This post was originally published on Financial Times.
Despite Beijing’s official policy of encouraging tech investments, several venture funds and companies in the Bay Area have been caught in the crosshairs of a policy that made it harder to move money out of China and into US dollars.
“It continues to be a challenge for us,” says Veronica Wu, managing partner at Hone Capital, a venture firm in Silicon Valley that is a subsidiary of CSC Group, a Chinese private equity firm.
“We slowed down a bit last year, especially for the later stage investments,” she says, adding that Hone is still able to back early-stage companies using funds that were moved out of the country before the capital window closed.
Fosun Kinzon Capital, a Silicon Valley venture firm owned by Chinese conglomerate Fosun, stopped investing in start-ups in the US last year. Its two investment partners based in the country now work full-time at a company they co-founded instead.
Managing partner Brad Bao says the company was somewhat protected from the shift in policy because it set up both dollar and renminbi funds before the imposition of capital controls. But he adds that the wider effects are only now becoming clearer, five months after the policies were introduced.
“The biggest impact is on whoever was denominated in renminbi, and they got really significantly impacted,” he says. “In 2017, it got harder and harder, and by the end of 2017 it became pretty much impossible”, to move funds from renminbi to dollars.
Data on Chinese investments in the US — which do not capture venture investments in start-ups — show that total Chinese foreign direct investment fell by more than a third in 2017 compared with 2016, according to a study released last week by the Rhodium Group, a China-focused research firm in New York.
Tech has often been viewed by analysts as escaping the worst of China’s crackdown, which has been particularly harsh on areas such as real estate and entertainment. US-listed Chinese tech companies such as Alibaba and Tencent have been unaffected because they have easy access to dollars, and both groups have been on investment sprees that are the envy of other Chinese investors.
Beijing has also long supported investments in technology — a sector it views as highly strategic.
However, the picture on the ground in venture investing suggests that the impact of the capital control is far-reaching — and also comes at a particularly delicate time for all Chinese investors in America.
But although Chinese-backed venture investing in Silicon Valley is a relatively small proportion of the country’s total investment in the US — most of which is made through acquisitions — the impact on the sector highlights how the capital control regime has had far-reaching consequences that are seemingly at odds with other government policies.
The shift also comes at a particularly delicate time for Chinese investors in the US. Under President Donald Trump, Washington’s attitude towards Chinese dealmaking has become much less welcoming. In January, US regulators rejected a move by Ant Financial, the payments affiliate of Alibaba, to acquire MoneyGram, a Dallas-based money transfer company.
In coming months, Congress is expected to tighten the regulatory review requirements for foreign investments, meaning that any overseas backing for a tech company — even a passive stake of less than 10 per cent — could be potentially open to scrutiny.
Many Chinese investors feel caught in the middle. “Now it’s harder from both sides,” says one. “The transaction they [Beijing] would allow would not be the transaction the US government would allow.”
Start-up investing, in particular, has been hit because the officials who approve outbound transactions find it difficult to tell the difference between investments in early-stage companies — which may have little to show in the way of revenue or assets — and activities such as money laundering.
Many Chinese in Silicon Valley privately admit that before the crackdown, venture investing structures had occasionally been used by individuals or companies that simply wanted to move money overseas. One common method was to inflate the deal size, so that the amount of capital exchanged into dollars might be several times greater than what was actually spent on the start-up investment.
The controls have become so tough, however, that some investors privately complain that Beijing has “thrown the baby out with the bath water”.
Hans Tung, managing partner at GGV Capital, a cross-border fund that invests in Silicon Valley and in China, says that his firm has not been impacted but the broader market has been hit hard.
“Some legitimate investors cannot invest in legitimate deals as a result of these policies,” he says.
One of the most long-lasting potential effects is reputational, with Chinese investors fearful that they will be seen as unreliable partners. In Silicon Valley, where dealmaking revolves around personal networks and trust, foreign companies already have a hard time getting access to the best deals.
Fosun Kinzon Capital’s Mr Bao says one start-up completed a fundraising round only to find that the wire transfer from a Chinese investor did not arrive due to the capital controls.
Some investors are taking steps to try and insulate themselves from the new regime.
Hemi Ventures, a Chinese-backed venture capital firm in Palo Alto, recently decided to start diversifying its investor base to minimise the chance of funding problems.
A senior executive at Silicon Valley Bank says the boutique lender has started avoiding taking money from Chinese limited partners.
Thilo Hanemann, director at Rhodium, says this phenomenon is playing out across Chinese investments in other sectors too.
“If you were considering selling to a Chinese buyer, there was this massive regulatory closing risk . . . that in turn causes a lot of foreign sellers to say no thanks to potential buyers,” he says.
Moreover, Mr Hanemann points out that a system in which foreign investments must undergo scrutiny and receive approval from Beijing could heighten political fears on the US side, where some in Washington already view China’s outbound investments as too closely linked to government policy.
“Beijing has really re-enacted a regime that allows the government to control and intervene in every single deal, which will further fuel the political backlash against Chinese investments, especially in the high-tech space,” he says.
“If you look at Chinese outbound investment in the tech space there are a lot of dark clouds on the horizon.”
This post was originally published on Financial Times.