How important are American investors to China's startup ecosystem?

This is The Startup Breakdown, the newsletter where we learn, laugh, and love startups. By joining this growing community of hundreds of future startup aficionados (think i spelled that right?), you're getting a beachside view of the ocean that is the startup and VC scene. This ain’t your grandpa’s newsletter, so prepare yourself for an inbox full of 4/20 jokes and Succession references.

Happy Tuesday, folks.

In case you needed further proof that we’re in a simulation:

Update on American VC Investments in China

Despite getting very cozy with Xi Jinping in SF just a couple of months ago, Biden has made it clear that China is a legitimate tech threat, both commercially and in military applications.

Last fall, Biden issued an order forbidding American venture capital and private equity firms from funding Chinese startups operating in sectors deemed of national security importance, such as semiconductors and AI.

Unfortunately, a new House report revealed that much of the damage was already done:

• GGV Capital

• GSR Ventures

• Qualcomm Ventures

• Sequoia Capital China

• Walden International

invested a combined $3 billion into Chinese chip and AI companies over the last few years, playing instrumental roles in the impressive progress being made. It’s feared that billions of unaccounted additional dollars were funnelled through a web of intermediate companies.

US officials have been concerned over the value of American investors not just for the obvious capital deployment, but also for the network and knowledge benefits that these well-connected investors can provide, and the report provides ample support for this argument.

Even more concerning for the United States is that several of the companies receiving the venture backing out are explicitly blacklisted:

• Megvii

• Intellifusion

• SenseTime

• DeepGlint

• Yitu

are all named for their roles in enabling human rights abuse and government surveillance efforts.

Several of these financial positions have since been exited, but there are still billions of American dollars supporting R&D in these companies, and some of the mentioned firms were reportedly slow to work with regulators during the investigation because they feared the consequences. From the CCP.

To be very clear, the report does not accuse any of these firms of breaking the law. However, it wouldn’t be shocking if there were still some hidden wirings as investors wade through the distressed venture market; Nvidia was recently found to be jumping through hoops to get their chips to China despite a chip ban.

The investment ban may be codified, and though likely it won’t halt all flows of capital, it will leave a dent given how critical this funding was to incubating Chinese startups.

US VCs invested more than $14 billion in Chinese companies in 2022, nearly 45% of the nation’s total fundraising. Last year, it’s estimated that this might have fallen as much as 10x.

This trend is already concerning, but to make matter worse, industries like AI and semiconductors are particularly capital-intensive, meaning being cut off from funding could be a crowbar to the kneecaps of China’s ambitions to be global leaders in these spaces.

While Chinese startups will be hurt by these geopolitical tensions, domestic companies may see an uptick in interest in the absence of some of these competitors, possibly even culminating in larger check sizes or more being written.

But at the very least, it will make investors jump through at least one extra hoop in their pursuit of IRR abroad.

Biden's order limits American VC and private equity investments in Chinese startups in critical sectors like semiconductors and AI, with past investments already bolstering China's tech advancements. The move aims to curb the strategic flow of capital and expertise but faces challenges in fully stopping investments, highlighting both the impact on Chinese startups and potential opportunities for domestic companies.

Cheers to another day,

Trey