The flow of record-beating initial public offerings held by Chinese firms over the past two years would seem to suggest that there's cash aplenty for companies doing business here. But while local oil giant PetroChina has become the world's most valuable company in the world by capitalization, smaller companies active in China tell a different story.

Foreign small and medium-sized enterprises (SMEs) here have a difficult time securing bank loans both from local and foreign banks. Lenders are scared off by difficulties assessing the creditworthiness of SMEs in China, says Carl van der Elst, relationships manager at Rabobank Shanghai. The lack of a secondary market for machinery and real estate also makes it harder to sell reclaimed collateral, he adds.

Foreign SMEs typically bring equity into China in the shape of a shareholder loan. However, a bank loan from abroad cannot be converted into renminbi. "It's easier to use it to pay for fixed assets such as machinery purchased from abroad," says Hanna Boehme, Beijing chief representative of Landesbank Baden Wuttenburg, a German regional bank servicing a large SME client base in China.

The majority of companies prefer to support expansion of Chinese operations directly from Europe, says Enrico Perlo, chairman of the European Chamber's SME Working Group. "This is also due to the difficulties, or at least perception, of difficult access to credit in China."

Newly established companies in particular struggle to provide collateral or prove creditworthiness. "You need collateral, but have no land-use rights," says Boehme. Local renminbi loans are often secured by arranging a bank guarantee from the local representative offices of a foreign bank from the SME's home country. A bank guarantee has typically been preferred to a corporate guarantee. A foreign firm has to pay a fee for bank guarantee, but it can mean more favourable loan terms and interest rates. "It's more likely you'll get a discount rate [if you get a guarantee]," says Boehme.

Liberalisation a boon?

The WTO-induced liberalisation of China's banking market has given SMEs more choices to borrow renminbi from foreign banks, which were recently allowed to incorporate as domestic institutions and offer equivalent services in the country. A wider spread of branches makes locally incorporated foreign banks attractive to SMEs, whose businesses are often located away from the largest cities, says van der Elst. Other foreign banks, he explains, are able to attract SME business by leveraging their stakes in a local bank. Dutch-based ING, for example, refers SME clients to its local Chinese partner.

SMEs can also be a conduit to business with mother companies back in Europe for locally incorporated foreign banks. "The more services the [locally incorporated] foreign banks here can offer, the more interesting they become to SMEs," says the China head of a European bank with a large client base of small and medium-sized European companies. "The gap between locally incorporated and rep office banks has widened immensely … It becomes harder for representative offices to justify their existence."

SMEs are using other methods in-house to get better value out of limited resources. Newer concepts such as factoring - company sells the receivables on its books to banks at a discount - are coming on the market in China but remain expensive here, says Boehme. The professionalism of domestic banks licensed to offer such services can be "variable at best," she says.

Cash-flow management is made difficult in China, says Perlo, by an entrenched "pay-receivable" system that he calls "unique."

He explains: "Basically, it is based on the power that a company has with its suppliers and customers. Big companies like raw material providers will sell only on the condition of 100 percent pre-payment and offer you alternative conditions only if you put in a big order, which is normally not possible for an SME. At the other end, your big customers, especially state-owned companies, often pay with bank drafts after six months."

Bank drafts are difficult to change or transfer as payment to suppliers unless they're from one of China's four major banks, he says, "so the big risk is that you cannot collect your money for six months, even though you paid for your raw materials three months before!"

Other resourceful companies see solutions in the rising power of the Chinese currency. Hedging against the dollar-renminbi exchange rate is an option for companies with large enough trade volumes who take a bet on the future fall of the dollar against the yuan. Some foreign banks set a minimum of US$1 million (€680,000) per transaction, says van der Elst, though he says it is possible to combine several transactions into one and hedge.

Cash can also be spared by leasing fixed assets rather than sinking registered capital into purchases of things like factory equipment. "Leasing doesn't affect the company's debt-equity ratio, and can also be tax-efficient," says Lu Qigan, the China head of Deutsche Leasing, a division of Deutsche Bank.

Lessees, he explains, can apply for "accelerated depreciation," under which leased equipment can be written down for tax deductions after three years rather than the five-year minimum allowed for purchased assets. Lessees are also attracted by a clause that allows them to purchase the equipment after four to five years "for a symbolic fee," says Lu.

Unlike banks, leasing companies don't seek collateral. "We own the legal title," says Lu. Privately owned Chinese SMEs in particular, he adds, are turning to leasing as a real alternative. In China, Deutsche Leasing focuses on road construction machinery, printing works, tool making and plastic moulding machines. The leasing industry is in its infancy here, accounting for only 3 percent of corporate fixed-asset transactions, compared to 30 percent penetration in Germany and 40 percent in the US.

