Understanding China’s tech sector means knowing the biggest players in the venture capital space. They are not the big tech companies like Tencent or Alibaba, nor international consortiums backed by Softbank. They are onshore funds that raise money from the Chinese state.
For years, China has adopted the so-called “Temasek model” of managing state wealth—setting up state-backed investment firms to manage hundreds of billions of dollars like the Singaporean sovereign wealth fund.
But unlike Temasek, China uses these so-called “guidance funds” as an upgraded tool for economic planning. Acting as state-led VCs, they’re an alternative to providing large subsidies to state-owned enterprises, and an incentive luring private capital to flow into certain sectors that carry China’s push for technological self-sufficiency.
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Those funds, accounting for only 26.6% of total Chinese VC firms, managed more than 60% of the money in China’s private equity market in 2019, according to a June report (in Chinese) by the Chinese investment research firm Zero2ipo.
They raise money from China’s finance ministry, state-owned enterprises, and local governments’ fiscal reserves, but some local funds also raise private money as well.
Unlike Temasek, which issues detailed reports to the public about its portfolio value and returns to shareholders every quarter, Chinese state funds often operate mysteriously and are sometimes criticized (in Chinese) by local media for a “lack of transparency.”
The outside world has very limited access to state-backed funds’ investment activities. Local media and research institutes often find out what these funds have invested in only after their portfolio companies have gone public and disclosed their shareholding structures. Other information, such as their backers and management, can be gleaned from corporate registration databases maintained by market regulators.
We don’t know about the returns they yield and how they make investment decisions. Critics say state-backed funds usually make decisions following economic plans rather than market incentives.
A brief history of state-backed funds
Back in the Stone Age (aka the 1980s), state funds were the only players in China’s private equity market. The country’s first PE firm was set up in 1985 by the State Science and Technology Commission (succeeded in 1998 by the Ministry of Science and Technology) to “provide funds for the industrialization of technology achievements.”
- 1992: Boston-based International Data Group (IDG) becomes the first foreign VC firm to invest in China.
- 1998: The first state fund, China New Technology Venture Capital Co., is shut down by the central bank with debts of around RMB 6 billion. Local media said in 2004 the firm had never made any venture capital investments but rather operated a loan business.
- 2004: The Shenzhen Stock Exchange (SZSE) opens a board for small- and medium-sized enterprises, providing more exit channels for VC firms.
- 2005: The National Development and Reform Commission, China’s top macroeconomic planning body, issues a guideline to advise central and local governments in setting up “venture capital guidance funds” to help out small- to medium-sized tech firms.
- 2007: A new company law allows limited partnership, a popular partnership for VC firms to hold their investment in companies.
- 2009: The SZSE opens the Chinext startup board.
- 2015: Chinese Premier Li Keqiang announces a plan to set up national-level guidance funds to support innovation and industrial upgrading.
- 2015-2018: A series of guidance funds are set up by central and local governments, targeting sectors such as high-tech, manufacturing, and aviation.
According to the Zero2ipo report, by the end of 2019 China had around 14,000 private equity and venture capital firms, 26.6% of them state-backed. Together, those funds managed 60.5% of all the money raised in the market.
Many more private firms have entered the market recently, but in dollar terms it has hardly changed. In 2014, around 70% of newly founded Chinese VC firms were state-backed, altogether managing around 59% of new funds raised in the market.
The report attributed the increasing share of state-backed funds to the foundation of a series of “guidance funds” founded between 2015 and 2018. “Their size usually ranges from several billion RMB to several tens of billions RMB, sharply increasing the scale of capital managed by state-backed funds,” said the report.
China’s so-called guidance funds use state money to invest in companies in industries that the government considers strategically important. There is no official list of those strategically important industries, but “Made in China 2025,” a government-led industrial subsidies scheme (as well as a focus of the US-China trade war), has outlined some “prioritized sectors” that include semiconductors, new materials, and next-generation information technology.
Not all guidance funds are relevant to tech. Other major funds have missions such as supporting the country’s small- and medium-sized enterprises.
The chip fund: The China National Integrated Circuit Industry Investment Fund, dedicated to investing in semiconductor firms, is dubbed the “big fund.” It was set up in 2014 and raised RMB 138.7 billion from the Ministry of Finance and China Development Bank Capital, as well as several other state-backed enterprises.
The chip fund was set up to invest in semiconductor manufacturing and designing, and to promote mergers and acquisitions, according to China’s Ministry of Industry and Information Technology (MIIT), which supervises the fund. In October 2019, the fund closed another financing round, raising RMB 204 billion.
