Every industry in China in the same situation, the number of companies competing vastly exceeds the official figures provided by the government and the number of firms that one might expect to find in the same industry in a more developed economy. Estimates of the business population are all over the map, but Ted Fishman, author of China, Inc., once told me that there are over 85 million private companies in China. That means that every industry in China is extremely fragmented. The sheer number of companies that operate in any industry is one of the reasons why the China market is so competitive.

The venture capital and private equity industry in China is no exception. China had more than 10,000 venture capital and private equity firms at the end of 2011, according to Liu Jianjun, an official in the department of fiscal and financial affairs at the National Development and Reform Commission (NDRC). Those companies managed nearly 2 trillion yuan ($313.9 billion) in assets according to Liu.

Officially, however, the NDRC reported recently that there were 882 venture capital and private equity firms registered with the NDRC at the end of 2011, a 34.3 percent increase compared to 2010. The NDRC also reported that the value of assets managed by these 882 firms had increased by 41.5 percent to 220.7 billion yuan ($34.6 billion) at the end of last year. In other words, the number of officially registered venture capital and private equity firms in China, and the amounts that they manage, are most likely less than 10 percent of the actual business that is being done in this space today.

Whatever the numbers, the private equity business in China is already large and is growing rapidly. Size and rate of growth are not the problems. The biggest problem by far is that there is too much money chasing too few deals. Every major private equity firm around the world wants to invest more capital in China, while China’s strong economic growth means that more and more capital is being accumulated in the country. With China’s stock exchanges in Shenzhen and Shanghai still in an early stage of development, private equity and venture capital are natural outlets for the growing pools of capital that are springing up all over. A shortage of good deals, not a shortage of capital, is the key issue.

According to the Asian Venture Capital Journal, investment by Chinese firms rose to $7.8 billion in 2011, exceeding for the first time the $7.4 billion invested by U.S. and other foreign funds. Moreover, yuan-denominated private-equity funds have raised $41 billion in the past two years, more than double the U.S. dollar amount in China.

In the competition for deals, international firms like The Blackstone Group LP (NYSE:BX) that have active programs in China have an advantage due to their global networks and reputations. The local firms, however, can act faster and have more exits available to them in China. Both types of firms are disadvantaged by the fact that debt financing is hard to come by in China. Therefore, deals have to be financed with all equity, lowering returns in the process, and narrowing the list of potential investments to companies that are growing fast enough to generate the returns required by private equity investors.

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