In Depth: Venture Capital in China Flounders as State Takes Over (Part 2)

Venture capital (VC) in China is currently facing a significant crisis, primarily due to the overwhelming influence of government guidance funds (GGFs) that have altered traditional investment practices. This has prompted intervention by top policymakers [para. 1][para. 2]. China’s State Council, led by Premier Li Qiang, introduced guidelines on January 7, with 25 measures aimed at resolving persistent issues in GGFs, particularly regarding their objectives, management, fund evaluation, and investment performance. The guidelines also impose stricter controls on the creation of new funds, particularly by lower-tier authorities, and suggest better program coordination to prevent excessive competition among local governments [para. 2][para. 3].

The State Council has outlined strategic aims within these guidelines. GGFs are encouraged to act as patient capital, supporting technological innovation and constructing a modern industrial system. The intention is to attract more non-state capital, including involvement from insurance companies and the national social security fund. Additional measures within the guidelines focus on developing exit channels for investors, developing private equity (PE) secondary market funds, and promoting merger and acquisition funds [para. 4][para. 5].

Furthermore, improvements are proposed for the management of GGFs to be more professional and market-driven. This includes implementing a new system for assessing fund managers interested in professionalizing the management of GGFs. There is an emphasis on creating a favorable environment that encourages innovation and tolerates failure [para. 6].

Amid responses from the VC and PE sectors, there is a call for a major overhaul of the local GGFs approach, with an adjustment required by practitioners to adapt to the increasing role of state capital [para. 7][para. 8]. An idea proposed to tackle these challenges is the creation of a national-level parent fund to unify local GGFs and reduce systemic constraints. Such a parent fund would operate on a fund-of-funds model to allocate resources based on market principles, without regional restrictions, while local governments would have no influence over investment decisions [para. 10][para. 11][para. 13].

Veteran investor Fang Fenglei emphasizes the benefits of establishing a national-level fund-of-funds to improve capital allocation efficiency and overcome the limitations and redundancies of local GGFs. The lack of efficient channels for equity investments is viewed as a problem, despite China’s high savings rates [para. 14][para. 15].

Proposals for the national fund suggest options for management by either establishing an independent management organization or entrusting it to the National Council for Social Security Fund. Capitalization options envision raising 1 trillion yuan over five years, with contributions from treasury bonds, local special-purpose bonds, and various institutional investors like insurance and pension funds. The fund’s investment horizon should span at least ten years [para. 17][para. 18].

A consensus exists that while a national parent fund is beneficial in concept, it faces practical challenges in ensuring long-term stability and stakeholder coordination. The fund must operate transparently, ensuring the whitelist of high-quality managers maintains legitimacy and transparency [para. 23][para. 25].

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