A Chinese start-up's unfolding dilemma exposes cracks in Beijing's tech funding machine

The rush of capital into China's tech start-up world hit a speed bump this month.

Within hours of each other last Friday, a Chinese city government ordered companies to disclose their financial ties to robot vacuum maker Dreame Technology, and China's State Council issued sweeping rules to tighten oversight of the country's 23 trillion yuan ($3.4 trillion) private fund industry.

The events, in quick succession, underscored Beijing's tough balancing act in trying to rival U.S. tech dominance. While the state pours in money to support China's tech ambitions, there are not always the guardrails and market forces to prevent widespread misallocation.

Beijing is reining in a co-investment model that local authorities have embraced in recent years to lure businesses into their regions, said Dan Wang, China director at Eurasia Group.

Local governments often "race to outspend one another" on strategic sectors, generating substantial fiscal waste and raising credit risks for the central government, Wang said.

Chinese local governments have sought to pivot from land financing — which has essentially collapsed since the housing crisis in the early 2020s — to equity finance, using state capital and government guidance funds to acquire stakes in startups and use capital gains as a new source of fiscal income.

Wall Street-linked U.S. funds that once invested in China have also largely pulled out in recent years due to geopolitical risk, leaving a gap for local Chinese yuan-denominated funds to fill.

Local officials cannot necessarily evaluate projects the way professional investors do, and tend to go all-in on one or a handful of hopefuls — leaving public finances exposed when bets sour, Wang added.