US Investors Exit China's VC Market: A 20-Year Partnership Ends, Leaving a Tech Landscape in Limbo

US Investors Exit China's VC Market: A 20-Year Partnership Ends, Leaving a Tech Landscape in Limbo

A significant shift is underway in China's venture capital (VC) industry, as the long-standing relationship between US investors and mainland startups comes to an end. This development casts a shadow over China's technology sector, according to industry experts and market data.

For over two decades, US dollar funding from global investors, facilitated by Chinese dealmakers, fueled the rise of China's most successful tech companies. However, this flow of money is drying up rapidly. Foreign capital in China's VC industry plummeted by 60% year-on-year in 2023, reaching just US$3.7 billion, a mere 10% of its 2021 peak, according to research firm Dealogic.

The "cycle is broken", according to Winston Ma, a law professor at New York University. The separation of US funds and Chinese tech startups is expected to widen.

American investors profited handsomely when Chinese startups pursued IPOs in the US. But the avenues for cashing out have narrowed considerably in recent years. This trend became particularly evident after Beijing launched a cybersecurity probe into the New York listing of Didi Chuxing in the summer of 2021. The ride-hailing giant later delisted and paid a US$1.2 billion fine.

International investors in China's leading unicorns, such as TikTok owner ByteDance and fashion giant Shein, are still waiting to cash out, with their IPO plans uncertain. This month, the South China Morning Post reported that Shein's plans to list its shares in London, after being rejected by New York regulators, have hit regulatory roadblocks.

Meanwhile, Washington is increasing its scrutiny of US investments in certain Chinese sectors, including semiconductors, artificial intelligence, and quantum computing. US investment houses like GGV Capital, GSR Ventures, Qualcomm Ventures, and Walden International were investigated by a US Congressional committee last year regarding their Chinese deals in sensitive technology areas.

This situation is a far cry from two decades ago when global investors flocked to China in search of returns. In 2004, Silicon Valley Bank brought a group of 25 US investors to China, including Sequoia Capital founder Donald Valentine.

In the subsequent years, Sequoia and other venture firms established themselves in China, supporting the rise of Chinese internet giants and reaping substantial returns for their investors. Sequoia alone invested in over 1,200 Chinese startups under Neil Shen, who ran its China business until the US firm separated the operation as an independent entity called HongShan in 2023 due to geopolitical tensions.

As private capital dried up in China's venture capital industry, local governments and state-owned enterprises stepped in, becoming major players and dramatically altering the business landscape. By 2023, China had established 2,086 so-called government guidance funds, with a target size of 12.2 trillion yuan (US$1.7 trillion) and committed capital of about 7.13 trillion yuan, according to data compiled by local research firm Zero2IPO.

The retreat of market-led capital and the expansion of state-backed funds, which are typically risk-averse and prioritize investments within their jurisdictions, has sparked debate over the future of China's venture capital industry. Wang Ran, the founding partner and CEO of CEC Capital, stated in a recent speech that China's primary capital market was "dead" as government funds, with their low tolerance for losses, took over. One Chinese venture industry executive in Shanghai, who wished to remain anonymous, said that many firms are trying to adapt to the style of state-owned investors, but the transformation is not easy.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for over a century.