“We are not going to die without the money. But we will not live well either,” she said. “Scale and speed are critical for any start-up, neither of which can be delivered without money.”

Around the world, doors are shutting on Chinese investment

The four-year-old company, which has raised over US$10 million from US and Chinese investors, is caught in the middle of a tech cold war between the world’s top two economies. A digital iron curtain was drawn when US President Donald Trump moved against Chinese telecoms giant Huawei Technologies, citing national security concerns.

The tensions are not only forcing corporations along the global supply chain to choose sides, but are starting to affect early-stage investment patterns and start-up innovation.

Silicon Valley start-ups used to open their arms to Chinese investors, both for their fat checkbooks and for their expertise in navigating one of the world’s biggest and most complicated markets. But the escalating trade war has made them walk away from China-linked cash for fear of triggering heightened government scrutiny. Chinese investors, who were keen to court US-based start-ups for more advanced technologies and higher skilled talent, have started to scale back or put on hold their plans to avoid the US government’s scrutiny.

Cross-border venture capital (VC) investment has entered a new era, in which the nationality of funding is something tech start-up founders need to think about, said Yi Min, president of the Boston Chinese Investment Club, which was created in 2017 to connect nearly 150 potential investors from China, including Zhangjiang High Tech Park, Shanghai’s answer to Silicon Valley, and start-ups and innovators mostly from the Boston area, home to MIT and Harvard University.

“The trade tension and US government’s regulations to limit Chinese investment in American companies has a chilling effect on our community. An increasing number of people, from the very beginning of their start-up business, will have to choose sides: Team China or Team US?” said Yi, who added that start-ups used to be able to leverage resources and expand to markets in both countries to achieve the fastest possible growth.

One of his club’s China investors said in June that he had put all financing for US projects on hold. And the feeling is two-way. A Silicon Valley start-up told Yi in the spring that it prefers American investors for the coming around of funding, worrying that US-China tensions will bring unnecessary trouble and potential business risk if it goes with Chinese investors.

After hitting record highs in deal values and deal counts in 2018, Chinese VC investment in the US has taken a sharp turn downward amid regulatory headwind combined with political uncertainty and slowdown of Chinese economy, according to PitchBook, a research company covering the private capital market.

US venture capital activities with Chinese investor participation took off significantly starting in 2015, peaking at US$14.5 billion in 2018. But investments plunged to US$4.5 billion in the first half of this year after a US$8.2 billion total in the same period last year. The same pattern can be found on the other end. US investor participation in Chinese VC has dropped from US$38.7 billion in the first half of 2018 to US$4.5 billion in the same period this year.

How Chinese firms are preparing for a potential US break-up

Behind the flagging momentum is the Trump administration’s effort to control technological outflows that could dampen American tech supremacy and threaten national security. A report published by a unit of the US Department of Defence in January 2018 portrayed Chinese VC investors as players in a technology transfer scheme and warned that Beijing could access “the crown jewels of US innovation” via early stage investment.

The report, which used third-party data, cited Chinese investors’ focus on US emerging technology, such as artificial intelligence (AI), robotics, and augmented or virtual reality, which are fundamentally dual-use in nature. The report also listed a handful of China-based investors operating in Silicon Valley – Westlake Ventures, Sinovation Ventures and Hax – and hints at “government sponsorship” for groups like Sinovation, an investment firm founded by Kai-fu Lee, a leading AI expert and former Google and Microsoft executive. It shut its office in Palo Alto, California, in May after years of operation in the US, the network CNBC reported.

Sinovation declined to comment on the report. But Lee, a Taiwanese-born American venture capitalist, told Bloomberg in November 2018 that he would withdraw from the US if relations with China deteriorated further.

Other China-rooted investment firms still in operation are trying to keep a low profile.

The ZGC Innovation Centre in Silicon Valley, which is backed by the state-owned Zhongguancun Development Group, used to have Chinese-language signs and a Chinese flag at its office in Santa Clara, California, but they have recently disappeared. The centre was set up in 2016 with in-house start-up incubators and accelerators under the goal of “tapping into global innovation resources”.

A year ago, Trump signed into law the Foreign Investment Risk Review Modernisation Act of 2018 (FIRRMA), which expanded the powers of the cross-agency Committee on Foreign Investment in the United States (CFIUS) to investigate mergers and acquisitions by foreign buyers, including attempts to purchase minority stakes in US start-ups.

