Silicon Valley's Chinese Backers Are Under Threat in Congress
(Bloomberg) -- In recent years, Silicon Valley startups have increasingly attracted foreign investment, much of it from China. The jolt of capital has made it easier for young companies to raise money and for U.S. investors to sell their stakes. That influx of foreign money is now under threat.
U.S. lawmakers introduced legislation last week that would toughen regulatory scrutiny of foreign investors buying minority stakes in startups. Up to now, U.S. officials have typically paid close heed to deals that would give foreigners all or a majority stake in U.S. targets. The new bill would have implications for such deals as Tencent Holding Ltd.’s 12 percent stake in Snap Inc. and could hamper investments in the hottest areas of technology, including artificial intelligence, augmented reality and robotics.
The proposal reflects growing concern among lawmakers and the Department of Defense that Chinese buyers could transfer key technologies to the Chinese military. The proposal, which has bipartisan support, may not be voted on for months, but passage of a version of the bill is expected.
For years, the Committee on Foreign Investment in the U.S. has reviewed foreign takeovers of U.S. companies for potential national security threats. If CFIUS doesn’t like a deal, it can recommend that the president block it. In September, President Donald Trump halted the sale of chipmaker Lattice Semiconductor Corp. to a Chinese-funded investment firm.
CFIUS already has the authority to look at minority investments when the backers would have some say in how the target is run. The legislation broadens the panel’s authority to examine such deals. If it becomes law, even small early-stage investments would trigger review.
“The minority investments rule may cause some heartburn for Silicon Valley,” says Steven Klemencic, who runs PricewaterhouseCoopers’s CFIUS practice. “It’s a review they’ve never had to deal with before.” Klemencic says that ruling will be the most contentious part of the bill with the business community, since it will slow down the speed of deals.
CFIUS reviews are currently voluntary, but if companies choose not to file, then the agency can initiate its own review and impose changes. For the first time, the bill requires mandatory filing for foreign investors that are at least 25 percent owned by foreign governments and acquiring at least a 25 percent stake in a U.S. business.
The bill targets minority investments in “critical technologies” that give investors any access to non-public information. Earlier this year, Commerce Secretary Wilbur Ross said the dangers aren’t “the giant companies, but two young kids in a garage somewhere that are onto some new technology.” While “critical technologies” are expected to include AI, AR and robotics, experts say the criteria could be much broader.
“Tell me a technology firm that isn’t using AI to improve its algorithm. I don’t know any,” says Tony Fratto, a former Treasury official in the George W. Bush administration and a founding partner of Hamilton Place Strategies. “The bill has the presumption that all Chinese investment is suspect.”
In the past few years, Chinese investors have developed a strong appetite for startups working on emerging technologies such as AR, AI, robotics and drones (see chart). From 2013 to 2017, deals with Chinese participation surged from $35.2 million to $714.45 million.
China’s determination to become a technology powerhouse is fueling the fears of U.S. legislators. Its State Council has announced aims to become the global leader in AI and called for China’s businesses, universities and military to collaborate more. The country’s technology heavyweights, including search giant Baidu Inc. and Alibaba Holdings Ltd., have been investing heavily in the technology. They’ve set up global research labs, invested in high-tech startups and beefed up their R&D.
U.S. officials have longed warned that Chinese investment in American technology poses a risk to the country’s security. In January, the Obama administration said China’s push to develop its domestic semiconductor industry through acquisitions threatened innovation and national security. The Department of Defense this year recommended toughening CFIUS reviews of investments in startups by China to maintain U.S. technological leadership.
“That’s part of China’s long-term strategy, to leapfrog ahead of us by investing as much in U.S. technology as possible, leading to the degradation and eventual loss of our country’s military technological edge,” Republican Senator John Cornyn of Texas and one of the sponsors of the legislation said this summer.
Chris Nicholson runs Skymind, a San Francisco startup that uses AI to help businesses analyze large data sets quickly. His early-stage company has benefited from investments from Asian investors, among them China’s Tencent Holdings Ltd. and Hong Kong-based Mandra Capital. Nicholson says his foreign investors have been supportive, and that there have been no signs of technology transfer.
Nicholson says the bill -- which extends the deal review period to up to 120 days -- will significantly hamper young startups. Some early-stage deals close in a week, according to his experience, and the extended review time means that many deals will fail to close.
“The fund-raising process is arduous already,” Nicholson says. “It’s a long, hard process full of uncertainty. If I thought there was a chance that an investor who put money into Skymind could have their deal unrolled by CFIUS, I would not spend a lot of time to solicit their money. That’s the chilling effect.”
U.S.-based investors could also be hurt because a CFIUS review might make foreign investors less likely to buy them out. The bill could also dampen dealmaking because startup investors often commit money as a group; if CFIUS blocks one foreign backer, the whole deal could fall apart. For those reasons, critics say the bill could shift foreign money to other technology hubs around the world, hurting Silicon Valley.
“For years, the government has conducted outreach to the tech community, trying to raise awareness of the national security dimensions of some foreign investment,” says Mario Mancuso, a lawyer at Kirkland & Ellis in Washington who works on cross-border deals. “Most of the time, that outreach was an attempt to coax and wheedle. This is a bear hug.”
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