When a Fund-of-Funds Is the Right Government VC Instrument

Government venture capital is moving toward fund-of-funds structures because the public role in VC is changing from supplying every investment decision to building a market around private expertise, institutional participation, and strategic priorities. The shift is defensible when intermediation addresses a diagnosed gap in scale, diversification, information, or investor capability. It is not defensible merely because an indirect structure sounds efficient. The final judgment in this series is therefore conditional: fund-of-funds can be a powerful public instrument, but its value depends on the stage, the depth of the manager market, the mandate, the time horizon, and the evidence used to test additionality.

The shift is a redesign of government's role

The financing problem comes first. Innovative SMEs often have intangible assets, uncertain cash flows, limited histories, and development timelines that do not fit conventional debt. Venture capital can supply equity and non-financial support, but private VC is selective and concentrated. Information asymmetry, high transaction costs, mismatched time horizons, and geographic or demographic networks can leave valuable firms without a suitable investor. A large market total does not guarantee access at the stage, location, or sector where a particular company needs capital.

The market cycle makes that problem more urgent. Global VC investment rose from USD 31 billion across about 3,500 start-ups in 2006 to USD 336 billion across 26,800 start-ups in 2020, then reached USD 669 billion across 30,500 start-ups in 2021. It fell by 19% in 2022 and 34% in 2023 as higher interest rates reduced liquidity and investors became more cautious. A public VC system may consequently be asked to perform two different functions: catalyse participation when markets are expanding and preserve financing capacity when private investors pull back.

Fund-of-funds is a response to the scale and complexity of that system. A public development bank or agency can commit as an anchor, select or assess private managers, coordinate due diligence, and help pension funds or other institutions enter an asset class they may not be ready to evaluate directly. The private manager then selects companies and supports them. The public actor remains influential through the mandate, manager selection, commitment terms, and reporting, but delegates much of the company-level investment judgment.

That is why the shift is better described as intermediation than as privatisation. Public capital is being used to connect different capabilities: a public mandate and balance sheet, private selection expertise, institutional capital, and the needs of innovative companies. The intended leverage has several dimensions. It can increase the amount of capital available, broaden the pool of investors, give institutions confidence and experience, and direct attention toward a region or technology. None of those mechanisms guarantees a financial return or a public outcome. They are reasons to test the structure, not reasons to assume it works.

The OECD's examples show the mechanism without proving a universal result. Denmark's Danish Growth Capital III reached DKK 3 billion in assets in 2023 and invested in 12 VC funds; pension-fund contributions rose from 25% in its first cycle to 33% in the second. Finland's KRR programme invested nearly EUR 600 million between 2008 and 2023 to encourage pension-fund investment in scale-ups within a controlled-risk framework. These figures demonstrate mobilisation and institutional participation. They do not reveal how much private capital would have arrived without public backing or whether the resulting investments achieved the broader policy goals.

Diagnose the missing capability before choosing the channel

A government should begin with a diagnosis that is more precise than “the market needs more money.” There are at least five possible missing capabilities.

The first is scale. A growth-stage company may need a large coordinated round, while individual investors prefer smaller exposures. A fund-of-funds can commit across several private funds and help create a network capable of assembling larger tickets. The second is diversification. A public commitment can spread exposure across managers and companies instead of concentrating public risk in one direct portfolio. The third is private investment expertise. A public agency may want access to managers with specialised knowledge of a sector, stage, or geography rather than building every function internally.

The fourth is investor confidence. Pension funds, insurers, family offices, and foundations may have capital but lack the experience or due-diligence capacity to invest in VC directly. A managed, diversified structure can provide a bridge into the asset class. The fifth is strategic or social reach. Public capital may be intended for a region, founder group, or technology that private investors under-serve because of networks, expected returns, or time horizon.

These gaps point in different directions. The first four often make indirect investment plausible. The fifth may require conditions that are difficult to transmit through a private manager and may therefore require direct investment, co-investment, or a targeted structure with strong oversight. A government should not choose an intermediary first and then retrofit a justification.