China’s tech development ambitions need more market-based venture-capital funding

In mainland China’s venture capital sector, two widely circulated documents are often discussed. New measures to promote “high-quality” development of the industry was released by the State Council on June 19, while the other document is based on a controversial speech of a Chinese venture-capital veteran who posed a question about the demise of the country’s primary investment market.

Beijing’s 17-article policy document outlines efforts to help venture capital on the mainland become “bigger and stronger, with funds being guided into key sectors through “market-oriented” means. All of these measures highlight the government’s “support” and “encouragement”.

Chinese authorities are taking the venture capital market seriously for good reason. By doubling down on a technology-driven development model, Beijing is trying to avoid the mistakes of the former Soviet Union, which blindly ignored the market in its pursuit of technological advances. China wants to foster the venture capital market for its role in helping finance promising start-ups.

In spite of the Chinese venture capital market’s vast size, one of the country’s most successful investors, CEC Capital founding partner and chief executive Wang Ran, has raised concerns about a disturbing trend in the sector. Over the past several years, so-called market money has retreated and been replaced by government money, according to Wang’s speech. That dramatic change means local governments have become the most powerful players in the market.

Over the past several years, Chinese local-government funding has replaced financing from private venture capital. Photo: Shutterstock

Unlike normal investors concerned about financial returns, local governments have put priority on attracting investment inflows into their regions, Wang said. Making it even more complicated is local governments’ risk-averse policy, which is contrary to the purpose of venture capital.

Wang’s speech became controversial amid many local governments’ belief that their role in the venture capital market was both necessary and desirable. They argued that local-government funding is more suitable as “the capital of patience” focused on growing “new quality productive forces”, compared to short-sighted, profit-thirsty private investors.

As a result, local government-controlled “mother funds” have mushroomed across the country. The government of eastern Jiangsu province, for example, set up a 50-billion-yuan (US$6.9 billion) mother fund over the weekend, which will be used in various specialised funds for local development projects.

Some local governments are already touting their exemplary “venture capital performance”. Southern tech hub Shenzhen’s Futian district, for example, said its guidance fund and various affiliated funds helped develop 122 unicorns, start-ups each valued at more than US$1 billion.

US government policy has made it harder for American venture capitalists to put money into Chinese technology start-ups. Photo: Shutterstock

The growth of such government funds happened at about the same time as the exit of market money such as US-dollar funds. While American investors helped build China’s most successful internet companies, they now find themselves quickly losing relevance in the country.

That has come about from the heightened tensions between Beijing and Washington, which has resulted in an economic divide. While Washington has made it harder for American venture capitalists to put money into Chinese tech start-ups, US funds now also find it more difficult to cash out owing to a diminished public-listing pipeline.

While there are instances of duplication, inefficiency and waste in government venture capital funds, their efforts to nurture the country’s “hard tech” boom cannot be ignored. Competition between local government funds is not necessarily a bad thing. A certain level of “overinvestment”, however, might be needed to flesh out the most promising domestic start-ups.

Still, the risks associated with the thinning ranks of private venture capital on the mainland cannot be overlooked. If local governments become the sole source of venture capital in China, this could mean a return to the kind of investments associated with planned economies. Ultimately, China needs to foster a vibrant market-based venture capital market to achieve its vision of greater innovation-driven technological and economic growth.

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