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Weekly UpdatesThis paper examines the formation of the initial capital structure of Chinese start-up firms. Contrary to the predominant view of Chinese family business, this study found that family funding is not the major source of start-up capital under certain conditions. Employing two surveys conducted separately in Hong Kong and the mainland of the People's Republic of China, it was revealed that Chinese entrepreneurs seek initial funding from their family rather than from outsiders only if they expected lower transaction costs and lower levels of family interference in the business. The implications of the findings for entrepreneurship of ethnic Chinese communities in East Asia are discussed.
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The nature of the capital structure of start-up ventures is critical to the ultimate success of those ventures (Cassar, 2004). For example, it has been argued that both the level and the sources of start-up capital can play a critical role in the success of the firm (Cooper, Gimeno-Gascon, & Woo, 1994; Florin, 2005). The amount of capital has been widely examined, and it is generally acknowledged that its absence is one of the defining characteristics of such firms (Marlow & Patton, 2005), which helps to explain the liability of newness that impacts new firms so negatively (Aldrich, 1999). But the source of the capital also impacts the success of the venture (Cassar). This perspective about capital has been far less examined. While the source of capital has been recognized as having a significant role in the success of a venture, the topic of why entrepreneurs seek out different sources is yet to be examined in detail. This paper fills this gap by examining the source of start-up capital for businesses in ethnic Chinese communities in East Asia.
Entrepreneurs are recognized as often turning to informal investors for start-up capital (Mason, 2006). The informal investors can vary from business angels who invest in firms for themselves to capital provided by family members. In either case, these financiers are typically informal and not organized as a business for such funding operations. In particular, family members have been widely acknowledged as playing a critical role in entrepreneurial ventures (Steier, 2003). For example, it has been found investigating over 30 countries that capital from close family members--parents, siblings, uncles, and the like--account for 42% of informal capital as reported by the surveyed entrepreneurs (Bygrave, 2005). Friends and neighbors make up the next biggest group, contributing 29% of informal investment. Thus, among informal investors, the dominant group providing financing is family followed by friends.
Yet while there is support for the predominance of family and friends as the funding source for entrepreneurial ventures, these two groups are not necessarily equal in appeal to the entrepreneur. In analyzing such issues, it needs to be recognized that financing of entrepreneurial ventures are set in social settings and as such are influenced by a network of social relations (Hoang & Antoncic, 2003; Steier & Greenwood, 2000). Thus, rather than focusing on all entrepreneurs, it is more appropriate to limit an examination to a specific set of entrepreneurs that are set in common networks of social relations (Zimmer & Aldrich, 1987). It has been argued that the most dominant single entrepreneurial ethnic group in the world is the Chinese (Weidenbaum & Hughes, 1996). While the People' s Republic of China (PRC) is widely recognized as a growing economic power that is driven in large measure by entrepreneurial ventures (Timmons, 1999), the ethnic Chinese are also a dominant entrepreneur group around the world, driving the entrepreneurial vitality of nations such as Malaysia, Thailand, Indonesia, Vietnam, and even increasingly Japan (Ahlstrom, Young, Chan,& Bruton, 2004; Beech, 2002). Thus, in this manuscript, we will focus on ethnic Chinese.
It is widely believed that in the ethnic Chinese community, family is central to the funding of new ventures and their growth (e.g., Redding, 1996). For example, Ahlstrom et al. (2004, p. 273) wrote, "Overseas Chinese owners of large firms historically have funded their firms internally [from family and close associates] and this was true for the entrepreneurial firms in our sample." But there is some evidence that this is not always the case. For example, Zimmer and Aldrich (1987) found that 49% of Asian entrepreneurs in England used funding from friends, whereas only one-third of the Asians raised capital from their family. In another study focusing on Chinese-speaking entrepreneurs in Hong Kong and Shenzhen, Au and Kwan (2005), using the Bygrave (2005) data set, found that friends and neighbors (Hong Kong: 56.8%; Shenzhen: 68.9%) are approached more often than close family (Hong Kong: 30.5%; Shenzhen: 8.8%) to provide start-up capital. A new study in Hong Kong replicated this pattern in 2007 (friends and neighbors: 51.0%; close family: 34.9%) (Thomas et al., 2007). In a longitudinal study conducted in Singapore, Wong, Lee, and Ho (2006, figure 18), principally examining Chinese entrepreneurs, found that equity from investors other than the owner (about 25%) is a larger source of start-up funding than family members (about 15%). (1)
Thus, there seems to be a conflict between established belief on the role of family in Chinese entrepreneurial ventures and practice, which deserves attention. Employing a social-embeddedness perspective on entrepreneurship (Aldrich, 1999), this research will therefore explain and study the financing choices of ethnic Chinese start-up firms. It will explore why ethnic Chinese invest in family business and if that level of investment is as widespread as some believe. The contributions of this study include expanding empirically the social-embeddedness perspective into socio-psychological aspects of family ties (Karra, Tracey, & Philips, 2006; Mason, 2006) and reexamining the role of family in ethnic Chinese entrepreneurs amidst the changing environment (Yeung, 2006).
