What should venture capital do when state-owned capital recedes?

In 1988, responding to the call of the national planned economic system, six state - level investment companies were established. Over more than 30 years of development, state - owned capital has evolved from being a general partner (GP) for direct investment to becoming a limited partner (LP), and then to setting up mother funds and sub - funds. Today, it has come to dominate the Chinese venture capital market.

However, from an economic perspective, this is not appropriate. According to a report by Economic Observer, Chen Wenhui, the former deputy director of the National Council for Social Security Fund, said in April 2025 that "it is not appropriate for government funds to dominate the venture capital fund market in the long run."

"We need to use equity investment funds as a converter to effectively inject government funds into the private economy and the science and technology innovation industry through market - oriented means, and give full play to the effectiveness and leverage of the funds."

Against the backdrop of the large - scale rise of state - owned capital, market - oriented investment institutions have been marginalized. They are struggling to survive under the "three mountains" of "difficulty in investment, difficulty in fundraising, and difficulty in exit."

Driven by the path dependence of concentrating resources to accomplish major tasks, state - owned capital investment has taken an intensive and large - scale path. However, this goes against the laws of the market economy.

Against this backdrop, when a founder of an investment institution was talking about this topic, he said: Maybe one day, the tide of state - owned capital will ebb.

"Only when state - owned mother funds continue to develop while sub - funds ebb can the venture capital industry truly become healthy," the founder further stated.

He believes that a large amount of state - owned capital entering the market has squeezed out many small and medium - sized private institutions, resulting in low innovation vitality in the market. It is more beneficial for the current equity market if state - owned capital shifts from being a "blood donor" to an "enabler" and from being an "athlete" back to being a "referee."

Excessive government funds and similar industrial logics have led to severe involution, resulting in phenomena such as redundant construction, overcapacity, and the withering of private capital: state - owned investment institutions → guiding funds → capacity - based investment promotion → overcapacity → a mess.

Private GPs Are Squeezed to the Margins

The ebb of state - owned capital is neither a conspiracy theory nor baseless worry. It is indeed inappropriate for government funds to dominate the venture capital fund market in the long run.

In July 2023, the founding partner of a leading VC institution admitted in an internal letter that "we are going through the most difficult time in our 20 - year career." This institution, with a management scale of over 30 billion yuan, was forced to suspend the fundraising of new funds due to the collective "cut - off" of social LPs.

This is not an isolated case. Data shows that in 2022, the number of newly raised funds in the Chinese equity investment market decreased by 18.5% year - on - year. Social capital is systematically withdrawing, while the proportion of state - owned capital contributions has risen to 75%.

Since 2014, against the backdrop of the state's encouragement of investment and the vigorous development of industries, municipal and district - level governments have attached importance to and recognized the important role of mother funds, and have accelerated the pace of preparing and setting up mother funds.

As the "source of water" for the equity investment industry, mother funds can empower sub - funds and enterprises. Their important role in promoting scientific and technological innovation and supporting the development of the real economy is being widely recognized.

But can this "source of water" cover all aspects? The answer is obviously no. At least more than 80% of non - leading, small and medium - sized institutions cannot access this source of water. Compared with market - oriented investment institutions, state - owned mother funds tend to favor local state - owned investment platforms and a few leading market - oriented institutions. Meanwhile, the compatibility of the discourse systems of state - owned GPs and state - owned LPs makes mother funds more inclined to state - owned GPs.

In the current market environment, state - owned GPs have unique advantages. Not only is it easier for them to succeed in fundraising with the backing, but they also have advantages in terms of resources, industrial policies, and project channels in terms of investment and empowerment. Therefore, many LPs prefer to cooperate with state - owned GPs.

Another well - known reason is that state - owned capital has an insurmountable red line - "no losses." Although the fault - tolerance rate of mother funds in many regions has increased recently, it has not become the mainstream.

"Private GPs have not performed well in recent years. They cannot meet the requirements of reinvestment, and their internal risk - control management capabilities are average. So, we prefer to cooperate with state - owned GPs. It's like an 'invisible threshold,'" an employee of an LP institution told The Capital.

