Why Government Venture Capital Is Moving Toward Fund-of-Funds
Government venture capital is not simply a government version of private venture capital. It is a policy system that connects public mandates, public development banks, private fund managers, institutional investors, and the start-ups or scale-ups those investors finance. The question this series examines is why that system is increasingly using private funds and fund-of-funds structures—and what changes when the state acts less like the sole investor and more like an intermediary. Understanding that shift lets readers judge when indirect investment can create useful leverage, when direct investment remains necessary, and which outcomes would show that public capital is genuinely additional rather than merely relabelled.
Government VC is a system, not a standalone fund
Venture capital matters because some young firms are poor candidates for ordinary bank lending even when their eventual economic value could be high. An innovative start-up may have little collateral, a short operating history, uncertain revenue, and assets that are mostly intellectual or technological. A lender that must be repaid on a fixed schedule cannot easily absorb that combination of risk and delay. Venture capital provides equity instead: investors share in the upside if the company grows, but they also bear the possibility of losing their investment. They may add managerial guidance, industry contacts, and strategic help alongside the money.
That private-market role does not by itself explain government participation. The public case arises when the private market systematically avoids or undersupplies opportunities whose social value, development time, location, or information profile does not fit private investors' incentives. Information asymmetry can make it hard to value an intangible business. Due diligence can be expensive relative to a small investment. Investors may prefer firms near established technology and financial centres, leaving other regions without the networks that make venture capital work. They may also favour faster-growing sectors and shorter routes to exit over deep-tech or climate technologies that need years of development.
Government VC therefore has several possible jobs. It can supply capital where a funding gap is acute. It can help build a market by signalling that a country, region, or technology is investable. It can stabilise financing when a downturn causes private investors to conserve cash. Or it can steer investment toward a strategic or underserved objective. Those jobs overlap, but they are not identical. A vehicle designed to attract pension funds into venture capital is solving a different problem from a vehicle designed to finance the first commercialisation round of a laboratory technology.
That distinction changes how the policy should be judged. If the objective is market-building, the relevant question may be whether other investors gain enough confidence and experience to participate. If the objective is access, a larger fund is not sufficient unless its managers reach firms that would otherwise be missed. If the objective is financial return, the public vehicle must still account for the time horizon and risk it has accepted. And if the objective is strategic capacity, a programme may deliberately support a technology whose development cycle is too long for ordinary VC. Calling all of these outcomes “leverage” can hide the choice the government has actually made.
The institutional actors matter because the policy is implemented through them. Public development banks and investment agencies increasingly carry government VC programmes, sometimes through subsidiaries that separate equity investing from lending. The OECD identifies examples including KfW Capital in Germany, the British Business Bank and its subsidiaries in the United Kingdom, Bpifrance in France, EIFO in Denmark, and BDC Capital in Canada. Other countries use state-owned investment companies or combine an indirect public investor with a separate vehicle that invests directly in start-ups. The visible fund is only one part of the design; the mandate, governance, investment team, and relationship with private managers determine what the public intervention can actually do.
This map makes the central relationship visible. Public capital may enter a fund or fund-of-funds, which then works with private investors and managers before capital reaches companies. The expected result is not only a financial return. It may also be a deeper investor base, better access to growth finance, or more capacity in a region or strategic sector. Each extra objective creates a measurement problem: a programme can attract private money and still fail to reach the firms the public intervention was meant to help.
Why the shift is appearing now
The policy question has become more consequential because venture capital grew rapidly and then became much more volatile. The OECD reports that USD 31 billion was invested across about 3,500 start-ups in 2006, compared with USD 336 billion across 26,800 start-ups in 2020. In 2021, investment reached USD 669 billion across 30,500 start-ups. Low interest rates, abundant liquidity, institutional-investor participation, and rising demand from firms built around intangible assets all helped drive that expansion.
