China's penetration of Silicon Valley creates dangers for startups


SAN FRANCISCO (Reuters) – Danhua Capital has invested in a few of Silicon Valley’s most promising startups in areas like drones, synthetic intelligence and cyber safety. The enterprise capital agency is predicated simply exterior Stanford College, the epicenter of U.S. know-how entrepreneurship.

FILE PHOTO: Stanford College’s campus is seen in an aerial photograph in Stanford, California, U.S. on April 6, 2016. REUTERS/Noah Berger/File Picture

But it was additionally established and funded with assist from the Chinese language authorities. And it isn’t alone.

Greater than 20 Silicon Valley enterprise capital companies have shut ties to a Chinese language authorities fund or state-owned entity, in response to interviews with enterprise capital sources and publicly accessible info.

Whereas the U.S. authorities is taking an more and more laborious line in opposition to Chinese language acquisitions of U.S. public corporations, investments in startups, even by state-backed entities, have been largely untouched.

That could be poised to alter because the U.S. Congress finalizes laws that dramatically expands the federal government’s energy to dam overseas funding in U.S. corporations, together with enterprise investments.

The brand new regulation would give the U.S. authorities’s Committee on Overseas Funding in the US (CFIUS) large latitude to determine what types of offers to look at, eliminating sure possession thresholds, with a specific give attention to so-called “crucial” applied sciences.

“The notion is that plenty of the tech switch of fear to the U.S. safety institution is occurring within the startup world,” stated Stephen Heifetz, a former member of CFIUS and now a lawyer representing corporations going by CFIUS evaluation.

The newest model of the invoice exempts “passive” traders, which might cowl most of the restricted companions that again enterprise companies. However restricted companions which have some management over the enterprise, or companies whose managing companion is a “overseas particular person”, might be topic to scrutiny.

The college endowments and household places of work that historically present a lot of the cash for enterprise companies are often one among many restricted companions and have minimal if any involvement within the startups they assist fund.

Chinese language entities additionally typically take a passive position in massive enterprise funds. However enterprise capital sources say that Chinese language authorities funds typically play a extra influential position within the smaller enterprise companies they again by offering a higher proportion of their funding. That empowers them to request details about startups or assist them to open places of work in China – probably opening these startups to CFIUS evaluation.

The potential for a regulatory crackdown has brought on unease within the startup world. Enterprise agency Andreessen Horowitz is counseling startups that in the event that they increase cash from a China-backed investor, they put themselves prone to authorities scrutiny, an individual with information of the matter stated.

“The window for some startups to boost cash from China could also be closing,” stated Chris Nicholson, co-founder of AI firm Skymind, which has raised cash from Chinese language Web group Tencent Holdings Ltd and a Hong Kong household workplace.

SENSITIVE AREAS

Till lately, the unique supply of funds for enterprise investments has not been a problem in Silicon Valley. Enterprise companies should not obliged to reveal who their traders are and entrepreneurs hardly ever ask, main some dealmakers to query how CFIUS may maintain tabs on startup investing.

Danhua Capital, which is backed by the Zhongguancun Growth Group, a state-owned enterprise funded by the Beijing municipal authorities, has holdings in a few of the most delicate know-how sectors.

Its investments embody information administration and safety firm Cohesity, which counts the U.S. Division of Vitality and U.S. Air Pressure amongst its prospects. Drone startup Flirtey, which in Might was chosen by the U.S. Division of Transportation to take part in tasks to assist the company combine drones safely into U.S. air house, can also be a part of the Danhua portfolio.

Shoucheng Zhang, Danhua’s founder and a Stanford College physics professor, declined to reply particular questions from Reuters. In an e-mail, he stated: “Most of our (restricted companions) are publicly listed corporations in New York or Hong Kong inventory exchanges. We are going to after all absolutely adjust to any legislations and rules.”

Cohesity declined to remark. A spokeswoman for Flirtey stated Danhua’s minority funding didn’t include any info rights or a board seat, and the agency is just not concerned in Flirtey’s operations.

“We might not knowingly settle for cash from the Chinese language authorities; we take funding from Delaware-registered, Silicon Valley-based enterprise capital companies,” the spokeswoman stated.

She added that Flirtey would help any new “mandate that traders should disclose if they’ve any type of backing from authorities entities, to assist guarantee there’s by no means a query sooner or later.”

The apply of investing by layers of funds, generally known as funds of funds, could make all of it however unattainable to know the place cash is coming from. Westlake Ventures, backed by the Hangzhou metropolis authorities in jap China, invests in at the very least 10 different Silicon Valley enterprise funds, together with Palo-Alto based mostly Amino Capital.

Larry Li, founder and managing companion at Amino Capital, stated he took the cash that was on provide when he launched his fund in 2012. He stated he felt his agency wasn’t the form of recognized amount that would faucet the massive pensions and endowments.

“We weren’t going to the Harvard endowment or Yale endowment; that’s like mission unattainable,” Li stated. “It is advisable have some particular supply of funds to get began.”

China-backed funds embody Oriza Ventures, which belongs to the funding arm of the Suzhou municipal authorities, and has backed AI and self-driving automotive startups. SAIC Capital, the enterprise arm of state-owned auto firm SAIC Motor, has invested in Silicon Valley autonomous driving, mapping and synthetic intelligence startups.

Even well-known startup accelerator 500 Startups raised a part of its most important fund from the Hangzhou authorities.

500 Startups and Oriza declined to remark, whereas SAIC didn’t reply to a request for remark.

Capital controls have slowed the movement of Chinese language cash into the US since 2016, however sources say enterprise investments have been extra resilient than sectors like actual property, partially because of the Chinese language authorities’s give attention to bettering its home high-tech trade.

‘CROWN JEWELS’

U.S. politicians suspicious of China’s intentions had been galvanized by a Division of Protection report launched final yr that warns that Chinese language enterprise traders are accessing “the crown jewels of U.S. innovation.”

The report helped information Sen. John Cornyn, a Texas Republican who sponsored the Senate model of the CFIUS reform invoice, folks with information of the matter stated. A spokeswoman stated Cornyn “is particularly involved with Chinese language state-backed enterprise capital investments.”

However the report was additionally panned by many personal sector consultants as overly simplistic and fear-mongering.

For now, at the very least, President Donald Trump has backed away from his declared intention to clamp down on a variety of Chinese language know-how investments by a particular emergency order, saying he would depart the job to CFIUS. But when Congress fails to move the invoice rapidly, Trump stated he would use his govt powers.

Reporting by Heather Somerville in San Francisco. Extra reporting by the Shanghai newsroom.; Enhancing by Jonathan Weber and Martin Howell.


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