For another example, currently, there is a wave of establishing bank AIC funds in the primary market. Data shows that the five major banks have now signed cooperation agreements covering 18 cities, with a total signing amount exceeding 350 billion yuan. This is a large amount of financial "living water." However, instead of contributing as limited partners to private equity funds, AICs have raised funds from other government investment funds and state - owned funds as direct investment fund managers. This has further increased the difficulty for ordinary private GPs to raise funds in the market.

Under these circumstances, it has become increasingly difficult for market - oriented investment institutions to raise funds. Market - oriented investment institutions are gradually being squeezed to the margins, with their living space being compressed.

Excessive government funds and similar industrial logics have also led to involution.

In the past decade, the logic of local investment promotion has been "competing in policies, subsidies, and land" - the place that offers more will attract the projects. As a result, there have emerged a group of "migratory bird - like" enterprises that go wherever the subsidies are high; local governments have been caught in "involutionary" competition, with malicious price - cutting and redundant construction; the market has been distorted, resources have been misallocated, and high - quality enterprises have been driven out by inferior ones.

Under the irrational involutionary competition, phenomena such as redundant construction, overcapacity, and the withering of private capital have emerged: state - owned investment institutions → guiding funds → capacity - based investment promotion → overcapacity → a mess.

Only When Unprofitable State - Owned Funds Ebb Can the Venture Capital Industry Develop Healthily

So, can state - owned GPs really make money?

The founder of the aforementioned institution answered, "Currently, various sub - fund management institutions with government attributes cannot make money, so they cannot last in the long run."

Sub - funds with government attributes face many restrictions in investment projects. First of all, there is a long approval process before investment. A previous investor complained to us that "an angel - round project has to go through 11 rounds of state - owned capital approval. By the time the process is completed, competitors have reached the B - round."

Investment, especially in the current trend of investing in early - stage and small - scale projects, requires quick, accurate, and decisive actions. Good opportunities are fleeting, but the constraints of the approval process can easily lead to missed opportunities, and missing opportunities naturally means no profit. In addition, a person in charge of a mother fund revealed that "state - owned capital can tolerate losses, but it cannot tolerate 'unintelligible' innovative models."

Delays in capital contribution due to slow internal processes and strict supervision in state - owned capital; non - contribution or even severe accountability in subsequent stages due to various reasons such as failure to meet reinvestment targets or non - compliance of projects are common.

In the past two years, mother funds have sprung up all over the country, with a large - scale investment. However, in recent years, the pace has significantly slowed down. In the first half of 2024, the total investment scale of Chinese mother funds was 294 billion yuan, a decrease of 20.6% and 47.4% compared with the first half and the second half of 2023 respectively.

The reason for the slowdown may be the difficulty in the exit of sub - funds.

One trend is that the slowdown of IPOs last year blocked the exit of a large number of sub - fund projects. State - owned capital was busy with audits, and for a large number of projects triggering the buy - back clause, appealing became the only way for GPs to account to LPs. According to a research report by the Shanghai Financial Court, from 2020 to the first half of 2023, there were 95 first - instance civil and commercial cases related to government - guided funds on the China Judgments Online. Among them, 38 cases (including equity transfer disputes, shareholder capital contribution disputes, etc.) were related to equity buy - back disputes, accounting for 82.11% of all cases. The main reason for the plaintiffs to sue was that the invested enterprises failed to repay loans as agreed or fulfill the equity buy - back obligation. In these cases, government - guided funds sued the invested enterprises or fund management companies as plaintiffs in 87 cases, accounting for 91.58% of all cases, and the government - guided funds won a large proportion of the cases.

In addition, an investor also revealed to us that it is an industry - wide chronic problem for investment managers to receive kickbacks through financial advisors. This gray area has existed since the industry's inception. It is urgent for state - owned institutions to establish a more complete prevention mechanism.

"Institutions that can really make money have no problem in fundraising. The root cause of the difficulty in fundraising is the failure to make money for LPs. The venture capital industry should retain institutions that can make money. It doesn't really matter whether they are state - owned or private," the founder of the institution said.

