In China private equity hasn't evolved as much as exploded.

A little over a decade ago, private equity was an esoteric financial contrivance employed by state-sponsored funds and a few global buyout groups. Thanks to increasingly favorable policies instituted in recent years and the success of the small-cap stock exchanges, China and its mercurial entrepreneurs have virtually reverse-engineered private equity into a financial growth engine.

In just three years, yuan-denominated or renminbi funds have spread like wildfire. Reports peg the number of local currency funds at more than 2,000. Many of these remain small, but several, including CDH China Holdings Management Co. Ltd., SAIF Partners, Hony Capital (Beijing) Co. Ltd. and Citic Private Equity Funds Management Co. Ltd., a unit of Chinese financial conglomerate Citic Group, have raised sizable amounts. In short the playing field has been unleveled, and the global buyout firms are in danger of being left behind. Many may have made enormous strides after more than a decade's work. But their size and scale are diminishing in relative import.

"It took this country a long time to know these names, but now these brands don't mean as much anymore," says Hanson Li, managing director at Hina Group, a Beijing investment bank and PE investor active in cross-border transactions.

To be sure, the majors have raised or are raising their own renminbi funds. And they've allied with powerful partners. Carlyle Group teamed with Fosun Group, for example. Blackstone Group LP, which counts sovereign wealth fund China Investment Corp. as a major shareholder, partnered with the city of Shanghai. That's helped open doors in China while facilitating Chinese enterprises' global ambitions.

Still, they've had to do without their traditional toolkit of leverage and the ability to buy controlling stakes. And no matter how localized, some are hampered by a global decision-making structure.

Early entrants such as TPG Capital, Carlyle and Warburg Pincus established a foothold in China in the '90s as they expanded across Asia. Investments were engineered with state organizations aiming to restructure state-owned enterprises, and these proved very successful.

"It's become much harder" for the multinational funds, says Monte Brem, CEO of StepStone Group LLC, a global PE advisory and investment management firm. "The market has changed, and it'll be hard for them to replicate their historical track records."

PE has benefited from more relaxed rules and incentives for growth. Local governments acted as catalysts, seeding renminbi funds to encourage the flow of capital outside state-controlled banks. But recent tweaks sought to retain capital within the country. China put restraints on offshore funds, making them less attractive relative to renminbi funds. The approvals process is also more cumbersome for offshore funds.

Global PE firms are further disadvantaged because a long list of sectors, such as oil exploration, are off-limits. Areas that have opened up, including finance and Internet-related sectors, still require onerous approvals.

Small companies that can't list on the big-cap Shanghai Stock Exchange got a boost from two new boards. ChiNext, part of the Shenzhen Stock Exchange, opened in 2009, and the Shenzhen Stock Exchange small-cap board, the SME 300 price index for small and medium-sized enterprises, launched in 2010. Both have eased bottlenecks for initial public offerings. "It used to be so much more difficult to go public in China, but since these markets opened, that's all changed," says Vincent Huang, a partner at Pantheon Capital (Asia) Ltd.

It's also resulted in elevated valuations. Brem believes "solid" competition has driven valuations up significantly. In some cases purchase multiples had been 30% higher than public comparables.

Private-market values have come off their highs since the downswing, so buyout funds may be paying a "more normal" range of 9 to 10 times Ebitda. But the two boards serving as benchmarks are still trading between 10 and 20 times price-earnings, practitioners say. Also, LBO firms have had to recalibrate strategies toward growth equity. Executing large deals such as take-privates is expensive.

The one thing the majors can offer is a global platform for Chinese companies with global aspirations. "The key is to make sure we can add value, or there's no sense coming in," says Brian Zhou at Carlyle in Beijing. But, even here, domestic PE groups such as Citic and Hony Capital are slowly but surely tapping into the growing outbound M&A trend. "The jury is still out whether the large PE fund will be successful," says Li.

Vyvyan Tenorio writes about private equity for The Deal magazine.