Long before Bob Xu became one of China’s most successful angel investors, he made his name as an entrepreneur, co-founding test preparation group New Oriental Education (EDU), to help Chinese students pursue a degree in the U.S.
That success, propelled his company to a public listing on the New York Stock Exchange in 2006. Since then, he has spent more time in Silicon Valley, first bringing Chinese entrepreneurs over to connect with their American peers, then investing in early-stage startups through ZhenFund, a venture capital firm he co-founded in collaboration with Sequoia Capital China.
In its eight years, ZhenFund has developed a portfolio of 700 companies, including China’s popular e-commerce app RED and Virgin Hyperloop One. Last year alone, it invested $229 million in 14 American startups, according to PitchBook.
But the fund is putting a stop on its U.S. investments — a decision prompted by the increasing scrutiny of Chinese investments in the U.S. and the Committee on Foreign Investment (CFIUS) reform.
“Since inception, ZhenFund has always been a China-focused seed fund. We do not currently have nor foresee having any future strategies related to investing in the United States,” ZhenFund said in a statement. “Our previous overseas investments have focused mainly on Chinese entrepreneurs who have studied or worked abroad, or whose products target the Chinese market.”
The Trump administration dramatically expanded the scope of its CFIUS review program in November 2018, subjecting companies to a mandatory review process that was once voluntary. For the first time, the program extended to minority investments and placed extra scrutiny on foreign investments in emerging technology, especially those from China. That resulted in a lengthy, 45-day review period with processing fees, creating additional strains for foreign investors.
“Basically, that makes investment impossible,” said Jiang Wei, a former U.S.-based venture partner of ZhenFund and founder of Momentor Ventures, speaking at the China Institute in New York in September. “Because no good deals could wait for 45 working days. Just really bad deals could wait, but we don't want to invest anyway.”
ZhenFund’s fate illustrates the increasing challenges Chinese investors face as they navigate the political hazards that come with seeking investment opportunities in the U.S, in the midst of a trade war between Washington and Beijing. While the Trump administration may be considering potential limits to investment flows between the two countries, investment data suggests the flows have already dried up. Last year, Chinese VC funds invested $14.8 billion in U.S.-based startups, a record total. In the first nine months of this year, that number was slashed by two-thirds, according to data compiled by PitchBook.
“No one wants to attract any more attention. They’re not going to come out and declare, ‘hey we’re shutting down,” said Edith Yeung, co-founder of VC fund Proof of Capital. “The reality is, that I don’t see [Chinese funds] doing any activities in the U.S. last year at all. My interpretation is, basically, they gave up.”
Independent venture capital funds aren’t the only ones feeling the heat. The investment arm of Chinese tech giant Tencent, with stakes in American tech firms including Tesla and Snap, has substantially slowed down its investment in the U.S. Over the past five years, Tencent on average, invested in 15 U.S. companies a year. But it’s only closed two deals so far this year, including a $150 million investment in Reddit in February. Instead, Tencent’s taken its money to other regions.
“I see Tencent people in Singapore more, much more often than I see them in San Francisco,” Yeung said.
Chinese money comes and goes
The spike in Chinese investments in the U.S. coincided with the booming tech scene back home. In September 2014, China’s Premier Li Keqiang started a national campaign to encourage college students to start their own businesses. Government incentives fueled startups and capital flows across the country.
Many investors with an overseas education background, looked to Silicon Valley as home to cutting-edge technology and innovative communities. The year following Li’s speech calling on “mass entrepreneurship and innovation,” China’s VC investments in the U.S. quadrupled.
Yeung recalls being surprised, when a Chinese investor committed to an untested drone company, at a Demo Day in California, during what she called the heydays.
“They barely had a prototype and maybe did like one, one or two flights. The valuation was $16 million. On the spot, the Chinese investor said ‘sure, count me in for half a million,’” she said.
Yeung added that valuations of U.S. companies were cheap in comparison to startups back home. Limited capital controls at the time also made it easier for investors to move money overseas.
Chinese investors have grown more cautious, along with the escalating tensions between the U.S. and China. ZCG, for example, a state-back VC and incubator, opened an innovation center as a co-working space in Santa Clara, California in 2015. The three-story building used to have signs showing its Chinese origin, but those signs were quietly taken down this year.
Not a big deal for US startups
Chinese investors often pitch to American entrepreneurs their ability to help them expand to the mass Chinese market. While U.S. startups may miss that benefit, a decline in investment from China won’t be too much of an issue for startups, according to analysts.
“For companies that are looking to expand globally, having a Chinese investor who can give a good introduction into the Chinese market is absolutely critical,” said Alex Frederick, a senior analyst at PitchBook. “But overall, capital is being invested very strong in the U.S. from us investors. So I would say, a slowdown of Chinese participation in U.S. companies probably aren't going to hurt.”
It’s the Chinese investors who are trying to adjust to the change. Some have to figure out ways to restructure their funds by appointing U.S. citizens as partners to circumvent the CIFUS review. As CIFUS targets all foreign investments, investors from other countries have set examples on how to build trust with U.S. regulators. Softbank, for example, agreed to give up a board seat on Uber in April.
“We have seen non-U.S. investors that are in some of these technology areas said, we don't need observer rights, or we don't need a board seat, or we don't need access to data,” Alan Enslen, an international trade lawyer at Baker Donelson, told Yahoo Finance.
As the pilot program of the CIFUS approaches its one-year mark, it’s expected to continue to dampen the interest of Chinese investment. The new CFIUS program is trying to address the technology transfer issue, a centerpiece of Trump’s trade talks with China. The Office of the U.S. Trade Representative has accused some Chinese funds using VC funding in startups to steal American technology in the Special 301 Report.
In fact, the CFIUS review could have a longer-lasting impact on young companies than trade negotiations or Trump.
“Despite political winds that change here and there, I would say that the foreign direct investment process, and the restrictions and requirements, that's not something that's likely to go away,” said Enslen. “It's a law. So there really isn't the same ability of an administration to negotiate away this process.”
Correction: A previous version of the story said Jiang Wei was a former partner at ZhenFund. He was a former venture partner.