1998         

Introducing the Growth Enterprise Market. The Stock Exchange of Hong Kong. 1999

Proceedings of the Symposium on Forum on Technical Innovation of SME.  

Organizing Committee of Beijing International High-tech Industries Week ??99. 1999