Not Chinese VC
What happens when China swaps out American investment for its own.
The great Chinese tech story – Alibaba, Baidu, Ctrip, etc – was built by venture capital. By American venture capital.
That capital is mostly gone now. Reliance on the purely domestic kind isn’t working so well, and the FT has a story out about one aspect of that problem.
As I detail in my book, PLANET VC (written with Terrance Philips), capital is the necessary ingredient to an innovation economy. China has unrivaled entrepreneurs, but they need risk finance to flourish.
The first VCs to enter mainland China were US-linked, US-experienced investors from Taiwan and Singapore. And while a huge domestic, renminbi-denominated investment industry emerged, it did so alongside US-dollar VCs with partnerships or networks into the US.
There was one other necessary ingredient specific to China: the VIE structure, a legal card trick that allowed Chinese entrepreneurs to outsource their shares to offshore centers, which served as repositories for New York IPO proceeds.
VCs were the connecting tissue between onshore entrepreneurs and shareholders, Cayman-based trusts, and New York investment bankers, lawyers and other enablers of IPOs. Thus Chinese entrepreneurs were able to create American-style wealth, while leading truly transformational startups.
Those arrangements no longer exist. Today’s dominance of state funds into favored tech sectors is not a substitute for US VC. For seed-level companies the money is necessary but risk equity plays a more subtle role than just writing checks.
Even though VCs are generally terrible at due diligence, they provide incentives for entrepreneurs to govern themselves to achieve an IPO in New York: the public markets are a harsher mistress. And international VC gave China entrepreneurs the tools to get fabulously rich. That’s gone too.
The rise of China tech was not just funded by US VC, but made possible because it let China outsource governance and wealth creation to the international sphere. Those doors are closed (by both Washington and by Beijing). I wager China still has more amazing entrepreneurs than anywhere else, but without a market-based risk-equity ecosystem, that talent will struggle to realize their dreams.
The government can still realize some of its tech ambitions by pouring resources into priority sectors – just as Mao’s “Two Bombs, One Satellite” strategy delivered a nuclear strike capacity. The country has a huge lead in advanced manufacturing and AI applications that will continue to yield innovation. But those yields will decline on the margin and incentives for a new generation of world-changing entrepreneurs are misaligned. The good news is that these trends are entirely reversible.
Interested in reading PLANET VC? Get it from Amazon.