SAN FRANCISCO (Reuters Breakingviews) - The manufacturing supply chain isn’t the only one upended by trade tensions between the United States and China. American venture capitalists pumped a record $19 billion into Chinese startups in 2018 while funds from the People’s Republic injected $3.6 billion into U.S. startups, also a record, according to research firm Rhodium. But tougher foreign-investment rules and rising nationalism are set to change the game for capital movement.
The relationship between the world’s two biggest economies is at a low point. President Donald Trump’s trade war and crackdown on Chinese telecommunications firm Huawei has sparked retaliatory levies from Beijing and calls for boycotts against Apple and other U.S. products. Last week, state media reported that China’s Commerce Ministry will draft a list of foreign companies it views as “unreliable.”
For all the trade sparring, investors in both countries have so far kept their wallets open for startups. American backing of young Chinese firms doubled in 2018 from the previous year, with VCs participating in fundraising rounds for at least one-third of startups through December last year, according to Rhodium. The push put U.S. venture funding in China above direct investment for the first time.
Financial technology and business services were popular outlets. General Atlantic was among the funds that participated in a $14 billion fundraising round in 2018 for Ant Financial, which was effectively blocked earlier the same year from acquiring money-transfer outfit MoneyGram by the Committee on Foreign Investment in the United States, known as CFIUS, on national-security grounds.
On the other side, Chinese funds poured 50% more money into U.S. startups last year than in 2017. The investment came as acquisitions of American firms by PRC entities plunged by more than 80%. Healthcare and biotechnology were the most popular sectors in terms of the number of deals.
Tougher foreign-investment rules are set to curb even these fundraising ties. CFIUS since last fall has the power to review the acquisition by foreign buyers of minority stakes in American companies, including where there is access to nonpublic, technical information, a board seat, or involvement in substantive decision making. The committee’s expanded mandate focuses on emerging technology such as artificial intelligence.
Semiconductors, biotech and financial services are vulnerable sectors. The People’s Republic wants to build its own chip sector, partly to decrease its reliance on American products, and U.S. startups in the field have benefited. In 2018, there were nine Chinese venture-capital investments into American chip companies totaling $219 million, making up 14% of the total number of deals that year and nearly 25% of total investment value, according to PitchBook data.
It’s true that Silicon Valley is awash in capital, but Chinese money has been critical in certain niches. For example, the semiconductor area has not been popular with domestic venture capitalists, who have favored consumer internet or software-as-a-service companies. A chip company founder who has received Chinese backing told Breakingviews he is worried about not drawing enough interest in his next fundraising effort later this year.
CFIUS is also becoming more aggressive when it comes to deals that have already closed. The Chinese owner of Grindr has been looking for a buyer for the dating app after CFIUS raised concerns over national security, particularly around the potential for Kompromat. Beijing Kunlun bought a majority stake in Grindr in 2016.
The U.S. Treasury-led committee also forced Shenzhen-based iCarbonX to sell its majority stake in PatientsLikeMe, acquired in 2017. The service helps patients find others who are suffering from similar health issues. Companies that hold potentially sensitive data have become an increasing concern for the committee.
Other deals could soon find themselves in the crosshairs. Chinese firm Zhenfund was part of a $41 million fundraising round in 2017 for Synthego, a genome engineering startup that allows researchers to streamline the design process for DNA-editing experiments. Last year, China Life Healthcare Fund led a $46 million investment in Massachusetts-based XtalPi, which combines quantum physics, AI and cloud computing for drug research.
The rules are murkier for U.S. investment in Chinese startups, but similar risks exist. There is a growing sense that American money is less welcome in the country’s tech sector, according to two financial advisers. It could affect even funds with a long history in China, like GGV Capital. Reuters reported in May that Sequoia’s China arm was looking to cut up to 20% of its investment staff, a story the fund denied.
Chinese firms and investors in them also have to watch for pressure from American politicians. DJI, the world’s largest consumer-drone maker, has backing from U.S. venture capitalists Sequoia and Accel Partners from 2014 and 2015, among others. Information passed through the company’s devices are stored in DJI’s cloud, which could present real or perceived national-security concerns when it involves video of sensitive places or installations, for example.
Last October, DJI said one of its drones will soon survey power grids for Southern, an Atlanta-based utility company. Senator Chris Van Hollen told Breakingviews in a statement that Chinese access to U.S. data, including through drones, threatens American privacy and national security and urged the Trump administration to take action.
Such tensions could mean less competition for Chinese venture capitalists in their home market. A local startup investor told Breakingviews he was already seeing prices drop by up to 40% for private China-based tech companies because of trade tensions and wariness on the part of overseas funds. It’s an example of how the changing U.S.-China dynamics are creating new winners and losers – among both investors and companies in need of cash.
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