Venture Capital

How Venture Capital in the US and China is Shifting

Dr. Peter Hsieh is a General Partner at Acorn Pacific Ventures, an early stage venture capital firm with a focus on global technology strategies in North America and Asia. Peter is one of the few venture capitalists with ten years of direct living and venture capital experience in Silicon Valley, and another ten years of the same in Greater China. He is an AAMA Cradle Plan mentor, and Vice Chairman of Monte Jade West.

There’s no shortage of headlines amidst the escalating US-China trade dispute. Even with the recent outbreak of Coronavirus, the US administration seems to have no intention to lift tariffs on China. The Chinese government is also implementing currency controls to prevent capital outflow that we have observed in the last five years. Additionally, home-grown trends continue to influence the trajectory of cross-border investments. In the wake of ongoing speculation, investors in both countries are left to navigate an increasingly complex web of political and economic variables.

Despite this ongoing uncertainty, venture capital (VC) flows between the US and China hit an estimated $22 billion in 2018, surpassing the $18 billion generated through direct foreign investment – for the first time in history. More specifically, between 2017 and 2018, US-owned firms doubled their investment in Chinese companies, reaching a record of $19 billion.

Recent reports indicate Chinese startups netted the smallest share of global VC investment in years. But there's much more behind these often contradictory trends that warrant exploration. Amid these shifting global dynamics, the question remains: what's next? In answering this question, it’s important to explore past and present VC trends in both countries while looking to emerging trends for a glimpse of what's to come.

How China’s venture capital ecosystem is changing

Over the last two decades, China has been the birthplace of several unicorn startups, or companies exceeding a $1 billion valuation. Although many of these high-profile juggernauts failed to thrive despite robust fundraising, the nation still has more unicorn startups than the US, sitting at 206 versus America’s 203. Together, they represent 80% of the world’s unicorn startups.

Many US-based VC firms have now established outposts in China. What’s more, many of them with offices in China have undergone a gradual decoupling from their American home base in response to lucrative opportunities in China. As such, the Chinese side of US-owned VC firms has seen independence equitable to Chinese-born counterparts like Sequoia.

Along with high-profile trade challenges, China faces home-grown headwinds that have begun to influence VC flows domestically and abroad.

Lack of Innovation

According to many Chinese investors, a lack of innovation is one of the primary forces behind the recent decline in VC tech investment. Despite the nation spawning several multi-billion dollar companies like TikTok owner ByteDance and Ant Financial, VC sentiment continues to falter, and the numbers confirm it. According to Preqin, VC investment in China was $9.7 billion in the second quarter of 2019. This figure is down from $41.3 billion generated in the same period last year, reflecting a 77% decline.

Slower GDP Growth

According to the New York Times, the 6.8% GDP growth reported by Chinese officials “represents the slowest pace [of growth] in China since the beginning of modern quarterly record-keeping in 1992.” Although this GDP growth appears remarkably high to outsiders, China's economy was growing over 12% in 2010, recovering from "lows," and averaging 6.5% after the 2009 financial crisis. Because the country has little experience with downturns, the effect on Chinese VC markets is poorly understood - driving further uncertainty.

Growing Late-Stage Investment

According to a Preqin report, eight Chinese “decacorns,” or private companies exceeding a value of $10 billion, attracted investment in 2018 - up from only one in 2017. As investors pour more capital into these later-stage tech companies, much less is trickling down to those startups looking to raise money in vital early-stage rounds.

VC Investment in Southeast Asia

In response to its current positioning, Chinese VC firms have begun to deploy capital in alternative markets. A long-occurring manufacturing shift has also altered the investment landscape. Chinese investment in Southeast Asia continues to expand rapidly in response to the region’s maturing mobile market, supply chain shift, and tech scene saturation in China. According to fintech firm Refinitiv, Chinese investment in Southeast Asian startups hit $1.78 billion in the first seven months of 2019, reflecting an eightfold increase over the same period in 2018.

Taiwanese Manufacturing Shift

The technology scene is also starting to see the effects of the current trade dispute and shifting supply chain dynamics as companies pivot to Taiwanese manufacturing. As this trend accelerates, VC investment will surely follow.

What’s next for the US venture capital ecosystem

The US is no stranger to the cyclical nature of VC flows. Unlike China, the country has experience dealing with the fallout of a declining economy and subsequent VC fallout, especially following the 2000 tech bubble. However, as Silicon Valley can attest, innovation continues to accelerate, with the VC industry emerging more prosperous than ever. While the VC market in the US remains resilient, it has begun to show signs of weakness. 

Strength Amid Declines

According to the third-quarter PwC and CB Insights report, US funding saw a 15% decline while deals decreased by 16% compared to the previous quarter. However, the same report suggests third-quarter VC funding will exceed the same period in 2018.

Regionally Static

Looking at the US market in isolation, the nation continues to operate in a regionally static reality. Unsurprisingly, the West and Northeast regions of the US, which include Silicon Valley and New York, accounted for 72.6% of all VC investment. For additional context, these regions account for only 41.1% of the US population. While it’s very likely VC ecosystems will remain on the US coasts for the foreseeable future, there are still deals yet to be uncovered in other regions of the country. 

Growing Financial Scrutiny

Although showing resilience, US-based VC firms are experiencing challenges similar to their Chinese counterparts. While US-owned companies continue to attract healthy levels of investment, growing scrutiny of startup financials is introducing another layer of complexity and initiating a constructive VC cycle. The recent WeWork IPO serves as an example of this emerging trend.

A Focus on Europe

As more US-based VC firms are priced out of Silicon Valley, many are turning their sights to European markets. According to a Dealroom and TechNation report, US VC firms invested $5.3 billion in European startups through July 2019. This figure represents a 40% increase over the $3.8 billion invested over the same period last year. 

The future of venture capital in the US and China

Amid trade tensions, slowing economic growth, and shifting sources of economic opportunity, venture capital flows in the US and China will likely remain in flux for the foreseeable future. Through this transformative process, investors in both regions will need to stay diligent in their understanding of political, economic, and social developments around the globe. And while it's unclear how long political forces will dictate the current narrative, it appears that each country has already begun to hedge their bets.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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