The internet fund: In 2015, the Cyberspace Administration of China, together with the Ministry of Finance and some state-owned enterprises, formed the China Internet Investment Fund. The fund focuses on investing in Internet-based services and promoting the development of “Internet innovation,” according to Xinhua. It raised RMB 30 billion in its first financing round and will have a total scale of RMB 100 billion. Portfolio companies of the fund include cloud computing company Kingsoft Cloud and voice recognition technology firm Unisound.
The manufacturing fund: In 2019, China’s finance ministry and several state-owned enterprises set up a RMB 147.2 billion National Manufacturing Transformation and Upgrading Fund. The fund will invest in companies working on areas including new materials, next-generation information technology, and electrical equipment, according to a filing by one of its investors.
The big funds’ biggest deals
- In October 2019, China State-owned Capital VC Fund led a RMB 1 billion Series A in Qianxun Spatial Intelligence, a company that uses China’s homegrown Beidou Navigation Satellite System for location and data analysis services.
- On May 13, the China Internet Investment Fund led a RMB 1.8 billion financing round in Cloudwalk, a facial recognition firm.
- In May, Chinese media reported that semiconductor maker Unisoc had raised RMB 5 billion from the China National Integrated Circuit Industry Investment Fund.
- On May 15, the chip fund injected more than $2 billion into domestic chip maker Semiconductor Manufacturing International Corp (SMIC).
- On June 1, the National Small and Medium-Sized Enterprise Development Fund participated in a RMB 180 million Series B in I-Kingtec, a Beijing-based commercial drone maker.
A vote of confidence
State-backed funds are seen by experts as a tool to execute economic plans while making a profit. But the idea is that they will “guide” private capital to strategic sectors rather than replace it.
Another report from Zero2ipo in January said the total scale of China guidance funds reached RMB 10 trillion and a total of 1,686 guidance funds have raised a combined RMB 4.7 trillion as of the end of 2019.
On top of making money for the state, these funds also aim to leverage China’s massive private capital to invest in sectors considered strategically important by the government.
State-backed funds targeting specific sectors are important because they are seen by the market as a vote of confidence, and thus help lure private capital to invest in those sectors, as Dong Dengxin, director of the Financial Securities Institute at the Wuhan University of Science and Technology, told TechNode in an interview last year.
Who are the decision-makers?
While the state-backed funds are born with political tasks, their decision-making processes are not market-oriented, according to a 2015 paper by Chen Zhihai, the general manager of Chengding Fund, a Shanghai-based venture capital firm backed by a state-owned enterprise.
State funds, especially those backed by local governments, are very cautious about their investments, said Guo Libo, research head of investment research and consulting firm Chinaventure, when he spoke to Chinese media outlet Caixin last year.
From 2015 to 2018, many state-backed funds preferred investing in pre-IPO companies because they wanted to avoid risks and pursue a quick return, said Guo.
In the paper, Chen wrote, the management of state-backed funds, especially investment decision-makers, was composed mostly of cadres allocated from central or local governments rather than professional investors selected from the market.
“[The cadres] may have done some research on the country’s macroeconomics or some specific industries, but in the long term, they won’t be able to put enough effort into the research of investments, sometimes resulting in inaction because they would rather avoid mistakes than make decisions,” wrote Chen.
Huge, but sluggish
State-backed funds have incubated some successful companies in key areas such as semiconductors and artificial intelligence. SMIC, a Shanghai-based contract chip maker backed by state money, has started to take over some chip production of Huawei’s chip designs from Taiwan Semiconductor Manufacturing Co. (TSMC) amid US sanctions. The Hong Kong-listed firm is expected to dual-list its share on Shanghai’s Nasdaq-style STAR board in July.
Despite the massive amount of cash injections, state investors, especially those backed by local governments, have sometimes failed to mobilize private capital into targeted sectors.
In October 2019, auditors of three provinces reported that their guidance funds yielded low returns and had not “sufficiently” mustered private capital, according to Chinese business newspaper 21 Caijing (in Chinese).
In central China’s Henan province, some 43 guidance funds were set up as of the end of 2018, with a planned target of raising RMB 38 billion from fiscal money and private investors. However, they only raised RMB 19 billion and fiscal money accounted for 92%, according to the report. In north China’s Hebei province, auditors said only 14.7% of RMB 6.3 billion raised by 13 guidance funds were used for investments by the end of 2018.
These setbacks are signs that while these state-backed funds have a huge share of the market, they hold big disadvantages in terms of inefficiency. Encumbered by their politicized nature and bureaucratic decision-making processes, their efficacy and results are still far from certain.