We examine the impact of the interaction between two sources of capital, the government and private equity investors, on innovation. To study this, we consider two possible government subsidy schemes that differ in how the amount of the subsidy is determined. The first scheme takes into account the firm’s investment in R&D and the other scheme is based on the investment made by private investors. The analysis shows that the relationship between the government subsidy and the investor’s investment is not monotonic. Moreover, the subsidy scheme linked to the firm’s R&D investment may even reduce its R&D inputs, but this scheme could lead to a level of R&D investment that cannot be achieved without subsidies. On the other hand, it is possible that the subsidized capital is not invested in the R&D project under the subsidy scheme linked to the investor’s investment. In terms of government expenditure, the R&D-investment-linked scheme incurs more expenditur when the government requires a certain R&D input.