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Chinese Investment Flows to Silicon Valley Venture Funds

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Chinese investment in U.S. venture-capital funds is flowing, demonstrating that economic ties between Silicon Valley and China remain deep despite political and national security risks, according to investors, government officials and a new report.

Chinese investment is on pace to reach about $880 million this year, the second-highest level in at least a dozen years, according to the think tank Foundation for Defense of Democracies. The report, a novel effort to quantify the opaque flow of money from China to U.S. venture-capital firms, shows Chinese government entities, funds, private individuals and corporations have invested at least $4 billion into U.S. venture firms since 2010, with at least another $3.5 billion going to U.S. private-equity firms.

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Silicon Valley investors and national security analysts say Chinese capital continues to back U.S. venture-capital firms large and small, sometimes accounting for a fraction of a venture fund and at times much more. U.S. government officials say their primary concerns have less to do with the amount invested, but are more about the investors’ personal and business relationships in Beijing, ability to access technical information and influence at the venture-capital firm.

The issue, said government officials, is that the Chinese can use their roles as investors to gain know-how for launching a startup or scaling a technology company. Such insights can inform how Beijing funds and develops technology in areas strategically important to the U.S., such as semiconductors and artificial intelligence, according to the think tank report.

Chinese capital is found in large global funds

Sequoia

Capital and Lightspeed Venture Partners, and smaller Silicon Valley firms including Playground Global, GSR Ventures, Foothill Ventures and 11.2 Capital, according to the report and investors at those firms.

“I think the Chinese are as aggressive as ever” in targeting U.S. startups, said

Michael Brown,

outgoing director of the Defense Department’s Silicon Valley Defense Innovation Unit and author of a 2017 report that drew national attention to the role of Chinese capital in U.S. startups.

Foothill Ventures said Chinese investors contributed 1.59% of its current assets under management, and GSR Ventures said less than 5% of its U.S. fund came from China. Chinese investors are contributors to

Lightspeed’s

China fund only, and Sequoia’s China unit operates independently, spokeswomen for the firms said. The other firms declined to comment.

The think tank report’s findings highlight an area of resilience in the U.S.-China relationship as the two countries decouple their economies and U.S. policies aim to limit Chinese investment in U.S. technology sectors. According to the report, Chinese investment this year is set to be around nine times greater than a decade ago and come in below only 2020, when more than $1.2 billion flowed to American venture-capital funds.

Tracking Chinese investment in the U.S. is challenging because the limited partners who fund venture-capital firms often don’t make public disclosures, sometimes use labyrinthine structures to shroud investments and frequently ask firms in which they have invested to keep their identities secret. The report’s authors said the dollar figures undercount the actual total.

“Limited partner capital flows are grossly underestimated for their strategic value and effect,” said Nathan Picarsic, senior fellow at the Foundation for Defense of Democracies who co-wrote the report, called “The Weaponization of Capital,” along with his colleague Emily de La Bruyère. “Their influence shapes how the venture capitalist thinks, because the limited partners are the venture capitalist’s customers.”

The Foundation for Defense of Democracies is a Washington-based nonprofit with conservative leanings; its work advocates an aggressive U.S. response to challenges posed by China.

“China is always opposed to the U.S. generalizing the concept of national security and strengthening unreasonable investment review,” said Liu Pengyu, spokesman for the Chinese embassy in Washington. He said the U.S. has used national security arguments to “put obstacles in the way of normal investment.”

Involvement by Chinese investors varies. Many are seeking a financial return and don’t have or want access to nonpublic information about individual startups, venture investors said. Other limited partners request introductions to startup founders or presentations from them, and get quarterly updates on startups’ progress and insights into technology sector trends, they said.

In a 2020 lawsuit, former partners at Silicon Valley venture-capital firm Hone Capital allege that the firm’s Chinese investor, China Science and Merchants Investment Management Group Co., Ltd., directed them to bring around 20 startups each quarter to China to pursue partnerships, joint ventures and additional investment. The lawsuit, which is ongoing, alleges the demands were problematic because of “legal issues regarding sharing sensitive technology with China.”

“They leveraged the system in the U.S. to gain access to more than 300 companies,” said Purvi Gandhi, a former Hone Capital partner.

J. James Li, a lawyer for China Science and Merchants Investment Management Group, said the allegation is false and an attempt by the firm’s ex-partners to gain leverage after his client sued them for breach of fiduciary duty.

The U.S. government can halt or unwind certain limited-partner investments from China. Legislation from 2018 handed the responsibility to the Committee on Foreign Investment in the U.S., a Treasury Department-led panel of government agency representatives that reviews foreign investments for national security concerns. The legislation, and efforts broadly to limit Chinese access to U.S. technology know-how, has had bipartisan support. But the challenges in identifying the limited partners behind venture-capital funds and understanding the national security risk they present have created a blind spot that hinders enforcement efforts, national security officials said.

Silicon Valley venture firm TSVC, founded by graduates of China’s Tsinghua University with assistance at one point from the university’s funding arm, made its mark with an early bet on Zoom.



Photo:

Jason Henry for The Wall Street Journal

President Biden on Thursday ordered tougher scrutiny of investment in the U.S. from China and other nations deemed adversaries, the latest move to combat what many in the administration see as China’s unwanted access to key U.S. technology innovation. The executive order is intended to sharpen Cfius’s focus on reviewing of foreign investment deals that involve key technologies, including those built by venture capital-backed startups such as semiconductors, artificial intelligence and biotechnology.

The order also calls on Cfius to scrutinize investments for cybersecurity risks, where China is active, and the possibility of giving a foreign investor access to Americans’ sensitive data.

The National Security Council has called for strengthening and broadening Cfius’s review, according to people familiar with the matter. That includes looking at sectors where an adversary has made multiple investments—even small investments through venture capital—that would give it an advantage in that particular technology, the people said.

As China’s economy slows, national security officials said they expect Chinese investment in the U.S. to accelerate, particularly in clean energy and semiconductors, sectors where the U.S. government has increased investment.

The financial success of a long-running U.S. venture-capital firm can further aid China’s technology ambitions, the report said. Silicon Valley venture firm TSVC, founded by graduates of China’s Tsinghua University with help at one time from the university’s funding arm, made its mark with an early bet on

Zoom Video Communications Inc.

A China-based affiliate of Tsinghua University on its website touted TSVC as a top-performing technology fund for mainland China in Silicon Valley, and said TSVC is using its capital and connections to advance China’s semiconductor industry in collaboration with local governments.

Spencer Greene, a general partner at TSVC, said the firm has no role in supporting China’s semiconductor industry or collaborating with any government and that the Tsinghua University affiliate was defunct, although public registries show it still has an active business license.

Write to Heather Somerville at [email protected]

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