The China-US rivalry is disrupting venture capitalists’ ability to back startups and the ability of innovative companies to globalize.
For fintech startups the situation is less acute because anything to do with financial services eventually must face local regulatory and licensing requirements. In that sense, geopolitics mean the rest of the startup world is becoming more like fintech: fragmented.
But fintechs can apply for a license; geopolitics means startups of all kinds are increasingly faced with barriers that are more difficult to overcome.
Some venture capitalists still speak as if the past several years hadn’t happened.
“No unicorns exist in just one country, not even in the US,” said Alireza Masrour, California-based general partner at Plug and Play, speaking at a recent VC event at Hong Kong’s Cyberport.
“It’s one world,” he continued. “If by your Series B [funding round] you’re not a global company, you can’t become a unicorn.”
A unicorn is a startup valued at $1 billion or more; Masrour says there are now 1,363 such companies worldwide.
The US-China rift
The global aspect may be true. So too that that startups will continue to build the future of corporations, just as the startups of the 2000s created the Googles, Amazons and Alibabas of today.
But geopolitical tensions suggest it will be harder for US and Chinese startups to globalize like their predecessors did. And those two giant markets remain the only places in the world with complete ecosystems for startups: a critical mass in numbers and variety of universities and research labs, entrepreneurs, VCs and their institutional investors, capital markets, and pro-innovation governments.
For VCs, the impact of geopolitics depends on their location, where their investors sit, and what companies they are backing.
The most important cross-border corridor of VC money over the past twenty years has been between Silicon Valley and China. That channel has been squeezed off, due to factors such as China’s clampdown on its technology sector and its capital markets, and Washington’s measures to disrupt China’s access to semiconductors and artificial intelligence.
“Just two or three years ago, many Chinese VCs invested in the US, and now they can’t,” said Jenny Xiao, partner at Leonis Capital in San Francisco. “And US-based funds like us can’t invest in China.”
China: Foreign backing fades
She notes that even if US investors spot an opportunity in China, they are limited by new regulation or internal controls on ticket sizes, and they are hindered from taking board seats. US-based VCs are also limiting the amounts they accept from family offices and funds of funds in Hong Kong and Singapore, where most of the assets originate in mainland China.
Worse, the rivalry is forcing founders to choose sides. A few years ago, Chinese entrepreneurs could study and start businesses in the US before returning home to build companies, and then return to the US as next-gen investors.
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“Now the social capital has diverged,” Xiao said. “If you build a network in China, it’s no longer well connected to US networks. Young [Chinese] people have to choose as soon as they graduate, to stay in the US or go back.”
In many cases, these entrepreneurs decide to stay in the US, because the new environment in China limits their prospects. This is true if they are in sectors that the government doesn’t support, but it’s even more true if they are in a sector such as AI that the government wants to direct.
VCs with a strong ethnic Chinese composition are finding a new opportunity, by backing Chinese entrepreneurs in the US, which gives them access to talent without the political baggage. But this is nonetheless a smaller pool to play in.
Within China: the GBA?
In China, meanwhile, local VCs say there remain big opportunities for backing startups.
Elissa Liu, operation partner at Lanchi Ventures in Beijing, says the country dominates in advanced manufacturing and AI, thanks in part to government subsidies of electricity and other inputs. “There is some talk of manufacturing leaving China, but our cost base is still competitive,” she said. “We have more than 400 unicorns and maintain an advantage in supply chains and manufacturing.”
There are also growing opportunities for Chinese startups to internationalize – to the rest of the region or to developing markets, if not to the US.
Chinese startups have typically shared with their American counterparts a preference to build domestically into a large and receptive market. “Now we see more startups thinking globally from the outset,” said Tony Tung, managing director at Gobi Partners, a pan-Asian VC.
They are doing so on the back of China’s supply-chain prowess, with more entrepreneurs seeking to follow those networks overseas. This is leading to more companies opening in Shenzhen and Guangzhou to source investment from local or Hong Kong-based investors.