Chinese Family Values and Family Involvement in Business
Ethnic Chinese both inside and outside of China often face a scarcity of resources, which forces peasants to rely on the family for protection and fulfilling various needs (Fukuyama, 1995). Confucian culture reinforces the focus on the family with the perspective that family was the central operating unit of society (Tu, 1984). As part of this, there was the strong emphasis on family relationships with that between father and son as pivotal due to the moral obligation of filial piety.
An ideal family for the Chinese is an entity in harmony (K.S. Yang, 1998a). Personal discontent and conflict among members are worked out according to an elaborate code of Confucian ethics built around patriarchal principles. Individuals are attuned to these codes and subsume their will under paternal authority. As a result, dissents may be concealed for the sake of harmony. Harmony is a feature that is more emphasized in Chinese societies than in other cultures. Indeed, it is a unique factor in, say, Chinese personality (Cheung et al., 1996, 2001) and Chinese organizational citizenship behavior (Farh, Earley, & Lin, 1997). Nevertheless, Chinese families are not always free of conflict. The family may be fraught with fault lines of inherent tensions (Lee & Mjelde-Mossey, 2004) such as rivalry between brothers and differences between the elder and the younger generations regarding obedience and autonomy (Fukuyama, 1995; Redding, 1990).
A long history of social influence results in "a set of values and their associated attitudes, beliefs, and behavioral norms that are family dominated in the sense that people holding these values adopt family as the basic social unit ..." (C.-F. Yang, 1988, p. 97). This proclivity is called familism value (Hsu, 1971; Triandis, 1995). People holding strong familism value give preference to family membership in terms of support, sacrifice, loyalty, reciprocity, closeness, and respect (Freeberg & Stein, 1996). They also believe that the family looks after the interest of members, and each member, in turn, has to make sacrifices for the collective good (Wong, Maher, Evans, & Nicholson, 1998).
Familism value has been argued as the engine of development for several Chinese societies because it helps to explain why Chinese families participate heavily in startups and family businesses (Lau, 1978; Schlevogt, 2002; Whyte, 1996; Wong, 1988). The family helps its members, including loyal employees, to branch out to form new businesses, as social-embeddedness perspective would predict (Aldrich & Cliff, 2003). Capital, goodwill, and referral are given to assist new business start-ups so that the family can be kept intact while expansion can occur. Hence, it is common for family to contribute start-up capital for members and invest in each other's business (e.g., Redding, 1996). However, while it may be common, that does not mean that it is the preferred source of capital of Chinese entrepreneurs. This next section will examine specific factors that may impact or affect the choice of initial sources of capital of a start-up firm.
Hypothesis Development
Family members do not invest out of complete altruism (Karra et al., 2006; Steier, 2003); rather, they expect a return on investments in family businesses just as they would in other investments (Bygrave, 2005). However, these returns in family business may not be all measured in terms of financial returns. The specific effects that may impact the flow of capital that we will examine include the ability of family to better monitor investments in family business and interference of family in business.
Monitoring of Chinese Family Business
Bankers and other outsiders assess default risk and financial return in deciding the amount of money they would supply to entrepreneurs. Due to difficulty in information access and monitoring, they often underestimate the value of the new business and find lending to start-ups risky (Amit, Glosten, & Muller, 1990). Therefore, bankers elevate the interest rate to compensate, apart from other hazards, for higher transaction costs, while other outsiders may choose simply not to supply capital to new firms (Berger & Udell, 2003). In comparison, family can better access information and monitor family members so that they can reduce transaction costs in businesses involving family members (Pollak, 1985). Thus, family can decrease opportunistic behaviors due to the interpersonal cohesion in family (Karra et al., 2006; Steier, 2003).
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