Chinese investment in Silicon Valley creates risks for startups

Chinese-government backed venture capital firms in the US are investing in some of Silicon Valley’s most promising startups in areas like drones, artificial intelligence and cybersecurity.

While the US government is taking an increasingly hard line against Chinese acquisitions of US public companies, investments in startups, even by state-backed entities, have been largely untouched.

That may well be poised to change as the US Congress finalises legislation that dramatically expands the government’s power to block foreign investment in US companies, including venture investments.

Venture capital firm Danhua Capital, is based just outside Stanford University, the epicentre of US technology entrepreneurship.

The company is backed by the Zhongguancun Development Group, a state-owned enterprise funded by the Beijing municipal government and has holdings in some of the most sensitive technology sectors.

And it is not alone.

More than 20 Silicon Valley venture capital firms have close ties to a Chinese government fund or state-owned entity, according to interviews with venture capital sources and publicly available information.

New law

The new law would give the US government’s Committee on Foreign Investment in the United States (CFIUS) wide latitude to decide what sorts of deals to examine, eliminating certain ownership thresholds, with a particular focus on so-called “critical” technologies.

The latest version of the bill exempts “passive” investors, which would cover many of the limited partners that back venture firms. 

But limited partners that have some control over the business, or firms whose managing partner is a “foreign person," could be subject to scrutiny.

For now, at least, US President Donald Trump has backed away from his declared intention to clamp down on a wide range of Chinese technology investments through a special emergency order, saying he would leave the job to CFIUS. 

But if Congress fails to pass the bill quickly, Trump said he would use his executive powers.

Funds of funds

The practice of investing through layers of funds, known as funds of funds, can make it all but impossible to know where money is coming from. 

Westlake Ventures, backed by the Hangzhou city government in eastern China, invests in at least 10 other Silicon Valley venture funds, including Palo-Alto based Amino Capital.

US politicians suspicious of China’s intentions were galvanised by a Department of Defense report released last year that warns that Chinese venture investors are accessing “the crown jewels of US innovation.”

The report helped guide Senator John Cornyn, a Texas Republican who sponsored the Senate version of the CFIUS reform bill, people with knowledge of the matter said. 

A spokeswoman said Cornyn “is especially concerned with Chinese state-backed venture capital investments.”

But the report was also panned by many private sector experts as overly simplistic and fear-mongering.