Chinese venture capitalists are retreating from Silicon Valley’s start-up scene as the Trump administration ramps up scrutiny over critical U.S. technologies.

Chinese President Xi Jinping (R) and US President Donald Trump attend their bilateral meeting on the sidelines of the G20 Summit in Osaka on June 29, 2019.
San Jose-based virtual reality start-up uSens was ramping up quickly until late last year when issues over the U.S.-China tech cold war intervened, and the fast-charging company hit a dead end.
With patented computer vision technology for smart TVs, mobile devices and cars, an experienced team from Apple, Intel, Samsung, Oracle and Amazon, and $27 million in venture funding in the past three years, uSens had sealed a partnership with San Francisco-based Pico Interactive to bring interactive hands gesturing to its virtual reality headsets. The start-up, formed by CEO Anli He and her husband, CTO Yue Fei, had scaled up from their living room and a Kickstarter campaign in 2015 to 60 staff in Silicon Valley, three offices in China and $2 million in revenue.
Their venture funding in three rounds came from a mix of leading U.S. and China venture funds investing in early stage technologies. Among them were cross-border investor IDG Ventures, Fosun Kinzon Capital, backed by Chinese conglomerate Fosun, and venture funds including Shenzhen-based Maison Capital and Lebox Capital in Beijing.
Now uSens faces the prospect of shutting down after failing to raise more capital, despite having a term sheet for a new venture infusion. The start-up’s office was shut down in the U.S., and everyone was laid off except for one salesperson. Remaining staff, including the co-founders, moved to China.
“Terrible things were happening,” said He, recalling the succession of events. “Now we are trying to survive.”
She blames fallout from the U.S.-China tech cold war for investor reluctance, both from China and American funds, to put more money into her high-tech start-up. “It was too easy to get capital from China-backed venture capitalists that had investment branches in Silicon Valley and liked to invest in cross-border deals at pretty high valuations,” she noted, adding that “lots of Chinese investors withdrew from the U.S., and then U.S. investors decided not to invest, too,” in U.S.-China-rooted start-ups.
To top off the misfortunes, venture capital firm Digital Capital Horizon, run by Stanford physics professor Shoucheng Zhang, dropped out of the picture as a potential source of funds when the professor, a friend of the founding couple, died in a suicide in December 2018 after a long battle fighting depression.
Fallout in Silicon Valley
Issues over national security threats and competition with China for future technology leadership are stopping the flow of China investment in tech companies. In the process, stifling cross-border U.S.-China collaboration that has long fueled next-generation innovations is being stifled.
The outbreak of the coronavirus is taking its toll, too, as travel to and from China for firms active in the Mainland is being restricted.
Jay Eum, co-founder and managing director of TransLink Capital in Palo Alto, California, points to three roadblocks to continued China investment in U.S. tech. Angel investment from China has “completely dried up,” while minority investments by VCs have become “extremely difficult.” The parade of acquisitions by China’s tech titans such as Alibaba and Tencent over the past few years is gone and most such deals “are not even attempted anymore.” He sums it up this way, China has “become a negative for all start-ups in the ecosystem. China is off limits.”
uSens is hardly the only Silicon Valley-type start-up with China connections that is caught in a cash crunch. Dozens of high-tech start-ups in the U.S. are stuck in getting to the next level of growth without more capital from their previous Chinese sources. These start-ups are victims of heightened political tensions over China’s rise as a tech superpower contender and potential risks to America’s global leadership.
Venture capital deals in the U.S. with at least one China investor fell to 163 deals and $6.5 billion of investment in 2019, according to private equity data tracking firm Preqin in London. That’s down from 236 deals in 2018, which had amounted to $10.8 billion. This China-to-U.S. venture boom started in 2014, when 157 deals totaling $2.7 billion were tallied up and grew rapidly.
Fueling the rush were several well-known, privately held Chinese VC firms such as CSC Upshot, ZhenFund and Kai-Fu Lee’s Sinovation Ventures, Chinese conglomerate Tencent, financial institution Ping An, accelerator TechCode in Beijing, numerous angel investors and state-owned funds such as Shanghai International Group’s Sailing Capital.
They targeted deep tech sectors important to global competitiveness such as artificial intelligence, robotics, autonomous vehicles, virtual reality and gene editing, according to a new report by the New York-based Rhodium Group, which tracks U.S.-China investment trends. Now all including tech giant Tencent, one of the more active investors in leading edge U.S. technology companies as a backer of Tesla and Uber, has pulled back.
Trump crackdown
Investment from China into U.S. start-ups slowed last year after the Trump administration in August 2018 stepped up vetting of deals over national security issues in American critical technologies, such as artificial intelligence and autonomous navigation that could be used for military purposes. The Rhodium Report notes that the U.S. has not found any “smoking gun” evidence that Chinese VC in the U.S. has led to leakage of sensitive U.S. technology to China that could harm national security.
