China was supposed to be the next big thing in venture capital. Now VCs are pulling back

Not long ago, it wasn’t unusual for the founders of Chinese tech companies to show up in droves to Silicon Valley in search of U.S. investors. And those investors were more than happy to meet them. To many of them, China looked like the next frontier.

Lately, it’s looked more like a minefield.

In a report issued in February, Congress accused five major U.S. venture capital firms—GGV Capital, GSR Ventures, Qualcomm Ventures, Sequoia Capital China, and Walden International—of fueling China’s “military, surveillance state, and Uyghur genocide” with more than $3 billion worth of investments in technology including facial recognition systems and semiconductors. The investigation, led by a select committee of the House of Representatives, prompted two of those companies, Sequoia and GGV, to spin off their Chinese operations and, in GGV’s case, even rebrand the business entirely. 

Last August President Joe Biden signed an executive order prohibiting U.S. investments in any Chinese companies involved in certain types of artificial intelligence, semiconductors, and quantum computing that the U.S. government deems to be a national security risk. The order also established new disclosures for investors funding other types of Chinese tech companies. Just last month, the House of Representatives passed a bill that would force ByteDance to divest from TikTok or face an outright ban in the United States. And this week, Microsoft said it was investing $1.5 billion in the Emirati AI company G42—a deal that was pushed forward by Biden administration officials seeking to cut China off from emerging technologies.

All of this scrutiny,  coupled with the broader global decline in VC investments over the past two years, has contributed to a stark drop in U.S. investments in China. Where once venture capitalists in the U.S. eyed China as the future—a country with a massive population, substantial investments in advanced technologies, and a vast community of mobile-first users that trounced that of the U.S., the allure has dwindled substantially. According to PitchBook, U.S. investors participated in $32 billion worth of deals in China in 2021. That number shrunk to around $8 billion by 2022, and last year it was less than $2.5 billion. 

“The aggressiveness of the U.S. government is a big, big piece of it,” says Kyle Stanford, lead U.S. venture capital research analyst at PitchBook. “Investors don’t want to get their name put in any of those House committee reports.”

For many U.S. investors with money in China, merely talking publicly about the changing geopolitical dynamics has become a kind of third rail. None of the firms named in the House investigation responded to Fast Company’s request for comment, and neither did several other leading U.S. firms with Chinese investments. A spokesperson for the National Venture Capital Association also declined to comment, noting that “most of our members are focused on U.S. investment.” (According to NVCA’s member directory, all but one of the companies named in the House report are part of the association).

But it’s not just the fear of being named and shamed that’s driving U.S. investors away from China. Investors are also realizing that even if they’re able to put money into Chinese companies, getting it out via exits is only getting harder. For one thing, China is cracking down on tech companies, including Beijing-based DiDi Global, which proceeded with a 2021 initial public offering despite the Chinese government’s attempts to delay the IPO over cybersecurity concerns. DiDi delisted from the New York Stock Exchange in 2022 and is now facing a shareholder lawsuit in the U.S. 

Chinese President Xi Jinping, meanwhile, reportedly personally canceled the financial services juggernaut Ant Group’s IPO over conflicts with the company’s founder, Jack Ma. Other major players in the Chinese tech sector, including ByteDance and Shein, have struggled to find an exit amid escalating tensions with the U.S. 

“Right now, it’s not just about the motion of investing. It’s about the motion of exiting,” says Edith Yeung, a general partner at Race Capital.

Biden’s restrictions on Chinese investments have had a further “chilling effect,” says Jacob Osborn, a partner and cochair of the law firm Goodwin Procter’s global trade group, but not because they directly prohibit a significant number of deals. Quite the opposite. 

“The scope of it is quite narrow,” Osborn says of the executive order, which bars only investments in the most sensitive categories of technology. And yet, he adds, the order has had more widespread ripple effects because “it’s a totally new framework, and it’s a totally new type of sanction at the U.S.’s disposal,” which, for risk-averse investors, can create unnecessary uncertainty about whether such a framework could be applied to other tech categories in the future.

In a cautious environment, PitchBook’s Stanford predicts investors will seek out investments in other countries throughout Asia, especially India, where the U.S. aims to forge a stronger diplomatic relationship, particularly as it pertains to the country’s tech sector. In 2022, according to PitchBook, companies in Southeast Asia secured a record $34.1 billion in private equity and venture capital funding, and more than 60% of those deals included investors based outside of the region. As investors continue to retreat from China, Stanford expects those numbers will grow.

“That money that had been invested in China is not going to go away, and it probably won’t revert back to U.S. investment,” he says. “[Investors] will look for the risk exposure that they had tried to find and then cornered in China.”

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