Recent developments in the escalating US-China tech war signal that a full technology “decoupling” between the world’s two largest economies might be inevitable. So far, new measures have stifled sectors ranging from telecommunications equipment to social media. But is it chilling US VC activity in China?
Two weeks ago, TechNode reporter Chris Udemans wrote that Chinese investments in US startups have fallen dramatically since 2018, the same year the US began to scruitizine Huawei and ZTE, two of China’s largest telecom manufacturers.
But when TechNode looked at US-to-China data, we got a surprise: things look normal. Investor and analyst data show that American capital flowing into Chinese startups has not yet taken a hit from geopolitical tensions between the two nations.
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Overall US investment in Chinese startups—including deals made directly by US institutions or China-based venture capital (VC) firms investing in US dollars—has fallen since 2018, but this is in line with a broader cooldown in Chinese tech investment due to a slowing economy and growing financial headwinds.
But it could be that the slow-moving field is still processing the changed environment. Some investors and analysts told TechNode that politics is going to catch up with investments. Chinese VC firms that raise funds in US dollars, which have played a big role in China’s decade-long technology boom, are having a hard time raising money from their limited partners in America. Growing hostility from regulators and lawmakers toward US-listed Chinese companies may make it more challenging for Chinese firms to float shares in American financial markets, which is where most US dollar-based venture investors seek to exit.
US VC investment shrank amid ‘capital winter’
American VC firms first entered the Chinese market in the early 2000s. Many credit these early American investors with helping establish modern VC investing in China. Among them were firms like Sequoia Capital, IDG Capital, and Matrix Partners.
US-China Investment Project, a research initiative led by Rhodium Group and the National Committee on US-China Relations, estimates that US VC firms invested in nearly one-third of all venture capital-backed Chinese companies from 2000 to the first half of 2019. It also estimates that US investors channeled around $47 billion into Chinese startups over the period, accounting for 16% of the roughly $300 billion in total investments.
Investment into Chinese startups by US venture firms took off after 2014, peaking at $19.6 billion in 2018, according to a US-China Investment Project report. The findings attributed this spike to a few massive late-stage fundraising rounds for prominent Chinese technology companies like Ant Financial, Pinduoduo, and Bytedance.
Venture funding, however, fell dramatically to $5 billion in 2019, the lowest level since 2015, according to the report. The drop was in line with a broader slowdown in Chinese tech and venture capital markets. Investors were becoming “more selective in the face of increasing economic uncertainty and a growing perception that parts of China’s tech ecosystem had become overheated after years of rapid growth,” the report said.
Total VC investment into Chinese startups fell by almost half from $204 billion in 2018 to $119.7 billion in 2019, according to Itjuzi, a Chinese venture capital data provider.
US backers, Chinese funds
US-owned VC firms only represent a small portion of the American capital that flows into Chinese startups. The majority of US dollar investments are made through Chinese VC firms that raise funds from American limited partners. These US dollar funds often include high-profile Chinese general partners such as Source Code Capital, which backed Chinese super-app Meituan Dianping; Lightspeed China Partners, which invested in social e-commerce upstart Pinduoduo; and Zhenfund, whose portfolio firms include social media app Xiaohongshu and the artificial intelligence unicorn Yitu.
Foreign backers in these Chinese US dollar funds include sovereign wealth funds, retirement funds, and big corporates, according to Liu Xiaoqing, analyst at Itjuzi. Liu told TechNode that while such funds raise money in countries like Japan and Singapore, the majority of their funding comes from the US.
Compared to RMB funds, US dollar funds participate in far fewer deals but tend to make substantially greater investments in each. The average investment made by RMB funds was $28.1 million in the first quarter, compared to an average of $103 million per deal by US dollar funds, according to a report (in Chinese) by financial advisory firm China Renaissance.
Investments by US dollar funds into Chinese startups peaked in the second quarter of 2018, with $42.8 billion invested into 217 venture funding rounds. In 2019, Chinese venture capital dropped by more than half, though this is still in line with the overall performance of the Chinese tech VC market. The transaction volume of financing rounds made by US dollar funds in 2019 also halved compared to the year before, according to China Renaissance.
Money is ‘not political’
In the second quarter, even as the US government tightened restrictions on Chinese tech companies, US dollar funds were still playing an important role in startups’ fundraising. US dollar funds accounted for 54% of VC transaction volume with Chinese tech startups in the quarter, according to Itjuzi (in Chinese).
Adam Lysenko, associate director at Rhodium Group, said there have also been tailwinds for increased investment over the last couple of years, such as Beijing’s embrace of foreign investment in the automobile and financial sectors, despite escalating US-China tensions. “Due to these factors, we haven’t seen a massive drop-off in US investment in China yet,” said Lysenko, who co-authored the US-China investment report.
But experts warn that investment data moves slowly. If investors are getting cold feet now, the effects may not appear in the data for years. In the VC market, the time horizon may stretch longer. “There is a delay in market data considering that the lifecycle of VC funds could be three to eight years,” Liu told TechNode.
Xu Miaocheng of Unity Ventures, a Beijing-based early-stage VC firm, told TechNode that some Chinese US dollar fund managers are already having a hard time raising money from their American limited partners. Reasons include the Covid-19 crisis which has hampered business trips, as well as escalating conflicts between the Trump administration and Chinese tech companies.
Liu, however, insists the impact will be minimal because money is “not political.”
“The US government will not regulate US investment in China in the same way it scrutinizes Chinese investment in the US technology sector,” she said. Beyond a number of select Chinese firms currently sanctioned by US regulators, “they [the US government] don’t care which countries American limited partners invest in, as long as they are making money.”
Not everyone believes the calculus is so clear-cut. “The future trajectory of US investment in China will depend on whether political concerns outweigh the powerful commercial motives that still exist to deploy capital there[China],” said Lysenko. He added that US venture capitalists continue to see China as a crucial market for growth in a world with slower economic growth.
Given the interdependence between the two countries’ corporate sectors, he continued, “I expect that only a dramatic decoupling path—with sustained US government pressure on US firms—will result in a meaningful reduction in US investment in China.”
Additional contributions by Chris Udemans.