“It’s not only talent looking to the Greater Bay Area, but capital,” Tung said. “The top-tier VCs in China are setting up offices in this area. I believe China’s future economic growth in terms of technology and innovation will center on the GBA.”
AI gets complicated
This could, of course, reflect a sense that purely domestic opportunities are diminishing in China, although China-based investors are unlikely to say so.
Nonetheless, when it comes to fund-raising from global VCs, some traditional Chinese strengths are becoming impediments.
Plug and Play’s Masrour says artificial intelligence will be a mega theme for VCs, not just among AI-focused startups, but among any companies deploying AI. For private-equity firms looking to restructure mature companies, AI is helping entire industries reinvent themselves. This leaves plenty of opportunity for startups to spark new business models and ideas.
This is a global trend, but for offshore VCs, the geopolitical situation means China’s AI startups are often off limits.
“The US is putting huge pressure on AI investment from the UK, Europe, Australia, to avoid China,” said Douglas Hansen-Luke, executive chairman in London at Future Planet Capital. “It’s sensitive to talk about but it’s a fact.”
It’s even true in parts of Asia: “China is being cut off,” said Tytus Michaelski, managing partner at Fresco Capital in Singapore.
But this doesn’t mean the end of China’s AI story: the company’s startups not only enjoy access to a vast userbase, but they can increasingly avail themselves of open-source innovations such as RISC-V for designing chips.
US: Splendid isolation
For startups and their backer in the US, the situation is more stable. Most American entrepreneurs have always focused on the domestic market. “Silicon Valley has the privilege to not think much about other places,” said Xiao from Leonis.
But geopolitical tensions are impacting the opportunities for VCs – and sometimes in a positive way.
Hansen-Luke likens the competition over AI to the Cold War-era space race, which gave Silicon Valley a huge boost: NASA was the major buyer of semiconductors and related tech in the 1960s.
“Competition will increase innovation, not hold it back,” Hansen-Luke said. Although the US-China rivalry could spin out of control, if it ends up as a cold war, each government’s focus on innovation could benefit the world.
But where will VCs find the most appealing startups in this new environment? The US remains the leader for generating startups and supporting entrepreneurs.
“Most of what we do is in US companies,” said Michalski from Fresco Capital. “The innovation there is world-leading, and it’s a relatively open place to invest.” VCs such as his, based outside the US, try to add value to their non-US companies by helping them expand into US markets.
Hubs and hotspots
But many VCs are looking to small, in-between places rather than inside the blocs of the US, China and the European Union. This includes city-states such as Singapore and Dubai. It could also mean finding companies that have multi-purpose technology that can be used for one thing in China and another in other markets, without triggering a political fight.
“City-state hotspots attract talent and capital,” Michalski said.
Medea Nocentini, senior partner at Global Ventures in Dubai, says the Middle East and Africa are now fostering plenty of homegrown startups that can address local problems.
While Dubai is more of an investment hub than a source of startups, the region has many countries with large and youthful populations, from Saudi Arabia to Nigeria, Pakistan to Egypt. These places are fertile ground for innovation in areas such as foodtech and energy.
They lack many ingredients that the US and China have, including a deep bench of founders, clear regulation, a strong LP base, and a vibrant IPO market. Alireza’s comment about the need for startups to be global by their Series B round is more true in such places than in established markets.
But with the help of global VCs they are now churning up a lot of startups. They are also open to investment and partners from China and the West – and ready to play the geopolitical card to their advantage.
“Frontier markets are the next markets for VCs who can deal with their risks and who are willing to be on the ground, finding solutions to fundamental needs,” Nocentini said.
Frontier markets put the ‘venture’ back into VC. For most VC firms, though, the focus remains on financial support rather than roll-up-the-sleeves grit. The new environment of higher interest rates will keep most firms focused on scalability and high valuations, and that is an environment that continues to favor startups either born in the US or able to make it big there.