President Donald Trump meets with China’s President Xi Jinping at the start of their bilateral meeting at the G20 leaders summit in Osaka, Japan, June 29, 2019.
Nevertheless, China venture investments and acquisitions in the U.S. face greater scrutiny by Washington, D.C. regulators, and start-ups are getting pinched. In November 2018, the Trump administration introduced pilot regulations to expand the scope of foreign investment transactions reviewed by CFIUS (the Committee for Foreign Investments in the U.S.), requiring notifications and clearance for transactions in emerging technology sectors such as AI, autonomous vehicles, robotics and augmented reality.
This stepped-up scrutiny was extended to include deals involving minority stakes below 10%, which takes in venture deals, many of them from China. The vetting also encompasses detailed information on venture fund structures and board seats, and has led to greater caution by U.S. venture firms about inviting limited partners with Chinese citizenship, the Rhodium report notes.
Additionally, lawmakers passed new export controls in August 2018 to introduce new safeguards under the Foreign Investment Risk Review Modernization Act. The act modernizes and broadens the authorities of the President and CFIUS to review and take action involving national security concerns over foreign transactions in emerging U.S. technologies such as machine learning, advanced battery technology, gene editing, nanotechnology and augmented reality that could be leaked to foreign entities such as through joint ventures with Chinese firms.
Uncertainty over how emerging and foundational technology are defined and long, cumbersome reviews of transactions have delayed and stopped funds to cash-strapped start-ups that are hanging on. Final regulations by the Department of the Treasury are set to become effective by February 13, 2020.
Meanwhile, some China acquisitions involving U.S. companies that were made several years ago are now under retroactive reviews. For instance, a deal by Shanghai-based social media service Musical.ly to buy short video app TikTok in 2017 is being re-examined by CFIUS, the Committee on Foreign Investment in the U.S.
A fractured relationship
This increased focus on national security issues and competitive threats has led to a decoupling or split of venture capital firms and their spending to opposite coasts of the Pacific, China on one side and Silicon Valley on the other. In turn, long-time co-investment and collaboration is breaking apart and impacting the pace of technology innovation.
Founders of U.S. tech start-ups are thinking hard about accepting Chinese venture capital and are carefully considering any offshore corporate structure to avoid being labeled as Chinese companies. Ben Sun, CEO and founder of medtech startup Evoco Labs in Menlo Park, makes AI-empowered hearing aids and his product was a hit at the recent Consumer Electronics Show. A former product engineer at Apple, he has a head start in raising capital and is now weighing his best options for sourcing venture money when he might have accepted China VC in the past.
Venture capital and angel investment for U.S. start-ups with China connections — through teams combining U.S. and Chinese talents, R&D operations in both countries, and experience in both markets has been hit. Several prominent U.S.-China venture and angel investor firms have retreated from U.S. investing and returned to Beijing including ZhenFund with $1 billion under management and Sinovation Ventures with $2 billion.
Moreover, ZZ Ventures, a San Francisco venture shop investing in technology start-ups and backed by real estate developer Zhongzhi Enterprise Group, has shut down and is selling most of its U.S. portfolio companies. Former managing director Tracy Wang is staying put in the San Francisco Bay Area, and expects to soon launch a new, U.S.-focused fund Agate Capital Partners.
Further capital crunches have cropped up as U.S.-anchored venture firms with Chinese limited partners have become more cautious about accepting more money from China for new funds. New restrictions keep foreign limited partners in funds from weighing in on prospective deals, getting access to investment data, and allow only U.S. citizens to become leading partners at venture firms on American turf.
Start-ups that previously depended on China capital in the U.S. are now looking to alternative funding. “U.S. VCs are taking advantage of the funding gap while corporate VC arms from the Pacific Rim are jumping into the pool,” says Thomas Gaynor, a partner at law firm DLA Piper in Silicon Valley.
SoftBank Group Corp. Chairman and Chief Executive Officer Masayoshi Son speaks during a press conference on November 6, 2019 in Tokyo, Japan.
One rich source for funding is Japanese conglomerate SoftBank and its $100 billion Vision Fund, which has invested about $80 billion in three years and is gearing up to raise another multi-billion fund. Overall, corporate venture capital led by such giants as Google, Intel and Salesforce, is on the upswing, reaching a 15-year high in 2018 and almost double the number of deals from the previous year, according to the National Venture Capital Association.
U.S. venture capital, meanwhile, is holding up, tracking at 4,633 deals totaling $105 billion in 2019 compared to 5,656 deals and $102 billion the year before, according to Preqin. In contrast, China venture capital plunged last year to 3,348 deals and $49 billion from a peak in 2018 5,356 deals totaling $107 billion.
Just a year before, China and the U.S. were nearly on par in spending for start-ups within their countries. Now, a gap between these two superpower nations is widening as the effects of an economic slowdown in China coupled with frictions over the U.S.-China tech war take effect. It’s start-ups that are caught in the middle.