A high-profile example of CFIUS’ power was its undoing of Beijing Kunlun Tech Co’s acquisition of the popular gay dating app Grindr after US officials raised national security concerns about its ownership.

US says Chinese ownership of Grindr is a national security risk

The uncertainty of making deals in the US has led to a significant decline in Chinese investors in Silicon Valley, which venture capitalist Edith Yeung witnessed first-hand.

“I saw very, very few Chinese this time while just two years ago Chinese faces accounted for one-third if not half of the attendees at all kinds of start-up demonstrations in Silicon Valley,” said Yeung, the Hong Kong-based managing director of Proof of Capital, a block-chain-focused VC fund, who was in northern California for business in early August.

She recalled the frenzy of investing in Silicon Valley start-ups and recounted how a Chinese investor immediately jumped in to offer US$1 million to a proposed company that had nothing more than a PowerPoint presentation.

“It did not make sense to me at all, but the valuation of Chinese start-ups were so high at the time, which made start-ups in the US a much cheaper choice,” Yeung said.

Powered by Beijing’s initiative of “mass entrepreneurship and mass innovation” – a top-down approach to making technology a new economic powerhouse through tax cuts and other preferential policies for start-ups – money flooded into early stage investments, driving up the valuation of Chinese start-ups and also encouraging investors to look to Silicon Valley for potential projects.

US venture capital activities with Chinese investor participation immediately skyrocketed to US$12.3 billion in 2015 from US$2.8 billion the year before. The trend slowed a bit to US$8.6 billion in 2017 because of China’s efforts to restrict capital outflows to protect the value of the yuan.

“But now, making no investment outside China has become a politically right thing to do for many Chinese investors,” said David Cao, whose company F50 introduces global investors to Silicon Valley start-ups.

Cao said F50’s Global Capital Summit, which was expected to attract nearly 1,000 investors and entrepreneurs to Silicon Valley in mid-October, is likely to lose traction among Chinese investors. A similar event F50 organised in April saw only two dozen investors from China, less than one-fifth the number attending last year.

Trump’s crackdown on Chinese investment in US sparks venture-capital shift

US start-ups founded by Chinese and ethnically Chinese US citizens, who are sought after by Chinese investors because of language and culture issues, are becoming the most vulnerable. “Just like Chinese investors prefer Chinese start-up founders, US investors have always favoured start-ups founded by local people,” Cao said.

“But the trade war has made Chinese and China an obvious label,” he added. “Every investor will think twice about the risk and uncertainty behind the label before making any decisions.”

The start-ups with the best talent, best ideas and track record of success are unlikely to be affected even if they have Chinese roots. But the less fortunate ones are expected to shift their expansion focus back to China, if not move back entirely.

While the situation is a lose-lose for innovation in both the US and China, there is disagreement about whether one country’s start-up industry can exist relatively independently.

Alex Frederick, an analyst with PitchBook, said the cooling of Chinese VC investment in the US would not have a major impact because abundant money is still flowing in. PitchBook data shows that in the first quarter of this year, capital investment in the US was just shy of 25 per cent of the record-breaking amount achieved in 2018, putting 2019 roughly pace to match the remarkable amount for VC investment of US$132.1 billion in 2018.

But others expressed concern that losing access to Chinese financing will slow down the creation of a new round of US companies, including Uber and Airbnb, both of which rely on Chinese markets and money to achieve high valuation.

In addition, many venture capitalists said they can’t afford not to be invested in the China market. Xiao Jianxiong, founder and CEO of the Chinese autonomous driving start-up AutoX, which has a research and development centre in Silicon Valley, said venture capitalists from Singapore, Japan, South Korea and the Middle East were still showing great interest in Chinese start-ups because they can offer the highest returns in the world.

US regulators scupper another Chinese acquisition

For investors and entrepreneurs in China, the US still has the best start-up system – a complete chain from basic research to transforming technology to commercial products on the market. Cici Zuo’s team still wants to keep fingers in both the US and Chinese pies.

She has been travelling to China to raise funds for a plan that could involve dual headquarters, one in China, one in the US. Being caught up in a conflict between two superpowers has added to her company’s challenges, but she maintains her perspective.

“Running a start-up business has always been hard,” she said. “That is the life we chose to live.”

Additional reporting by Sarah Dai