That's perhaps because leasing companies shy from leasing real estate due to China's laws on property ownership. "You only get use rights, not full ownership," says Lu.

Grey areas in Chinese law make it difficult for leasing companies to offer other assets such as vehicles. Leasing motor vehicles is complicated by rules on motor registration: If an accident happens, the owner (the leasing company) is automatically at fault, whereas in EU countries a clause allows culpability in accidents fall to the user.

The VC option

For companies preferring not to shoulder bank interest payments, there's also venture capital, though European investors have been more hesitant than US counterparts about putting money into China. Whereas China is a "sold story" for US fund investors, their European counterparts have only gradually shifted their attention to the country's private equity opportunities, says Andre Loesekrug-Pietri, manager of China Equity Links (CEL). Losekrug-Pietri's firm targets European companies with at least US$44 million in annual sales, as well as Chinese firms clocking a minimum US$20 million in sales each year (and with plans to expand sales or operations in Europe).

Slower economic growth in mature economies due to tightening in the wake of the past summer's financial crises connected to the US mortgage market has, he believes, shifted European attention to China's attractions.

"High-growth levels are definitely the most promising markets for private equity these days," says Losekrug-Pietri. "The August crisis changed the traditional perception of 'mature economies equals quantifiable risk versus emerging markets equals unpredictable risks.'" CEL's funds are focused on industries where it has expertise: agribusiness, healthcare, energy and specialised retail and logistics. Companies benefit by not having to service loans and enjoy the expertise and international market knowledge a fund's advisors can bring new business.

Companies are also drawing down local private equity funds. Domestic yuan-denominated funds structured onshore enjoy government approval and "feed a growing appetite of domestic investors for the private equity asset class," says Loesekrug-Pietri. The long-term approach of private equity investors and an ability to "cushion the inevitable ups and downs" of business cycles make private equity attractive to companies, he adds.

Yet SMEs bring their own difficulties for funds. Increasing regulations, particularly in sensitive sectors such as IT and telecommunications, mean legal bills for companies structuring deals. "It may be seen to ultimately not be worth the while," says Frances Du, a partner at JL McGregor & Company, a research firm that monitors private equity deals in China.

Funds backed by European governments are increasingly accessible to China-based SMEs. Many active European funds in China are backed by government support in one way or another, particularly in industries linked to sustainable development, says Loesekrug-Pietri.

Germany's state-owned KFW bank has a US$510 million loan and private equity portfolio active in China, with maximum investments of US$7.3 million in individual companies. Its sister institution DEG has supported 13 German-owned and three Chinese-owned SMEs in China through private equity channelled through Chinese partner banks and through a pilot private equity fund for SMEs in Sichuan province.

Others see hope in increased political goodwill towards SMEs. Reform of China's accounting and credit reporting standards would make it easier for banks to assess credit, says Wang Jun, a senior financial sector specialist at the World Bank's Beijing offices. More competition between Chinese banks will mean more products tailored to SMEs, which he says are unfairly perceived by lenders as too risky.

"SMEs account for 16 percent of corporate bank loans in China but they account for 60 percent of China's GDP and its exports, as well as 70 percent of employment here."

European-based SMEs, meanwhile, can look forward to more guarantees and risk capital in a US$1.5 billion fund created by the European Commission. The EU's long-awaited Small Business Act, set for enactment in 2008, should cut red tape and improve cash aid for SMEs. An increasing percentage of EU structural funds, designed to aid member states, are being steered towards SME growth, with grants for innovation in particular available to smaller EU firms.

Information deficit

Knowing where to get cash and support could be as crucial to an SME's success as a loan or venture capital injection. "There are a lot of good programmes, but how do you find out about them?" says Boehme. "SMEs here, as well as at home, are expected to do everything at once. They can't afford to have someone on the computer scanning all this information full-time."

The EU has promised to open a centre in Beijing to help European SMEs through the red tape of setting up in China. The centre will be welcome, says Boehme. "Rather than being a source of information on useful products, commercial banks are often more focused on selling products. The generalist approach of the bank-SME relationship also means there's a lack of information coming through on alternative sources of finance."

On the whole, China is more "a large corporations' playground rather than an easy country for SMEs," as Loesekrug-Pietri puts it. Yet smaller firms seeking courage need only look to China's IPO winners. Some of China's most recognisable corporate names began life as SMEs. Alibaba, which began in a lowly Hangzhou apartment block, recently scored the world's second-largest ever IPO for an internet company, second only to Google. Not bad for a little guy.