Silicon Valley venture capitalists are breaking up with China

DCM Ventures, a Silicon Valley venture capital firm, began investing in Chinese startups in 1999. This move delivered such blockbuster returns that DCM said it planned to “double” about his strategy to invest in China, the United States and Japan.

But last fall, as DCM sought to raise money for a new fund targeting very early-stage companies and promoting its cross-Pacific expertise, the company described plans to invest in the United States, Japan and South Korea, according to a fund. raising memo that was viewed by The New York Times.

China was not mentioned.

DCM's reporting is an example of an industry-wide shift between Silicon Valley investors and Chinese startups. U.S. venture capital firms that once saw China as the next frontier for innovation and investment returns are retreating, with some separating their China operations from their U.S. operations while others refuse to make new investments there.

The reversal comes amid tense relations between the United States and China as they battle for geopolitical, economic and technological primacy. The countries have engaged in a trade war amid a diplomatic rift, introducing tit-for-tat restrictions, including US moves to curb future investments in China and scrutinize past investments in sensitive sectors.

“It was an incredibly fruitful partnership for a long time,” Tomasz Tunguz, an investor at Theory Ventures, said of how U.S. venture capital firms had invested in China. Now, he said, most investors are “looking for places to invest those dollars because that market is essentially closed.”

A DCM spokeswoman said the strategy had not changed and that investments in China had always been “a smaller part” of the funds targeting very young companies. The company monitors U.S. regulations on China to comply, she added.

In Washington, actions to limit investments in China are piling up. President Biden signed one executive order Last year, investments by American companies in Chinese start-ups involved in artificial intelligence, quantum computers and semiconductors were restricted.

This month is one investigation by a congressional committee has sharply criticized five U.S. venture firms in a report outlining their investments in Chinese companies that helped facilitate human rights abuses and built weapons for the Chinese military. The committee did not accuse the companies of breaking the law, but urged lawmakers to pass legislation further restricting such investments.

“We cannot afford to continue financing our own destruction,” said Representative Mike Gallagher of Wisconsin, the Republican chairman of the House Select Committee on the Chinese Communist Party.

Rep. Raja Krishnamoorthi of Illinois, the top Democrat on the committee, said Congress could look at other areas where U.S. venture capitalists had invested in China, including biotechnology and financial technology.

Increasing scrutiny has pushed U.S. venture capital firms to make changes. Last year, Sequoia Capital, one of Silicon Valley's leading investment firms, which has invested in China since 2005, separated its Chinese operations in an entity called HongShan. The companies, which shared profits and other administrative operations, now function independently.

GGV Capital, another venture capital firm with a long history of investing in China, said in September it would separate its U.S. and Asian operations. It is also trying to sell its stakes in two companies that the congressional committee found are helping the Chinese military.

According to PitchBook, which tracks startups, deals for Chinese startups involving U.S. investors fell 88 percent from 2021 to 2023, from $47 billion to $5.6 billion.

These moves are a painful step back for the venture capital industry, which has transformed from a cottage industry to a global force over the past decade. China has been a key part of that expansion, with companies like Lightspeed Venture Partners, Redpoint Ventures and Matrix Partners entering the country.

Silicon Valley venture capitalists “have made a whole series of bets that the U.S. and China would converge,” said Matt Turpin, former China director at the National Security Council and a visiting scholar at the Hoover Institution.

Some China watchers trace the shift in sentiment against Chinese technology investments to 2016, when then-U.S. Commerce Secretary Penny Pritzker issued a report warning about unfair competition from China in the semiconductor industry.

John Chambers, CEO of networking giant Cisco who had expanded the company's operations in China, said he had seen the Chinese government become more aggressively involved with multinational companies by the time he resigned in 2015. Now a startup investor, he has chosen not to invest in Chinese startups and has strongly encouraged his 20 portfolio companies not to do business there.

“You can see the security problems and a government that has become a win-lose situation,” Mr Chambers said.

The difficulties of investing in China increased in 2020 when President Donald J. Trump tried to ban TikTok, which is owned by Chinese conglomerate ByteDance. Two American investors of ByteDance, Sequoia and General Atlantic, lobbied members from the Trump administration to allow the company to strike a deal so that TikTok could operate in the United States.

Last year, the congressional committee began investigating investments in China by Sequoia, GGV and three other U.S. venture capital firms: GSR Ventures, Qualcomm Ventures and Walden International. It concluded that they had invested $3 billion in technology that would ultimately help China's military and surveillance state, as well as other human rights abuses.

The commission's report said the companies had offered more than just money, helping Chinese companies go global and recruit talent, providing management expertise and mentorship, and giving them credibility.

One of those Chinese companies was Megvii, a facial recognition company backed by GGV. The United States has blacklisted Megvii for its use in surveillance of Uyghurs in China's western Xinjiang region. The United States has also blacklisted Yitu, a chip and facial recognition company backed by Sequoia's Chinese arm.

The report, which uses an acronym for the People's Republic of China, added that some Silicon Valley venture firms noted in their internal memos the “strategic priorities and support of the Chinese government as a positive factor weighing in favor of investments.” .

In response, Sequoia and GGV pointed to the breakup of their Chinese businesses and divestments in the region and said they had complied with the law. For example, GGV says it wants to sell its stake in Megvii. Qualcomm said its investments in venture capital arms amounted to less than 2 percent of the funds discussed in the report. Walden International and GSR Ventures did not respond to requests for comment.

Any divorce from a venture capital firm is complicated. The companies invest from funds with a term of ten years. Some companies, including Sequoia, are holding on to their investments even longer. Selling shares in young companies can be difficult because the companies are privately owned. Some investors have said Beijing has pressured them not to sell their stakes in Chinese companies.

Beijing's practice of using companies for its own purposes, such as helping with surveillance and modernizing its military, has created further challenges.

“These are not private sector companies in the traditional sense of the word,” said Rep. Krishnamoorthi. “It's just a very different type of entity than we've ever seen before.”

Josh Wolfe, an investor at Lux Capital, a venture capital firm based in New York and Silicon Valley, said it is unfair to punish U.S. companies for assumptions made years ago about their investments in China.

“But it would merit further investigation if, as American investors, they were recently ignoring the growing moral, technological, economic and military conflicts we face” with China, he said.