The boom did not establish a stable new normal. Global VC investment declined by 19% in 2022 and 34% in 2023, according to the OECD's account, as inflation and higher interest rates redirected money toward fixed-return assets and reduced liquidity. Valuations and exits weakened. Investment edged up in 2024, but mainly late in the year and with a major contribution from artificial-intelligence deals; early 2025 brought further volatility. For an innovative SME, this matters because a funding round is not an isolated purchase. A company that cannot secure its next round may have to slow research, abandon a market, or relocate before its technology has had time to mature.
The aggregate figures also do not mean that capital is evenly available. Venture investment tends to cluster around sectors, stages, and places where investors already have information, networks, and a record of exits. A market can therefore be large in total and still leave a particular region or technology with too few relevant investors. This is one reason a government may pursue both scale and selectivity: it wants to enlarge the pool of capital without allowing the pool to become a larger version of the same concentration problem.
Volatility changes the public role in two directions. During an expansion, governments may want to make sure that private capital reaches a wider set of firms, regions, and technologies rather than simply amplifying the most fashionable deals. During a contraction, they may want to prevent the financing network from disappearing just as promising firms need follow-on capital. Public participation can be catalytic or countercyclical, but neither function is automatic. A public investor that merely follows private enthusiasm may add little during a boom, while one that keeps funding weak projects without disciplined selection may not stabilise the market in a useful way.
This is the setting in which indirect investment has gained prominence. Governments have increasingly committed money to private VC funds or fund-of-funds, alongside support for scale-ups and efforts to bring institutional, retail, and family-office investors into the asset class. The apparent change is therefore not simply a matter of choosing one legal wrapper over another. It is a response to the scale and complexity of the market: public actors are trying to access private investment expertise, pool commitments, spread exposure, and bring more investors into a sector that many institutions find difficult to evaluate on their own.
What fund-of-funds changes—and what it does not
Direct investment puts the public institution close to the portfolio company. It can select a start-up, negotiate terms, monitor progress, and provide support itself. A fund-of-funds works one level up: it commits to private funds or managers, and those managers select and support companies. That distance can be an advantage when the public institution wants diversification and access to specialised private judgment. It can also be a disadvantage when the public mandate requires close knowledge of a local market, a very early technology, or a policy population that mainstream managers overlook.
The attraction of the indirect model is best understood as three possible forms of leverage. First is capital leverage: a public commitment can help a fund reach a scale at which pension funds or other institutions are willing to participate. Second is expertise leverage: private managers may have more specialised experience in sourcing, evaluating, and supporting companies than a public agency can build quickly. Third is confidence leverage: a public development bank can signal that a market is credible, coordinate due diligence, and give new investors experience with an unfamiliar asset class. These are mechanisms to be tested, not guaranteed outcomes.
The distance between the public institution and the company also changes accountability. A direct investor can observe a portfolio firm closely, but it may lack the breadth or specialist knowledge to build a diversified portfolio. An indirect investor can spread commitments across managers and companies, yet it must judge the managers' incentives, selection process, reporting, and actual reach. Public influence is therefore exercised through terms and governance rather than through every individual investment decision. If those terms reward only familiar sectors or managers, intermediation can reproduce the private market's blind spots while appearing to broaden participation.
The OECD's examples also show why the headline trend should not be mistaken for a universal replacement of direct investing. In France, Bpifrance's portfolio is described as roughly 45% direct investment and 55% fund-of-funds. In Canada, BDC Capital's assets under management were still 62% direct in 2025. The OECD links such differences to institutional context, including the structure of national pension systems and the availability of a public development bank. A government may need direct capacity when the private-manager market is too thin, when the mandate is highly specific, or when public knowledge and patient capital cannot be delegated without losing the purpose of the programme.
The important question, then, is not whether fund-of-funds is more modern than direct investment. It is what capability is missing and who is best placed to supply it. If the gap is a lack of scale, diversification, or institutional experience, intermediation may be powerful. If the gap is a neglected early-stage technology, a peripheral region, or a strategic capability with no established manager base, direct or mixed participation may be more credible. The next question is the foundation for that judgment: why do innovative SMEs remain difficult to finance, and what exactly is public venture capital meant to solve?