Yes, you read that title correct. To promote ‘mass entrepreneurship and innovation’, the Shanghai government will compensate local investors for their financial losses. Investment firms can get a compensation of up to 60% of their losses due to investments in seed-stage technology-based enterprises, and a maximum of 30% of losses in early-stage startup investments. The compensation for each investment project cannot exceed RMB 3 million, and the annual compensation for each investment firm is capped at RMB 6 million. A policy to promote disruptive innovation or one that will disrupt innovation? Time will tell.

This investor safety net is created by the Shanghai Municipal Bureau of Finance, the Science and Technology Commission of Shanghai Municipality (STCSM), and the Shanghai Municipal Development and Reform Commission (SHDRC). The name of the policy is: ‘Interim Measures for Administration of Angel Investment Risk Compensation in Shanghai’. This bold policy is in place since the first of February 2016, and has been the talk of the town ever since.

The authorities of Shanghai are looking for ways to increase the global competitive position of the city. They intend to do this by creating a hub for innovation and by encouraging entrepreneurship. With this policy they hope to increase seed funding for early-stage startups. It is yet unclear if this safety net for investors will be effective. But the move itself will likely motivate more people to get involved in startups, since their risk profile will improve.

Compensation conditions

The investment has to be in a seed or early-stage startups which have been operating for less than three years. For seed-stage startups the yearly sales can not exceed 5 million RMB and they should employ fewer than 50 people. Early-stage startups with fewer than 200 people and assets less than 20 million RMB are also eligible. Compensation for losses is up to 60% for seed-stage and up to 30% for early-stage.

The maximum amount of compensation will be 3 million RMB. A single investment organization can not receive more than 6 million RMB in total compensation per year. Investors have to show documentation about their losses to get them approved by authorities before the loss will be compensated. The amount of compensation will be calculated based on the difference between the profit investors gained from the investment and the amount of capital that was used to fund the startup. The program is scheduled to run for the two years.

Criticism

Some of China’s netizens are not happy with the news of Shanghai’s risk compensation policy. They are afraid their tax money goes to investment firms because of this policy.

Also some professional investors criticize the policy. They think it is violating market principles and it is filled with loopholes. According to one private equity partner:

“VC investments are extremely risky and limited to only a very few people and institutions. The negative consequences of using public money to compensate investment losses will be unimaginable.”

The mayor of Shanghai, Yang Xiong, has vowed to upgrade supervision to address the concerns that the policy will have negative effects for the city and its taxpayers. “When carrying out the policy, we will improve our supervision, especially in preventing fraud. Our next step will focus on better verification, supervision and more openness, to make sure the policy will help startups and the development of angel investments.”

Similar ‘risk compensation’ policies have been implemented in China before. For instance in 2013 in Jiangsu. The government announced a ‘Provisional Measures for Guiding Angel Investment Funds’, which offered something similar as the Shanghai policy. But aside from this funds targeted at compensating investors for losses, the Chinese government has been been funding venture capital (VC) firms focused on small and medium-sized enterprises (SMEs) much longer and throughout the whole country. At Datenna we map these investments and have seen a steady increase in the amount of funding going into such VCs.

Chinese Governmental SME Venture Capital Funding (2010-2014) - Funding investments in innovative enterprises

Chinese Governmental SME Venture Capital Funding (2010-2014)

Besides funding, also other measures are being pursued to support startups. To increase the amount of knowledge workers the Shanghai Government announced a new policy in September 2015 that would make it easier to obtain the hukou (city residency) for tech entrepreneurs.

If we would have to make a policy suggestion to the Shanghai government to promote entrepreneurship and IT startups specifically, we would suggest having (licensed) incubators with unrestricted or less-restricted internet access. Especially in seed and early-stage startups you want to try ideas quickly. Because quickly means cheap. Wasting less time, money and effort. For this you need easy access to code-sharing platforms and being able to interact with existing global IT solutions to see if they are useful, can be improved, or if you are building something disruptively better.

Source: Science & Technology Commission of Shanghai Municipality

Featured Image: Safety Net/Chad