Tensions between the United States and The People’s Republic of China (PRC) have been rising over the years, ranging from trade and tariffs to tech rivalry and alleged spying—and are affecting everything in between including venture capital investments into the tech startup ecosystem.
According to an article by CNBC, things escalated again after the US shot down an alleged Chinese spy balloon. This triggered Secretary of State Antony Blinken to cancel his trip to Beijing over the incident last month.
However, U.S.News reported on Thursday that Jake Sullivan, the White House national security adviser met with senior Chinese foreign policy adviser Wang Yi in Vienna with a message – the US is looking forward to moving beyond the tensions escalated by the spy balloon incident.
Neither countries publicized the meeting possibly due to upcoming high-level talks expected in Australia on Wednesday. The White House described the meeting between the two officials as “candid” and “constructive.”
Strained Tensions Between the US and China Sink Holes in The Startup Ecosystem
As tensions between the two superpowers rage on, investments into Chinese startups are drying out, perhaps exacerbated by a report that said President Joe Biden is ready to sign an executive order limiting investment into certain sectors of the Chinese economy by US investors such as semiconductors and artificial intelligence.
The directive will only drive the nail deeper as the US had already restricted the export of critical American technologies into the PRC. US investors in the tech startup ecosystem appear to have read the cue even before the directive becomes official by significantly cutting down on investment into The Red Dragon.
Investment from US investors into the Chinese economy is at the slowest in 2023 compared to recent years based on data by Crunchbase. Whereas deal-making investments in China surpassed 300 in 2019 and 2020 combined, they ticked up to 426 in 2021 alone. At the time, the venture capital market was thriving hitting a fever pitch.
However, as political pressures between China thawed, investment deals dwindled settling at 283 in 2022. The slow pace appears to be on course as Crunchbase shows that by April US-based investors were on course to participate in less than 150 deals with Chinese tech startups.
Investors are not expecting those numbers to improve in the near future.
A Plethora of Issues Plague The Pace Of US Investments Into Chinese Tech Startups
An investor familiar with the matter who requested to remain anonymous said that there are a host of reasons why his company had to halt investment in China citing the political pressure, evidence of government action targeting Chinese tech firms, and concerns over the ability of Chinese startups to go public on the largest stock exchanges in the US.
“There is uncertainty to begin with investing in this business, and this just added another level of uncertainty,” the investor said.
Furthermore, some limited partners (LPs) expressed apprehension concerning the environmental, social, and governance sectors.
Based on data from Crunch base, most of the largest US-based investors in China have put significant brakes on pumping money into The Red Dragon region in recent years.
- Based in Menlo Park, California, GGV Capital has completed the majority of its 133 deals in China since 2019 but has made only two so far this year, compared to 24 in 2022, according to Crunchbase data.
- Another Menlo Park firm, formerly known as Nokia VC, BlueRun Ventures has made 71 investments since 2019, yet only 19 in the previous year and none in 2023.
- Operating out of San Francisco, GL Ventures, which focuses on sports tech and online gaming, has executed 62 Chinese deals since 2020, with only 11 deals made within the last 16 months.
- GSR Ventures, a Palo Alto-based firm specializing in early-stage technology companies advancing AI-enabled technology, has finalized 60 deals in China since 2019 but completed only 13 in the past 16 months.
- Both SOSV and OrbiMed have completed over 40 deals individually over the past four years, but together they have only achieved one deal in the current year.
It is worth mentioning that the numbers mentioned above are not inclusive of major venture capital firm, Sequoia Capital China mainly because it is a one-of-a-kind legal entity – independent of Silicon Valley’s Sequoia Capital and headquartered in China.
Nonetheless, Sequoia has a unique profit-sharing relationship for its partners based in the US to benefit from its counterparty investments in China.
Sequoia Capital is a renowned tech investor in China boasting 400 investments in Chinese firms since 2019 and has so far made 19 in 2023.
Venture Capital Funding on a Downtrend
Although Sequoia Capital investment deals combined with other China-based investors seem high, the ongoing exodus out of the world’s most populous nation by companies based in the US has significantly impacted funding.
Data shows that Venture funding in the PRC almost doubled in 2021 at the peak of the COVID-19 pandemic, climbing to an $87 billion all-time high.
However, those figures dropped significantly in 2022 to $46.3 billion, a 47% decline.
Considering the first quarter of this year, where venture funding fell to its lowest overall of $ 8.1 billion in years, representing a 38% decline both year-to-year and quarter-to-quarter, the situation is unlikely to improve in the short term.
Crunchbase has refrained from making any predictions as to whether that drop will continue or slow down as the year progresses.
Hurst Lin, a general partner at DCM Ventures and leader of its China division since 2006, reckons that American investors have been keenly interested in the vast potential of the Chinese market from the time the country entered the World Trade Organization in 2001.
Nevertheless, in the wake of the COVID pandemic, perceptions of the region evolved, and escalating political tensions continued to further complicate the situation.
“I think there was a cooling-down period as the media (reporting) of China changed,” Lin said. “That led to a drying up of foreign capital. LPs started to change their perspective, and as an investor, you need to be concerned about that.”
Lin admits that apprehensions around Chinese regulatory oversight of tech companies along with challenges of going public on foreign exchanges such as those in the US which tend to impact investor sentiment are not new.
SinaNet, which Lin helped to co-found became the first Chinese internet firm to successfully go public on the Nasdaq exchange. Lin said the listing was made possible through a variable interest entity which is allowed to date. However, they are heavily regulated by the government at the moment.
Challenges with listing on Foreign exchanges do not deter China-based firms from going public either. According to Lin, Hong Kong-based exchanges are seizing the opportunity to fill the gap.
Bloomberg recently reported that the Chinese e-commerce giant Alibaba Group was mulling initial public offerings (IPOs) for two of its business units— Cainiao Network Technology and Freshippo on Hong Kong-based exchanges.
Despite the efforts, there are some caveats as Hong Kong exchanges have always stood out for their focus on retail investors and particularly in markets like manufacturing and real estate, Lin added.
Furthermore, the region lacks research analyst coverage which tech companies bank on to spread the word to potential investors. This is a significant drawback for tech startups eyeing a public listing in China.
“Will this turn around?” Lin asked, “I really don’t know.”
Despite the alarming drop, US investment in the Chinese market is not yet at a record low. Market watchers agree it is in a depressed state within the robust investing cycle witnessed in recent years.
“We’ll see how this plays out,” Lin added.
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