Beijing Steps Up To Bankroll Chinese Startups

"A sharp drop in venture-capital funding for Chinese startups is forcing Beijing to get more involved in grooming the country's tech industry, a strategy that threatens to handicap China's efforts to catch up with Western technologies in the long run.

Private venture-capital investment -- including U.S. money, which helped turbocharge China's technology boom before the pandemic -- has dried up since investors lost faith in China's economy and moved to steer clear of geopolitical tensions. Early-stage funding levels are at their lowest in nearly a decade, with the decline especially dramatic among foreign funds.

Overseas and domestic venture-capital funds invested about $6.4 billion in China through October this year, a decline of 40% from the same period last year, according to Dealogic. Foreign investors, which invested an average of about $14 billion a year between 2018 to 2022, contributed almost nothing in 2023 and so far this year.

In response, Beijing is getting more involved through a variety of funding vehicles that further entrench the state in China's tech scene. Investors say government funds now provide the bulk of investment into tech startups, with the number of state-sponsored incubators multiplying as China tries to thrive without American money and technology.

Chinese banks, many of which are state-owned, are also ramping up lending to startups at the state's urging. Historically, Chinese banks avoided supporting startups, which often lack traditional forms of collateral needed for large loans. Now, more Chinese banks are accepting patents and trademarks as collateral, an unusual method of financing that allows them to proceed with loans.

Such intellectual-property loans in China have grown by more than 40% annually over the past three years to $117 billion in 2023, according to the China National Intellectual Property Administration. They grew a further 57% year-over-year in the first half of this year.

 "Government financing is stable capital and often available in larger sums than what the private sector can offer" now, said Han Shen Lin, China country director at strategic consulting firm The Asia Group. "The challenge is that government entities rarely have the skill sets to identify technology winners."

Government funds typically have a low tolerance for loss and are often reluctant to back the type of moonshot companies China needs to push its innovation barriers, instead preferring to channel money into safer bets, investors say.

Previous Chinese efforts to inject state funding into favored industries, such as semiconductors or airplane engines, have yielded mixed results. In some cases, billions of dollars have been wasted or siphoned away through fraud, Chinese officials say. The heavy hand of the state has already threatened to slow advances in artificial intelligence, because AI startups must adhere to China's free-speech restrictions. "China's innovative edge risks severe erosion" as foreign money for its tech companies dries up, Gavekal Dragonomics, a research firm, said in a recent report.

China's State Council, the country's cabinet, didn't respond to questions. In a high-level meeting Sept. 18, the council emphasized the importance of venture capital for innovation, promising to solve bottlenecks in the fundraising and exit of startups.

Chinese leader Xi Jinping has vowed to nurture promising companies in capital-intensive sectors such as semiconductors, AI and biotechnology, areas that he sees as critical for the country's growth. 

Such sectors require massive amounts of capital.

Until a few years ago, private money was flooding China, as big names such as Sequoia Capital's China arm and SoftBank Group bankrolled startups in areas from e-commerce to ride-hailing, drawn by China's large consumer market and the prospect of billion-dollar exits.

In 2021, venture-capital funds invested $42 billion and struck more than 2,400 deals in China, Dealogic data shows. Numerous Chinese startups were becoming unicorns -- privately held companies worth more than $1 billion -- feeding the perception that China was overtaking the U.S. as the world's tech hub.

But geopolitical tensions snuffed out some of the interest. China's regulatory clampdown on private-sector companies such as Ant Financial and a stagnating economy further damped sentiment.

"A lot of money has gone back to the U.S.," said David Yin, a partner at GSR Ventures. Yin said investing in China has become tougher compared with a decade ago, when firms such as Alibaba, Tencent and Pinduoduo changed the way consumers shopped and interacted.

Chinese authorities have also frozen domestic initial public offerings to support a tepid stock market, closing off a traditional avenue for funds to exit investments. Although the market rebounded over the past week after a blizzard of new economic stimulus, strategists are unsure whether the rally can last.

Companies raised only $6.8 billion from the domestic stock market via initial public offerings through September, an 85% year-over-year drop and about one-fifth of the funds raised by companies listing in the U.S., according to financial data provider Wind.

The Chinese state is now gradually taking over funding -- and even exits -- of tech startups.

In April, the People's Bank of China set up a roughly $70 billion relending facility to encourage banks to lend to science and technology firms, with a fifth of the sum set aside for startups and growth tech companies.

Chinese banks are framing their efforts as a public duty. Bank of China, the country's largest bank, said in its annual report that it granted more than $200 billion in credit lines last year to about 68,000 enterprises to "promote major technological breakthroughs." 

A bank in southwest China has said it went so far as to help a small tech company register patents to obtain an IP loan.

State-owned companies with minimal tech connections are joining the push. Kweichow Moutai, China's largest producer of baijiu, a liquor served at state banquets, and its smaller rival Luzhou Laojiao both recently made investments in chip-related companies.

To overcome the bottleneck in IPOs, Chinese local governments including Shanghai have set up secondary funds to buy out early investors.

China's government has had success nurturing some tech companies. Its "Big Fund" for semiconductor investments, which was launched a decade ago and recently raised about $48 billion in its third installment, helped support China's top contract chip maker, Semiconductor Manufacturing International Corp., in its early days. State funding was also critical in the growth of Contemporary Amperex Technology, the world's biggest maker of electric-vehicle batteries, and has helped Huawei Technologies survive after it was put on a U.S. trade blacklist and its revenues fell.

But Chinese state investment has also yielded duds and other headaches. In 2022, several semiconductor executives were detained over corruption allegations involving Big Fund spending.

In August, the northern Chinese province of Shanxi released an audit that found government investment funds were set up without following proper protocols, or were subject to mismanagement and fraudulent behavior. About $1.34 billion of funds were at risk of losses because of bad investments, the audit revealed.

Chinese state funds often have different priorities -- such as boosting employment or aligning with other government objectives -- than do private investors and startups. Additionally, Chinese state funds generally have shorter investment horizons and have a much lower tolerance for losses.

The loss of state-owned assets in China could be considered a crime, punishable by up to seven years in jail. Officials at state funds could also lose their jobs for incurring investment losses. Some state investors attach more strings to protect their investments, such as requiring company founders to personally guarantee loans." [1]

China's leader Xi is an engineer. America's Harris is a prosecutor with a law degree. If you have a hammer you see only nails around. America is also using a lot of government money to develop industry. Guess what a prosecutor would do with the money?

All this geopolitics is harmful. Attempts to shut off the financial oxygen to the world's best global warming fighting  engineers in China, are putting the people of the world at risk.  

Oh, and American investors have pulled out of China's largest and fastest-growing market. What a loss for them...

1. Beijing Steps Up To Bankroll Chinese Startups. Lin, Liza; Feng, Rebecca.  Wall Street Journal, Eastern edition; New York, N.Y.. 04 Oct 2024: B.1.