Caught In The Crossfire Of U.S.-China Tech War, American Venture Capital Strives To March Forward

“A phenomenon noticeable throughout history regardless of place or period is the pursuit by governments of policies contrary to their own interests…Why do holders of high office so often act contrary to the way reason points and enlightened self-interest suggests? Why does intelligent mental process seem so often not to function?”

These questions, from historian and author Barbara W. Tuchman’s illuminating book The March of Folly: From Troy to Vietnam (1984), may have appeared more often in people’s minds now than at any time during the past few decades.

Gary Rieschel, founding managing partner of Shanghai-headquartered $6.2 billion-under-management venture firm Qiming Venture Partners, is likely one of them.

In his eyes, policy-making on both sides of the Pacific Ocean could potentially lead to “disastrous” outcomes. Dangerous brinkmanship should be avoided at all cost, and yet it seems to be happening more often.

Rieschel seems to have plenty of reasons for concern. Qiming, like other U.S. dollar venture funds in China, are caught in the crossfire of the worsening U.S.-China tech war.

In the fashion of for want of a nail, a series of interwoven events: questions around U.S. public pension funds indirectly financing Chinese tech firms; China’s harsh tech crackdown; U.S.-listed Chinese firms facing potential delistings; and a massive stock market bloodbath of the China tech sector has led to a thorough shake-up of the venture capital game in China.

U.S.-owned venture investment in Chinese startups has shrunken to a trickle of the estimated $2.5 billion in 2020, a far cry from the nearly $20 billion witnessed in 2018, according to a research report by the Rhodium Group and the National Committee on U.S.-China Relations last year. Chinese internet entrepreneurs, specifically, have raised more RMB funding and reduced fundraising in U.S. dollars from 2019 to 2021.

The decline was consistent with a broader Chinese VC market cooling from 2018 to 2020, and there was a rebound in activity in 2021 that may last. But there is no question that the logic of U.S. dollar funds’ investments in China has forever changed.

Political considerations have become equally important to financial calculations. Gone are the days when investors and entrepreneurs cared only about market competition, growth projections and investment returns. Today, there are a new set of questions: Should I take U.S. dollars from American venture funds? Is this company too sensitive? Does this startup have too much government involvement?

Venture capitalists are forced to become political analysts, turning an endeavor of calculated risk-taking to a random walk down political gamesmanship. What’s more, Chinese venture capitalists are forced to become philanthropists. Sequoia Capital China’s founder, Neil Shen, said in a 2021 speech that early-stage investments should be “half commercial, half non-profit.”

These are, of course, troubling developments, and one can’t help but to be worried under such circumstances. But Rieschel told me in an interview last week that he still sees reasons for optimism.

He expects the potential delisting of Chinese companies from American exchanges to be resolved soon, and more communication leading to better collaborations. But with more regions going into Covid lock down in China, it is hard to see how that can take place. But being hopeful may be the only option at this uncertain time.

Nina Xiang: What is the most fundamental driving force for the changing U.S.-China relations: power, ideology or trust?

Gary Rieschel: It’s about all of them. Xi Jinping is really the first Chinese leader in generations to focus on an ideological competition. Deng Xiaoping, Jiang Zeming and Hu Jintao never did that.

This happened at a time when the U.S. is going through its own identity crisis. Almost everything in the U.S. is now viewed through the lens of politics. What the U.S. needs to do (to fix its problems) has little to do with China.

China would view some U.S. actions (even if designed to fix its own problem) as trying to contain its rise, thus communications are critical. Both countries need to focus more on the development of their own people and society, and be more transparent about each side’s policy intentions.

Is the relationship still salvageable?

I’m optimistic and I’m hopeful that it will work out. But due to Covid, there has been very little interaction between Chinese and American business people, politicians, military, and students for over two years.

Xi Jinping may be trying to use Covid to force more independence of China from the West to fit his own purposes. I think that’s a mistake. Both countries need each other and needs to make an effort to reengage with each other. People here (in the U.S.) say that we should stop Chinese students from coming to universities here because they might be spies. That’s shortsighted too.

Is the Biden administration’s tech policies toward China, which is a continuation of the Trump era policies so far, appropriate?

Some Chinese companies are sanctioned because of human rights and Xinjiang. I don’t agree with the U.S. categorization of what happened in Xinjiang. It’s awful, but I’m not sure I would call that a genocide. But certainly, that kind of minority repression is completely wrong from an American point of view.

DJI shouldn’t be on the list. Tiktok should never be considered to be on the list. But then, China blocks all sorts of American companies too. China has been favoring domestic industries for a long time. Huawei has benefited greatly from Chinese government support and financing.

