If You're a Startup Looking to Capitalize on U.S.-China Border Investments, Here's How
Developments in the Chinese technology sector, and cross-border investment, are opening important doors for U.S. startups. As the general manager of the first U.S.-China technology incubator platform and an observer of U.S.-China cross border investments and entrepreneurship, I'm often asked about key investment trends, issues and tips on how U.S. entrepreneurs can navigate their companies in this new reality.
Related: China's Effect on the U.S. VC Game
Here are some of the trends I see, and how American entrepreneurs can take advantage:
Trend 1: Chinese companies are seeking “innovators” for acquisition -- and looking beyond their own backyard.
After years of growth, Chinese venture capital and technology industries had a downturn in 2016 due to the failure of Online to Offline (020) businesses. O2O was supposed to create a plethora of unicorn companies, but that didn’t happen. True, there were some successes: DidiKuaidi, LittleRedBook, and Yingke live-streaming.
But many new businesses failed to anticipate the time, money and resources needed to acquire users and compete with large internet and mobile companies, like Alibaba, Baidu and Tencent, which were also deploying O2O strategies.
With little competition from unicorn companies, there’s now fierce competition among these giants to gain a leadership position in China and other regions. The result: I see this trend opening the door for more Chinese investment into the United States, as China’s tech giants race to acquire companies that further strengthen their monopolies. Acquisition is, in fact, favored over building from scratch.
Tip: If you’re looking for funding, you have more options than ever. Chinese investors are supporting innovators creating disruptive technologies. And they’re putting hard cash into those companies. Just look at unicorn companies like Zoox, Tesla, SpaceX, Hyperlook, Uber, and Airbnb -- their funding isn't coming just from U.S. investors.
Hot industries include augmented and virtual reality, artificial intelligence, robotics and autonomous vehicle applications. And, of course, many of these technologies are being developed in Silicon Valley.
Trend 2: M&A teams and venture capital funds are taking hold at China’s tech companies.
Beyond their growing U.S. presence, focused on R&D, business development and marketing, Chinese tech giants are investing and creating their own venture funds.
In 2013, Tencent invested $330 million in U.S. game developer Epic Games, and now owns 48.4 percent of the company. According to Forbes, the company also invested in four of China’s largest technology venture deals, in 2014. More recently, Baidu announced Baidu Capital, a $3 billion investment fund focused on mid-to-late-stage deals in the internet sector. I believe these types of activities will continue, though they have slowed down in 2017.
Tip: While their overall approach is the same, Chinese investors operate differently: Chinese venture capitalists, I believe, are more practical than their U.S. counterparts because they come from a highly competitive domestic market. Their expectations are higher regarding a company's growth and the founder's ability to achieve healthy business metrics.
Chinese VCs possessing business backgrounds in banking and business similar to those of U.S. VCs also usually co-invest at Series A or B rounds, or later. They have more data about companies at later stages, making this an easier decision because it requires less work; that's important when you’re doing deals remotely.
The exception is consumer technology. That's a field where some Chinese VCs are willing to take more risks. Many of these investors witnessed Chinese consumer tech companies that started with tiny or even negative margins, then became enormously successful. Those companies grew so fast they had to raise a huge amount of money right at the start.
This aggressive approach has carried over into how some VCs approach acquiring companies in markets beyond China. That, however, is starting to change based on the experiences investors are having.
Further, corporate and strategic investors from China take more risks. They look at their existing businesses, see what’s lacking and find what’s better in terms of innovation and technology. They are more likely to bet big on moon-shot projects regardless of the tremendous technological and market risks. They’re also more likely to invest big in companies building new platforms without substantial near-term revenue. Magic Leap is such a company that raised a lot of money from China.
Chinese angel investors typically are high net worth individuals and successful entrepreneurs, themselves. They may do deals at early stages, but as is widely known, given the restrictions on investment flow, U.S. dollars are hard to come by, so participation may be limited at this time.
Trend 3: Cross-border investment is slowing with Chinese regulatory tightening.
An additional trend is that in the last few years, a large amount of cash has flowed out of China into real estate and technology. The Chinese government has taken greater steps to regulate these transactions, including temporarily forcing all applications of foreign deals to slow down. Applications are being looked at with more scrutiny, and big investments are being temporarily suspended.
Although it’s difficult for Chinese investors to get their RMBs (short for Renminbi, China's currency) out of the country right now, don’t expect investment flow to completely shut down. Stronger policies to control the flow will lead to a healthier cross-border investment environment.
The inancial Times reported that more than $75 billion of overseas deals was canceled due to regulatory tightening and foreign exchange controls, resulting in only 30 Chinese acquisitions of European and U.S. companies. Canceled transactions in 2015 totaled about $10 billion and increased seven-fold in 2016.
According to the People's Bank of China and China Foreign Exchange Trade System, foreign exchange reserves fell $320 billion last year. To maintain reserve levels, Chinese-funded enterprises may find new obstacles to overseas acquisitions.
Yet, a caveat here: While so many deals were canceled, Rhodium Group’s Baker McKenzie reported that China's investment in North America and Europe still reached a record $94.2 billion, with U.S. investments tripling.
Investment interest, meanwhile, doesn’t look to be dipping any time soon. I believe this tightening is temporary, as the government puts more sound processes in place to handle investment outflow and ensure foreign deal validity. In the long run, better transaction processes would benefit only cross-border investments.
Tip: Keep calm and go with the flow. How much such investment will slow down is tough to predict. Also, it’s unpredictable when the Chinese government will re-instate cross-border investment activity, given the state of U.S. and China trade relations with the Trump administration. As a best bet, my suggestion is that startups will do well to find investors with a footprint in both the United States and China.
Cross-border investment opens the door to a world of opportunities -- in China and globally. China’s transnational companies are truly reshaping global business and competition. So, if yours is a company interested in Chinese investment, embrace the opportunity to see how those Asian transnational companies are innovating new business models and products. This will help you better compete in the global economy.