Xi Jinping’s $920b VC push has a dark side

China’s industrial policy seems to have fans across the Pacific. The US’s $280 billion Chips and Science Act is a direct response from the Biden administration to Beijing’s spending to help key industries. But just as the likes of Intel Corp and Micron Technology Inc jostle for a slice of US government support, the perils of relying upon public money are sending shock waves through China’s chip industry.
In recent days, corruption investigations have engulfed top officials in a sector that is integral to President Xi Jinping’s “Made in China 2025” ambitions. At least three senior executives from a $20 billion state-owned private equity fund, set up in 2014 to invest mainly in chip manufacturing, were detained; so was Xiao Yaqing, the head of the agency in charge of the nation’s industrial policy and the most senior sitting cabinet official ensnared in a disciplinary probe in almost four years.
It’s intriguing that the anti-corruption agency is looking into a top venture capital fund that has yielded substantial results. Phase 1 of the National Integrated Circuit Industry Investment Fund raised billions from the Ministry of Finance and China Development Bank Capital. Between 2014 and 2019, the so-called Big Fund invested in 23 chip companies, churning out one national champion after another.
It backed Semiconductor Manufacturing International Corp, whose advanced chipmaking abilities may put it ahead of its US peers. It also seeded Tsinghua Unigroup Co subsidiary Yangtze Memory Technologies Co, China’s best bet in NAND flash memory manufacturing.
Does this mean the state-run venture capital model, which flourished during Xi’s reign, no longer works? Government-owned venture capital funds raised about 6.2 trillion yuan ($920 billion), almost all in the eight years through 2021. These funds have emerged as a key funding source for private companies, contributing about 10% of total capital raised last year.
The Big Fund and thousands of so-called government guidance funds are designed to mimic venture capital. The ultimate investors — for instance, the Ministry of Finance in the case of the Big Fund — are not involved in daily fund operations or investment decisions. And the funds themselves are largely passive stakeholders in the companies they seed.
The Big Fund’s involvement in the flash memory maker YMTC is a good example. It contributed 49% of the initial capital, much more than the 13% from parent Unigroup. But it didn’t control YMTC.
This model was intended to encourage best practices in corporate governance. After all, what do bureaucrats know about running companies? However, with government investment — and the prestige that comes with it — the portfolio companies can easily go haywire. That guidance fund’s prestige opens doors to loans but can lead to excessive borrowing.
Guidance funds are known for the use of their reputation as leverage. An initial contribution from the government — often seen as a stamp of approval — can attract many multiples of the sum from other investors, the thinking goes.

—Bloomberg