After nearly a decade of deliberation, the growth enterprise market (GEM) on the mainland will soon be opened, providing a boon to the country's start-up companies.

Shang Fulin, Chairman of the China Securities Regulatory Committee (CSRC), vowed to push forward the debut of China's growth board to establish a multi-layer capital market.

The exciting news for growing enterprises was marked by the debut of the draft rules guiding GEM listing, published on March 24. The draft rules outline basic requirements for growth enterprises, allowing a more generous threshold for those companies that want to list.

The government expects the GEM to function like the U.S. NASDAQ, which has created many hi-tech miracles in its history. But how to turn goodwill into reality is a question for all.

SMEs applaud new channel

Currently, a large number of fast growing companies are thirsty for capital. The GEM has been greeted warmly by those with high growth potential.

Xing Ming, CEO of Tianya.com, said his company planned to launch IPO in the GEM in 2009, even though Tianya.com's profitability has met the criteria to be listed on the main board. It was one of the 13 companies invited by Shenzhen Securities Exchange to discuss the CSRC's GEM draft rules. "The pricing mechanism on the GEM is more flexible and this allows a higher price/earning ratio," said Xing, "We eventually came to the decision that we should be listed on the GEM."

Tianya.com was founded by Xing in 1999 and did not make a profit until 2005 when it received $5 million in venture capital, mostly from Legend Capital and Zero2ipo. The company's business has soared since then. As a fast-growing online community, Tianya.com's profits in 2007 were 18 million yuan ($2.56 million), nine times higher than its 2006 profit. Xing expected the website's profits this year could triple or quadruple that of 2007.

Xing said he is confident about the GEM function to finance growth enterprises. "Currently, venture capital and private equity investments in China are very vibrant, and the country is filled with capital liquidity," said Xing.

Traditionally, most of the small companies are funded by individuals who start the company. They will pitch investment proposals to venture capital firms or other investment agencies after their businesses are taking shape and starting to make money.

Yobo.com, set up in 2006, is a typical example showing how Chinese small companies are growing. Its director of technology Yu Tuo told Beijing Review that the company got angel investment (funding companies at an early stage), and later secured venture capital from several American companies. The company works to decode people's music DNA and provide music products according to individual needs. The company has no timetable yet to list, as "we have to make profits first," said Yu.

Timing is key

After the GEM draft rules were released in March, the market had a heated discussion on when the board would finally be put into practice. Clearly, the present bearish atmosphere on the mainland is not a good sign.

Zhou Yousu, professor with the Sichuan Provincial Academy of Social Sciences, suggested the GEM be postponed, as "the sluggish stock market is not ideal." From last October to the present, the benchmark Shanghai Composite Index lost almost half, resulting in the shrinking of investors' wealth. "The most urgent task is to rebuild investor confidence," said Zhou. Many new individual investors have lost a significant amount of wealth due to the market turmoil, and are reluctant to start trading again.

The GEM is expected to divert large sums of capital from the main board, which will knock out the already listless market. It is estimated that each of the GEM-listed companies will raise 100 million yuan ($14.2 million) to 200 billion yuan ($28.4 billion). "Though the volume is not devastating for the main board, the volatile capital in the main board market will flow to the GEM for speculative trade," said Zhou. Zhou contended the system and market supervision on the main board are not perfect yet. "If the government rushes to launch the GEM without considering the market capability, how to protect retail investors' interests will be a great challenge to the authorities," said Zhou.

The draft rules are a forerunner of the GEM, while the securities watchdog did not give a specific timetable for launching the market, only saying it could be "any time soon."

Risk control paramount

"The growth board is set to be an active market, producing numerous opportunities but risks as well," cautioned Wang Hanqi, a financial lawyer in Shanghai.

The NASDAQ is an extreme case of successful growth boards, while similar boards in some foreign markets have run into problems. Last year, NASDAQ became the largest U.S. exchange by handling 29 percent of all equity trades, up from 27 percent in 2006. The United States has a deep-rooted tradition of supporting small tech-related companies with high growth potential. The favorable environment in the United States also attracts many emerging Chinese companies like Sina Corp., Baidu.com Inc. and Focus Media, which picked NASDAQ for initial public offerings (IPOs).

Other boards, such as the Alternative Investment Market in London stock exchange and the GEM in Hong Kong stock exchange, were more lackluster. The later did not attract a single new company to launch IPO in the market last year and only six companies chose it for IPOs in 2006.

Can China be luckier than those mediocre GEMs? Wang had as many doubts as other experts. Wang said the mainland stock market was still immature compared with those in developed countries. Institutional investors are not strong enough and the individual investors are not experienced, who only wish to gain trade margins instead of focusing on the long-term development of a company. Without sufficient supervision, GEM might be another playground for the speculators, many fear.

Wang argued that the guarantee institution must play a vital role. "The companies listed on GEM have high operational risks compared with those listed on the main board," Wang said, "It poses a difficult task for guarantee institutions to discriminate the companies with real growth potential from the faked potential."

Key Elements in the Draft Rules for the GEM

-The company should operate for at least three consecutive years with a clear-cut core business.

-The company's two-year earnings should exceed 10 million yuan ($1.43 million).

-The company's most recent yearly revenue should exceed 30 million yuan ($4.26 million), growing no less than 30 percent from a year earlier.

-The company's core business should generate earnings no less than half of total revenue.

-The daily trading limit will be 20 percent.

October 2000: Shenzhen Securities Exchange stopped IPOs to prepare for GEM.

Early 2001: Cheng Siwei, then Vice Chairman of the Standing Committee of the National People's Congress, suggested postponing the GEM, drawing lessons from the dot-com crash of the U.S. NASDAQ and the omnipresent domestic listed companies' scandals. Later that year, high level officials decided to rectify the main board before introducing GEM.

2002: Cheng Siwei proposed a "three-step" approach to establish the GEM, suggesting that the government launch a small and medium-sized enterprise market (SME Market) before the GEM.

May 2004: CSRC approved the establishment of an SME Market in the Shenzhen Securities Exchange.

June 2004: Shenzhen market resumed IPOs-eight new companies were listed in SME Market.

June 2005: Marked the 50th company listed in SME Market, after which IPO was totally stopped in both Shanghai and Shenzhen markets, as the mainland would undergo a shareholding reform across the country.

June 2006: The two markets resumed IPOs, and China CAMC Engineering Co. Ltd. was the first one listed in SME Market after the shareholding reform. In late 2006, Shang Fulin, Chairman of CSRC stated the government would launch GEM at an appropriate time.

March 2008: The regulator issued the draft rules for GEM market, laying legal foundations for IPOs in the GEM Market.