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For US venture funds, next Jack Ma is outside China

Sudden drying up of investment threatens the next generation of tech startups

(Nikkei montage/Reuters)

HONG KONG -- From the earliest flourishing of China's startup ecosystem in the late 1990s, U.S. investors have played an important, if not pivotal, role in the country's emergence as a tech superpower.

One of the most famous of several consequential investments was the $3.3 million that Goldman Sachs put into a scrappy startup called Alibaba in 1999. Not only did the money help Jack Ma and his small team get started, it also conferred a status that helped with its media profile and in later financing rounds.

Goldman cashed out its stake for $22 million in 2004, earning nearly seven times its money. That may have seemed like a fair profit at the time, but it remains paltry by comparison with some of the bumper returns that other Western venture capital firms have reaped over 20 years as China's tech sector boomed.

Now, however, it appears this golden era is slipping into the past. The suspicion and uncertainty that characterizes U.S.-China commercial decoupling and geostrategic rivalry is having a dire effect on U.S. venture capital flows to China -- and Chinese investments in U.S. startups.

The implications are profound. The downdraft of U.S. venture funding to China is contributing to a "capital winter" that is undermining the valuations of China's constellation of "unicorns." It also threatens to stymie the emergence of a new generation of Chinese tech stars.

Such judgments derive in part from the outsized role U.S. venture capital has played in the China tech scene for almost 20 years. "Most of China's leading technology firms today, including Alibaba, Tencent, Baidu and others, received financing from U.S. venture investors," according to a recent report by the Rhodium Group, a U.S.-based research company.

"We estimate that U.S. players invested in nearly a third of all Chinese companies that received venture backing from 2000 to [the first half of] 2019," the report continued.

In terms of hard numbers, 2018 was a record for U.S. venture investments into China, totaling $17.4 billion, roughly double the previous record of $8.4 billion in 2017, according to Rhodium's estimates. But by the first half of 2019, the most recent period for which Rhodium has data, such inflows had dwindled to $1.3 billion. There is scant sign of any pickup in the latter half of last year.

The reasons for the slump stem mostly from the policy and regulatory environment. Before 2017, there seemed to be little interest among U.S. policymakers in regulating outbound U.S. capital flows. But this is no longer the case. Concerns that U.S. company involvement in China was contributing to leaks of sensitive technologies have made Washington wary.

In one example, the addition of eight large Chinese technology companies onto the U.S. Commerce Department's "entity list" in October 2019 -- because of concerns over human rights abuses -- have effectively cut them off from U.S. suppliers and investors.

But such actions have had a wider impact, too. They have made U.S. venture investors re-evaluate almost all of their potential tech investments in China, at least until such time as U.S. policy is further clarified. Artificial intelligence and big data -- two of the areas that the eight "entity listed" Chinese companies are engaged in -- have hitherto been among the hottest sectors for U.S. venture investors.

China, for its part, has also tightened the regulatory environment around inbound venture investments.

The result has been a drastic cooling of one of the world's most productive fonts of money and ideas. In the space of 20 years, Alibaba has gone from a scrappy startup based out of Jack Ma's apartment in the Chinese city of Hangzhou to the seventh-largest company in the world, valued at around $570 billion at the end of last year.

One question that flows from the growing U.S.-China venture estrangement is over displacement activities. Will U.S. venture funds find other uses for their money, perhaps among startup candidates in India and Southeast Asia, or will they focus more on nearer horizons? Somewhere, a Jack Ma of the future is waiting to learn the answer.

James Kynge is editor of Tech Scroll Asia, a newsletter on technology in Asia that combines the best reporting from Nikkei and the Financial Times. He is also the FT's Global China editor, writing about China's growing footprint in the world, and won the Wincott Foundation award for the U.K.'s Financial Journalist of the Year in 2016. His prizewinning book, "China Shakes the World," has been translated into 19 languages.

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