China’s ambitious tech funding model, reliant on direct government equity stakes in startups, is facing increased scrutiny following new State Council rules and an audit of robot vacuum maker Dreame Technology. Dreame’s vast expansion into various sectors, largely fueled by local government funds, highlights the ‘spray and pray’ approach that, while sometimes yielding champions, often leads to misallocation and fiscal waste. Beijing is now tightening oversight to address the risks associated with this decentralized investment strategy.
A whirlwind of events this month has put the brakes on the rapid influx of capital into China's tech startup scene. In a striking sequence, a Chinese city government demanded that companies disclose their financial ties to robot vacuum giant Dreame Technology, while Beijing's State Council simultaneously rolled out comprehensive regulations to tighten control over the nation’s 23 trillion yuan ($3.4 trillion) private fund industry.
These developments highlight the delicate balance Beijing attempts to strike in its quest to challenge U.S. tech supremacy. While the state pours enormous sums into fostering its technological ambitions, the system often lacks the necessary guardrails and market forces to prevent widespread misallocation of resources.
Dan Wang, China director at Eurasia Group, points out that Beijing is now curbing a co-investment model that local authorities have enthusiastically adopted to attract businesses. Local governments frequently engage in a 'race to outspend one another' in strategic sectors, leading to significant fiscal waste and increased credit risks for the central government. In recent years, Chinese local authorities have pivoted from land financing—a revenue source that largely collapsed after the early 2020s housing crisis—to equity finance, utilizing state capital and government guidance funds to acquire stakes in startups and generate fiscal income from capital gains.
Adding to the complexity, many U.S. funds with Wall Street ties have largely withdrawn from China due to geopolitical tensions, creating a vacuum that local yuan-denominated funds have rushed to fill. Wang notes that local officials often lack the expertise of professional investors, tending to commit heavily to a few promising ventures, thereby leaving public finances vulnerable when these bets fail.
What happened
Dreame became the world's leading robotic vacuum manufacturer by sales in the first quarter, according to IDC, rapidly expanding its presence in Europe and the U.S. However, the startup's ambitions extend far beyond household cleaning. Since its establishment in 2017, Dreame has reportedly spawned nearly a thousand affiliated businesses, venturing into diverse fields such as electric vehicles, smartphones, humanoid robots, bubble tea, and satellite networks. Founder Yu Hao famously declared in January that he was building an ecosystem poised to become 'the first $100 trillion company in human history.'
This expansive diversification has recently come under intense scrutiny. A city government in Jiangsu province, a key electronics manufacturing hub in China, instructed local companies to audit their exposure to Dreame-linked entities, scrutinizing investment amounts, fiscal outlays, and operational activities. Furthermore, Yu Hao's social media account on Weibo was suspended, silencing the outspoken founder's viral commentary.
Much of Dreame's rapid expansion was fueled by state capital. Its Sky Factory Venture Capital Fund manages 41.6 billion yuan in assets, with approximately 80% sourced from local government industry funds across cities like Suzhou and Xiamen. Nearly all of its 29 funds reportedly involve local state-owned capital and are distributed across more than 10 cities. Reflecting the complex layers of financing, China's asset management association recently called for greater disclosure when a fund allocates over 90% of its assets to a single underlying fund.
'Patient capital'
This intricate structure mirrors China's industrial strategy. Local authorities have been encouraged to deploy guidance funds as 'patient capital,' providing long-term backing to startups in uncertain technology fields to allow them time to mature. However, this model inevitably incentivizes companies to pursue funding by presenting themselves as aligned with government priorities, according to Tilly Zhang, an industrial policy analyst at Gavekal Dragonomics.
Unlike the U.S., which indirectly supports technology companies through procurement, grants, and tax breaks, Chinese governments at every level take direct equity stakes. This approach places public money at risk regarding valuation, exit strategies, and governance. It also intensifies pressure on companies to deliver, even in high-risk ventures, with much of the capital originating from state-linked funds drawn to tech for political expediency rather than deep technical knowledge or investing experience.
Zhang highlights that local governments are often 'not professional enough to distinguish between credible ones from opportunistic ones,' citing a 2021 case where a loss-making semiconductor project in Wuhan cost the government about 15 billion yuan. Research by Rhodium Group indicates that Chinese local governments established thousands of such funds over the past decade, frequently resulting in duplicated investments and wasted capital. By the end of 2025, China had established over 2,100 government guidance funds with target capital exceeding 11 trillion yuan.
Bob Chen, a Shanghai-based investor in a renminbi-denominated fund, likened the situation to 'Singapore has Temasek. In China, every level of government has its own Temasek,' referring to Singapore's sovereign wealth fund. The State Council's new guidelines directly target this model, mandating 'strict control over the establishment of new government investment funds' and prohibiting counties and districts from setting up new funds without higher-level government approval. Chen explains that these new rules centralize oversight to the city and provincial levels.
'Spray and pray' approach
Despite its inherent flaws, the state equity-investing model has also yielded significant successes, underpinning the rapid ascent of some of China's tech champions. Hefei province's early investments in EV manufacturer Nio and chipmaker CXMT, for instance, transformed the city into a prime example of successful government venture investing.
We describe China's innovation drive as 'enormous in scale but low in productivity' — a 'spray and pray' approach that produces enormous output but with a high failure rate.Yuen Yuen AngAlfred Chandler Chair Professor of Political Economy
Chen notes that smaller cities, having missed out on earlier waves in semiconductors and core AI, have been actively seeking the next major opportunity. 'They are eager to develop good companies but not in a position to win national-strategic hard-tech projects like chips,' he said. 'So they went looking in the consumer tech sub-theme. Dreame was handing them exactly what they wanted.' Yuen Yuen Ang, a professor of political economy at Johns Hopkins University, characterizes China's innovation drive as a 'spray and pray' approach—massive in scale but often low in productivity, generating vast output alongside a high failure rate, with success ultimately judged by the emergence of a few true champions.
The Dreame episode, Ang suggests, fits 'a recurring phase in a familiar policy cycle: mobilize toward a national priority, tolerate significant gaming of targets and waste, then course correct.' As Beijing tightens its regulatory grip, lower-tier governments are expected to feel the initial impact. Chen predicts that if equity investment is curtailed at the county level, 'there won't be many other levers left for local governments to drive investment.'
