Proposed Biden curbs could starve Chinese tech of early funding, expertise
THE startup world is bracing for new US government measures expected to expand the crackdown on American investment in Chinese tech to venture funding, as local entrepreneurs look to institutions at home and in the Middle East to get their companies off the ground.
The impending investment crunch has brought calls for Chinese policymakers to create new yuan-denominated funds to invest in early-stage startups, which are traditionally shunned by such institutions because of the high risk of such investments.
There are growing concerns that a foreshadowed US government order restricting outbound investment in key technologies will slow China’s high-tech development in critical areas such as semiconductor manufacturing and advanced computing. It could also cut immature firms off from the expert advice of seasoned tech investors.
US Assistant Secretary of the Treasury for Investment Security Paul Rosen confirmed persistent rumours about the existence of such a plan for the first time on May 31, when he spoke before a senate banking committee hearing headed “Countering China: Advancing US national security, economic security and foreign policy”.
Rosen said officials were working to restrict investment from the US to “countries of concern” that “comes with know-how and expertise into certain specific sectors and sub-sectors of concern such as advanced semiconductors, artificial intelligence (AI) and quantum computing”. He singled out China and its military, intelligence capabilities and mass surveillance.
No timeline has been given. Rosen did not elaborate on which types of investment would be impacted, but observers say the plan is likely to cover private equity and venture capital investments.
BT in your inbox
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
The US investment curbs could throttle entrepreneurship and innovation in China, said Han Yuze, founding partner at NewMargin Ventures, a Shanghai-based tech focused private equity firm. “You’d expect startups to face more challenges in fundraising, especially in the areas of AI and semiconductors,” Han said.
Chinese startups have already been looking for other non-US investment sources amid geopolitical tension that has seen the superpower set up various roadblocks to drag the pace of China’s technological advancement.
That’s especially the case in the semiconductor sector, a top-level Chinese government priority, where many startups have shifted to raise money from Chinese institutions, industry experts and investors said. But those in many other sectors will struggle to have their needs met by RMB money.
US investors have traditionally been the ones to chip in early to help get Chinese startups off the ground, including in angel rounds, while most Chinese investors tend to join in later rounds, said Dai Menghao, a compliance specialist with law firm King & Wood Mallesons based in Shanghai.
“The potential US investment curbs will make it more difficult for Chinese startups in certain sectors to raise early-stage funds,” Dai said.
Tightening grip
In recent years, US administrations on both sides of the political aisle have imposed restrictions aimed at slowing China’s technological advancement, in efforts they have said are intended to prevent American tech falling into the hands of the Chinese military.
That has included controls on the export of critical manufacturing equipment to China’s semiconductor industry. The US has also long blocked foreign investment at home in sensitive high-tech areas through implementation of increasingly stringent regulations set by the Committee on Foreign Investment in the United States.
The latest White House plan marks an escalation, building on other policies that have limited US investment in Chinese firms.
In 2018, the Trump administration launched the Communist Chinese Military Companies List, which the Biden administration renamed the Non-SDN Chinese Military-Industrial Complex Companies List in June 2021. US investors were barred from purchasing or selling publicly traded securities of those companies listed. As at Dec 2021, when the list was last updated, it included 68 publicly listed parent-level corporations such as facial-recognition specialist SenseTime and China’s largest chip foundry Semiconductor Manufacturing International Corp.
While the list only affects targeted Chinese companies, the new White House plan would cover entire sectors in areas such as AI and semiconductors. The US government will find it more difficult to regulate outbound investment than inbound foreign investment, said Frank Xue, a lawyer specialising in cross-border transactions at Womble Bond Dickinson.
He gave the hypothetical case of a US firm that sets up a fund in Europe to pour investment into Chinese tech startups. “Would that be allowed?” he asked. “For many US investors, it is hard to part ways with China entirely as investing in the country is still a very lucrative business,” he added.
AI in the spotlight
Among the three areas – AI, semiconductors and quantum computing – mentioned by Rosen, AI has garnered the most attention. That’s partly due to a report published in February by the Center for Security and Emerging Technology (CSET), a tech policy group at Georgetown University, which found that US investments played a significant role in China’s AI sector.
According to the report, which analysed data from Crunchbase, 167 US investors took part in 401 transactions, or roughly 17 per cent of the investments into Chinese AI companies during the years between 2015 and 2021. Those transactions amounted to a total of US$40.2 billion in investment, or 37 per cent of the total raised by Chinese AI companies globally during the seven-year period.
CSET laid out a series of recommendations for the US government to consider including establishing a scoped and clearly defined screening mechanism for US outbound investment and imposing updated disclosure requirements for US-based funds. In fact, US investors’ involvement in Chinese AI startups has already cooled over the past two years amid scrutiny of the role of such firms in Chinese government surveillance. The past few years have seen many of the most successful companies in China’s AI sector sanctioned by the US government.
Dai Wenyuan, CEO of AI specialist Beijing Fourth Paradigm Technology (4Paradigm), told Caixin in April that the current round of AI investment in China amid a mania incited by OpenAI’s rollout of ChatGPT last year is not as strong as years ago when “both US and Chinese investors were very active”. 4Paradigm has been barred from procuring some critical components made by US firms such as advanced chips since Mar 2, when it was one of 28 mainland companies added to the US Commerce Department’s Entity List.
Preemptive moves
Some big US investors appear to already be preparing for the new US rules. Sequoia Capital, for one, announced in June that it would spin out its Chinese unit into an independent company as part of a bigger break-up plan.
In the announcement, the US-based venture capital firm did not mention regulatory restrictions on US outbound investment, saying only that it has become “increasingly complex to run a decentralised global investment business”. Its Chinese investments have included Alibaba, food delivery leader Meituan, as well as TikTok owner ByteDance.
Meanwhile, Chinese startups have ramped up their efforts to seek non-US investment. One alternative to the US is the Middle East, where firms have been increasing investment into China’s AI and new energy sectors, said NewMargin Ventures’ Han.
Industry experts and investors also appealed the Chinese government to take actions to cope with the upcoming US policy. Han suggested that Chinese governments set up more yuan-denominated funds to invest in strategically important sectors such as chips and AI, where firms tend to need significant funding in their early stages.
But previous experience shows yuan-denominated funds tend to be risk-averse and prefer to pursue stable returns, meaning that they are reluctant to invest in early-stage tech firms. Such an attitude should be changed and governments need to adopt a more market-oriented approach to manage their funds, Han said.
Copyright SPH Media. All rights reserved.