This goes back to my point about how the U.S. needs to fix its problem by focusing on, in this case, having an American company that directly competes with Huawei.

Questions have been raised about whether U.S. capital should be used to help finance China’s tech rise. What’s your view?

I’m biased because Qiming invests in Chinese tech firms. I am against banning U.S. capital investing in Chinese private tech companies. Conversely, I don’t think the U.S. should block Chinese private money investing in American firms. We need to work very hard to keep bilateral capital and intellectual flows open.

Of course, some types of investments like U.S. governments investing in sensitive Chinese firms or Chinese entities like its sovereign wealth fund China Investment Corp. investing in sensitive American firms may not be appropriate. But a blanket ban of American capital into Chinese firms would be a mistake.

How do you see things evolve from here?

There is pressure to become more restrictive about investing in China. Public money may run into more restrictions. The Chinese and American securities regulators have been working diligently to resolve the potential delistings of Chinese firms from American exchanges. But they should have been working on this 15 years ago!

Unfortunately, our systems change only when we are standing at the abyss of something truly disastrous. At some point, it could go too far. That’s what I’m worried about. If we don’t increase those dialogues in intensity and breadth, we run much higher risks.

A technological decoupling between the two countries will see varying degrees of separation across different sectors selectively. How do you see this playing out?

This decoupling is asymmetric. There is very little Chinese tech in the U.S. But China clearly doesn’t want its enterprise software be based on U.S. tech. It is not much about decoupling but rather China providing financial incentives to have its tech be more natively sourced.

One thing that is troubling the U.S. is that China isn’t playing fair. There are reports of hundreds of billions of dollars of potential intellectual property-related losses, but in a $14 trillion economy, it’s really not that big. Yet, I don’t think that throwing up your hands and say you should have never worked with Chinese firms is the intelligent response.

It’s also not an intelligent response for China to say that we never stole any IP, or you have to transfer your IP in order to operate in China. Both sides are taking positions that are not really best for long-term collaborations.

Is China’s tech sector still investable?

China’s regulatory actions should have happened a long time ago to correct some of the anti-competitive and monopolistic behavior. That is needed. Some people say that it means companies can’t get too big in China in the future. I don’t think that is the case.

But some policies, like in the education sector, didn’t solve the problem. The real solutions might be to change the Hukou system, the qualifications of college entrance exams, and create quotas for poorest provinces at top universities.

Will the very strict data security, privacy protection laws hinder Chinese tech companies’ future development?

Since the laws are applied to companies operating in China, it should be a level playing field for all firms. It may be all right but we will have to see.

Yet, I think the Chinese government has perhaps overreacted. More often than the U.S. government, the Chinese government tends to look at successful entrepreneurs and say “they are successful because we let them be.”

The Chinese government often grossly overestimates their own abilities. They could do well by deciding which sectors to encourage development in. But now they are transferring to picking winners on an individual company level with programs like the “little giants.” It’s going to be disastrous.

How has all these impacted Qiming’s investments?

Both the entrepreneurs and investors need to face uncomfortable questions. When we think it’s sensitive, we will tell entrepreneurs that you shouldn’t take money from us. In other situations, If they are really worried about what the Chinese government would feel about them having foreign investors, even from our RMB denominated fund, then they should better take money from pure Chinese funds. There needs to be honest discussions.

There is nothing prohibiting U.S. dollar-funded companies from listing in the Shanghai, Shenzhen or Hong Kong exchanges. Right now, you can take dollar-funded companies public on Chinese exchanges. They just have to be structured correctly and investors need to be more patient because the conversion of dollars takes time.

Does this mean you can invest in a smaller range of companies now?

Ten years ago, we could invest in 90% of the opportunities with our U.S. dollar funds. Let’s say that now, we can still invest in 75% of them, so we are still covering the vast majority of the opportunities.

We have a significant semiconductor practice, large investments in artificial intelligence, advanced manufacturing, healthcare, and enterprise software.

Qiming is the first venture firm that was funded in China but raised funds in the U.S. with a strategy to invest in American healthcare companies for cross-border collaboration. How well is this strategy operating?

We have raised $600 million across three funds in the U.S. over the past five years. We’ve had nine IPOs, four companies licensed their tech to Chinese firms, and we helped a handful of Qiming portfolio firms to connect with U.S. firms.

Neil Shen, founder of Sequoia Capital China, said in a speech that early stage investments should be “half commercial, half non-profit.” Would that work?

Every billionaire in China is figuring out a way to talk about the “common prosperity” positively and to give money back to society. Suddenly, people are all becoming very philanthropic.

The conversation has been edited and condensed for clarity.