Should governments run venture capital and private equity funds?
Private investors in government-owned venture capital have a positive impact, according to UNSW Business School’s Jo-Ann Suchard and Mark Humphery-Jenner
Governments around the world have been increasingly interested in boosting entrepreneurship to drive innovation, employment, and productivity. One manifestation of this trend has been government efforts to increase financing for start-ups. This has taken the form of government grants, tax subsidies or government involvement in venture capital (VC). Governments have invested in privately managed VCs and have also directly owned VCs, mainly in Europe.
In our recent paper, we analyse how government ownership impacts VC performance. We focus on the Chinese market: an increasingly important, yet underexplored, venture environment. The VC sector has become an important force in the country’s industrial transformation. China is the second-largest VC market globally, accounting for 30 per cent of worldwide VC activity.
Based on data from Tracxn, funding in the past 12 months in China was US$67.6 billion (A$91.9 billion) – about one quarter of VC funding globally. In terms of return, as of 2020, China is home to 227 unicorns, together with 233 in US, and account for 79 per cent of global unicorns, according to TradingPlatforms. Chris Pu, head of Greater China at Telstra Ventures, says the Chinese Government plays a key role in VC market such as guiding the industry policies, setting security regulations, and creating friendly environment for start-ups. For example, the government-guided funds are the important investors (i.e., limited partners) for local VC to raise capital and follow some of the guidance.
Unlike many other VC markets, the government has played a significant role through the ownership of VCs, accounting for approximately 20 per cent of the VCs in our study. VCs can be either wholly or partially owned by government, and this difference has implications for the companies they invest in.
Our results are particularly important in the light of China’s ambitious US$1.55 trillion government guidance fund program, which aims to channel capital into strategic industries through co-investing with private investors.
The purpose of the study
We look at whether government-owned VCs improve venture success, whether they respond differently to policy uncertainty, and whether the specific location of the government owner matters. We also look at whether the impact of government varies with the degree of involvement or ownership.
We hypothesise that government VCs could convey benefits, but also come with costs. The benefits could include government connections and policy expertise that can be especially important given the frequent policy changes in China. However, we also hypothesise that government VCs confer disadvantages: Government VCs might be less incentivised to improve start-ups’ performance as they are limited in their ability to attract and incentivise managers. Government VCs might also direct start-ups towards government priorities, which might not necessarily benefit the start-up. Thus, we expect some benefits from government ownership, but that these benefits will decrease with the extent of government involvement.
We find limited evidence that government ownership can help on average. But, this could depend on the specific value that the government VC purports to add. While partially government-owned VCs appear to improve start-up success rates, wholly government-owned VCs do not. Further, the success rate appears to decrease with the extent of government ownership. In part, this echoes a fear that government owners might be more interested in policy decisions than in the start-up’s business success.
Unsurprisingly, start-ups supported by government VCs are less badly impacted by policy uncertainty. This is because government VCs’ regulatory connections, or expertise, could help start-ups to understand and navigate rapidly changing government policies.
Our results also imply that government VCs’ benefits decrease if the government oversteps its role as an investor and starts directing companies towards uneconomic activities. This is particularly the case when the start-up is invested by VCs who are owned by governments located in the same province as the start-up. A local government VC could convey more directly relevant government connections, or institutional knowledge. However, government VCs might influence the company to undertake uneconomic activities that benefit that government, but do not benefit the start-up. This, in turn, harms any other outside investor, whose funds are then being misdirected. Such harmful results would damage the whole VC and entrepreneurship ecosystem.
A general policy implication of our research is that government can support start-ups through the venture capital sector. The government is best placed to do so by investing in private VCs, rather than by attempting to act as a VC itself.
The implication for countries such as Australia is relatively clear. Excess government ownership can be harmful. A wholly government owned and run VC could run the risk of merely implementing government policy which may harm start-ups by directing them towards uneconomic outcomes. Our results clearly imply as much: the benefits of government ownership of VCs decrease with the degree of government ownership, and government’s main benefits appear to arise during periods of economic and policy uncertainty.
Government should keep encouraging private capital to invest in start-ups. The Australian government currently does this through existing policies, such as the ESIC arrangements, R&D tax credits, and other incentives. The government has also established the ESVCLP structure, which helps to encourage investment in innovation. Such programs are vital to the VC sector, and more helpful than direct government investment. The government could also consider revisiting programs such as the shelved Innovation Investment Fund program, which provided capital to private sector VCs.
Jo-Ann Suchard and Mark Humphery-Jenner are Associate Professors in Banking and Finance at UNSW Business School. Jo-Ann has conducted pioneering research on the Australian and Chinese venture capital and private equity markets. Mark has been published in leading management journals and his research interests include corporate finance, venture capital and law.