The relationship between LPs and GPs is always linked to financial interests. We cannot say that all state - owned investments can make money, nor can we say that all small and medium - sized market - oriented institutions cannot make money. If unprofitable state - owned sub - funds ebb and more funds are invested in market - oriented investment institutions with the ability to make money, the venture capital industry may achieve a healthier situation.

What Will the Market Be Like After the Ebb of State - Owned Capital?

What will the situation be like after the ebb of state - owned capital?

Data shows that state - owned capital and government investment funds are entrusted with the important task of being the "leading geese" because they have advantages such as capital intensity and technology intensity. Data indicates that by the end of 2023, a total of 2,086 government - guided funds had been established in China, with a target fundraising scale of about 12.19 trillion yuan.

For hard - technology investment, the return period is long, and the failure rate is extremely high. Moreover, most market - oriented investment institutions do not have the ability to participate in early - stage financing. State - owned capital is different. By supporting seed - stage and start - up technology enterprises, it can help break through key core technologies and improve the industrial chain layout.

If state - owned capital shrinks significantly, the current early - stage hard - technology investment may also decline sharply.

However, the ebb of state - owned capital is not a decline of the industry but an inevitable process of market structure optimization.

Facing the ebb of state - owned capital, market - oriented venture capital institutions need to be anchored in long - termism. They should build core competitiveness in the hard - technology track through four strategies: diversification of funds, specialization of investment, market - orientation of exit, and adaptation to regional policies. At the same time, they should closely follow the implementation of policy tools such as the National Venture Capital Guiding Fund and secondary (S) funds to achieve value leapfrogging in industrial upgrading and technological innovation.

The Chinese venture capital market needs to cultivate a healthier capital ecosystem: state - owned capital should transform into a "provider of institutions" (improving fault - tolerance rules and opening up scenarios) rather than just a provider of funds; at the same time, long - term capital such as insurance funds and pensions should be encouraged to enter the market to make up for the shortage of patient capital. Only in this way can a resilient pattern of "hard - technology investment remains active, and innovation never stops" be established between state - owned capital and the market.

The alarm of overcapacity has been sounded across the country. The overall industrial capacity utilization rate has dropped to 74%, the lowest since 2022. In the photovoltaic industry, the production line operation rate of component manufacturers is less than 60%, and the components in the warehouses are piled up to the ceiling, "enough to fill 50,000 containers."

Macroeconomic data confirm the plight of private enterprises. From January to May, the profits of industrial enterprises above the designated size decreased by 1.1%, and the proportion of private enterprise profits was only 16%. Private investment has been in negative growth for three consecutive quarters. In Wenzhou, a city in Zhejiang Province known for its active private capital, manufacturing investment decreased by 3.8% in the first half of the year, which is rare.

In response to this dilemma, policy adjustments have begun. In early August, the National Development and Reform Commission issued two draft solicitation documents: "Guidelines for the Layout Planning and Investment Direction of Government Investment Funds" and "Measures for Strengthening the Guidance, Evaluation, and Management of Government Investment Fund Investment Directions."

There is a more obvious signal: The Politburo meeting on July 30 for the first time proposed that "local government financing vehicles (LGFVs) should be completely cleared up." It is estimated that more than 5,000 LGFVs will complete the "exit from the platform" in 2025. The State - owned Assets Supervision and Administration Commission is promoting the integration of central enterprise resources to avoid redundant investment and homogeneous competition, and has put forward the four - character principle of "entry, exit, integration, and consolidation."

State - owned capital should shift from being a "blood donor" to an "enabler" and from being an "athlete" back to being a "referee." When funds no longer compete on reinvestment ratios, when investment promotion no longer relies on tax rebates, and when LGFVs truly become market players rather than government tools, the distorted production capacity and the withering private capital may finally see a real spring.

This article is from the WeChat official account “The Capital” (ID: thecapital). Author: Wang Tao, Editor: Wu Ren. It is published by 36Kr with authorization.