As in other countries, China’s venture capital/private equity (VCPE) market involves both limited liability partners (LPs), who are the investors providing capital, and general partners (GPs), who are the fund managers investing capital into firms for equity stakes. China’s multi-trillion-dollar VCPE market is the second-largest market in the world for innovative and high-growth firms. How do the players in China’s VCPE market assess the relative costs and benefits of state capital investments? 

The data. Researchers first conducted an experiment in 2019 in collaboration with Zero2IPO, the leading VCPE industry service provider that matches capital investing LPs with profit-seeking GPs. The experiment sought to explore the preferences of GPs for different characteristics of LPs. Researchers first created hypothetical LP profiles that mimicked authentic LP profiles in Zero2IPO’s database. A total of 688 GPs then rated a subset of 20 LP profiles on a 1–10 scale across two dimensions: how interested would they be in establishing an investment relationship with the LPs, and the GPs’ own beliefs about the likelihood that the LP would be interested in entering an investment relationship with them. Based on GP profile ratings, researchers then estimated GP preferences for characteristics of potential LPs.

Researchers supplemented the experimental data with Zero2IPO’s database that provides administrative data on 6,308 GPs and 7,954 LPs to capture investment flows between GPs and LPs and measure firm performance. Next, they measured government ownership using business registration data from the National Enterprise Credit Information Publicity System. Researchers finally distributed a second round of surveys to 361 of the original surveyed GPs in 2021 to explore mechanisms behind firm preferences. 

VCPE limited partner investments by industry

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China’s government is the largest investor in the VCPE market. The government — represented by central, provincial, and local government agencies, as well as by state-owned enterprises — is the leading investor in China’s VCPE market, investing about six times more capital than privately-owned LPs. The government is a majority owner of about half of all LPs. Among LPs that have at least one government shareholder, the average government ownership share is 83%. Government-owned LPs tend to invest disproportionally more in government-owned GPs. The government is also a minority owner of about a third of GPs. Government-owned GPs tend to perform worse than privately-owned GPs on measures of fund performance like comprehensive return and internal rates of return. 

GPs generally prefer to avoid LPs with government ties. The survey experiment reveals that GPs generally dislike government LPs and are willing to give up nearly 70 million dollars in potential investments to avoid them. All else equal, GPs tend to prefer deep-pocketed LPs (those that have allocated at least roughly 140 million dollars to VCPE and those with at least roughly 140 million dollars in registered capital); LPs that are headquartered in Beijing; and LPs that are not focused on specific industries or stages of investment.  

Dislike of government capital varies across firm types and sectors. Researchers found that GPs displayed the largest dislike for LPs with ties to central government agencies, followed by provincial governments. However, GPs seem to be neutral (and if anything, positive) about working with local government-affiliated LPs, which, by means of regulatory approvals and tax benefits, are presumably important for the growth of early-stage firms. They also found a lower dislike for government-affiliated LPs among GPs working in sectors where the government plays a more dominant role, such as mining, construction, and real estate, relative to those in sectors with a smaller government role, such as cleantech and health. Privately-owned GPs (as opposed to government-owned GPs) appear to drive the general dislike for government-affiliated capital. Finally, dislike for government capital is especially pronounced among the best-performing private GPs.  

The pros and cons of state-linked investors

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Political interference, lack of professionalism drive dislike for government capital. The researchers used a qualitative survey to shed light on why GPs dislike government-affiliated capital. They find that GPs rank political interference in decision making as the main drawback of receiving capital from government LPs. GPs also cite extra exposure to policy uncertainty due to changing government objectives and the lack of professionalism as unattractive features of government LPs. While government LPs tend to have different risk appetites and shorter investment horizons due to political incentives, this did not seem to bother GPs. When analyzing the main advantages of receiving government capital, GPs cite the ability to obtain more favorable local government support as the most attractive feature of government-affiliated LPs.  

Risk of misallocation higher when state actors dominate. The researchers conclude that demand for government capital in China differs across different types of firms. The dislike of government capital, particularly among private, high-growth firms, highlights the potential for misallocation in parts of the VCPE industry where state actors dominate. In addition, the results suggest China’s government investors may not be able to attract the best firms to pursue their economic or societal goals.