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Chinese Venture Capital and Competition with the U.S.

May 12, 2019
In 2018, Chinese firms secured more than $30.9 billion in venture capital funding, surpassing for the first time that received by their U.S. counterparts in the same year, by $3.7 billion.[1] The technology-led revolution that China has undergone has spurred major innovations in the sphere of mobile payments, Financial Technology (FinTech), and transport. Nine of the world’s one-hundred largest technology companies, home-grown giants such as Tencent, Alibaba, and Baidu, have thrived on the global stage. Simultaneously, venture capital funds are beginning to search for opportunities that exist beyond the mature and competitive markets in North America and Europe, markets in which there exist many established incumbents and a lack of new entrants. China, with its 700 million internet users (more than twice the population of the United States) and strong tax and loan incentives from the central government, is looking to be a more attractive destination for venture capital firms. In addition, the “Made in China 2025” plan looks to increase investment even further in the Chinese technology sector. However, despite the upside, foreign investors are reluctant due to navigating a digital, economic, cultural, and political climate entirely different from the one they are familiar with.

For investors, this cultural acclimation is likely to be worthwhile. Between 2005 and 2018, the percentage of global patents issued to Chinese inventors has more than doubled. In addition, Chinese technological developments in e-commerce, online gaming, instant messaging, and renewable energy have not only been oriented towards domestic consumers but have also gained substantial presence on the international stage.[2] This article seeks to explore China’s current policy direction and history with venture capital. Of particular emphasis is the changing global competitive landscape as a result of China’s technological advancements and the intended policy direction of the U.S. government such that companies in Silicon Valley can remain internationally competitive in response to Chinese growth.

Venture Capital Funding in China: An Overview

In the 1980s, the first international venture capital firms entered China following government initiatives to encourage private enterprise and foreign investment in the country. Despite having opened its economy to foreign investment since the early 1970s, China lacked the venture capitalist financing models for innovation that had thrived in the United States. The introduction of international venture capital firms was part of an effort to both encourage investment in high technology–including military and infrastructure technology–and bring state-owned enterprises to international quality and productivity standards.[3] Initial investments faced difficulty and venture capital funds were primarily interested in infrastructure and tourism investment projects, including hotels and recreational facilities.[4] Notably, whereas the central government wanted to fund long-term technology and infrastructure projects, many investors preferred to fund technology industries which were already well established and thus carried lower levels of risk. This meant the market did not grow as rapidly as the government would have hoped. Due to the conflicts of interest that manifested in the previous model, local and state governments distributed their own venture capital funds in order to make up for the lack of private funds. Simultaneously, as the experience of domestic entrepreneurs grew under this new model, foreign investors gained a renewed interest in regional investment opportunities.

The total amount of venture capital funding in China has grown significantly in the past ten years; venture capital funding totaled $30.9 billion in the first half of 2018–up from $4.8 billion in 2005. Given the potential presented by a consumer population of 1.386 billion and a growing demand for innovative technological products and services, many major foreign venture capital players have allocated a portion of their portfolio to opportunities in the Chinese market.

However, despite the enormous potential upside for investors, the relative youth and uncertainty surrounding venture capital in China has brought forth three challenges. First, given the large amounts of investor funding chasing a small number of quality deals in an unfamiliar cultural and business environment, there is a growing need for funds to source insider local knowledge to conduct quality due diligence. Second, fund managers are cognizant that opposition exists from within the central government surrounding concerns that foreign venture capital funding can undermine the socialist system. Third, and linked to the previous point, the presence of foreign venture capital funds pose a competitive threat to SOEs (state-owned enterprises) which continue to employ the majority of China’s industrial and service workers, and could hinder development in the domestic sector. Therefore, initiatives from the Chinese government will need to address these concerns if the goal remains to welcome foreign investment in the country.

Evidently, despite the volume of total funding, China remains in the process of establishing a system that will continue to allow innovation to flourish, attract foreign investment in high technology and remain internationally competitive. The second part of this article discusses the “Made in China 2025” plan, its ramifications on the Chinese technology sector, and the U.S. policy response in order to maintain local competitiveness.

“Made in China 2025”

The Chinese government created the “Made in China 2025” campaign to enhance the development of early-stage technology start-ups in China.[5] The government has combined hundreds of billions in venture capital funds with the more traditional incentives for corporate growth such as tax incentives, grants, low and zero-interest loans, and rental subsidies.[6] Local governments and state-owned companies have founded “government guidance funds” to invest in domestic technology companies. According to KPMG, almost all Chinese cities have their own funds to distribute, ranging anywhere from $10m to $50m. As of December 2018, the Chinese government claimed that it has accumulated approximately $1.8 trillion in state money across thousands of venture capital funds in order to achieve its goal of technological dominance by 2025.[7]

Venture capital funds experience decreasing returns to scale, meaning that an increase in the inflow of money into a VC fund will lead to a less than proportional increase in returns.[8] It is well established that larger VC funds have difficulty in delivering exceptional returns. This is most often due to reasons such as limited human resources or reduced time spent on research and due diligence stemming from the quantity of available opportunities.[9] In 2012, only four out of thirty funds with committed capital exceeding $400 million outperformed a benchmark index fund, whereas funds under $250 million more than doubled investors’ initial committed capital 34 percent of the time (a rate almost six times greater than the rate for larger funds).[10] Also, by obtaining access to significant amounts of available capital, state-owned funds risk financing companies that are sub-optimal, those with product and service offerings that are less likely thrive in a competitive market place, or distracting founders from attaining the operating-model discipline (lack of capital forces founders to be more disciplined in the company’s operations, such as experimenting and iterating at a small scale, building better customer experiences and providing products that consumers want and need).[11]

Having a significant amount of “committed capital” (which is a contractual obligation for the investors to contribute funds to the venture capital firm) could also create other issues such as the state-backed VC funds’ inability to effectively deploy funds, meaning the funds have not been able to inject much of the promised money into the Chinese technology sector. In other words, a proportion of the money that the government had allocated for tech investments has not yet flown into the economy. The Financial Times suggests that the different state-owned funds have investment strategies that severely overlap which may result in overcapacity in some technology sectors.[12] The excess money sitting in VC funds could be spent on other government programs to help develop the economy, another drawback of the over-investment by the Chinese government in venture capital.

The Impact of Chinese Growth

Asset bubble in equity markets

The Chinese economy is at risk due to overinvestment directed by the government, which could subsequently cause a global financial collapse. The Chinese state-owned funds could be contributing to China’s artificially inflated economy which could indicate that the “Made in China 2025” strategies would bring further financial risks and distress onto its economy. China has a bubble (an artificially inflated price) in its real estate market, as prices per square foot for Chinese real estate have increased 31 percent within three years, and the price is now nearly $202 per square foot. The China per-capita income is seven times lower than in the US, but the median per square foot price is now 38 percent higher than the median in the US.[13]

This economic imbalance in the real estate sector could potentially jeopardize the sustainability of “Made in China 2025” since maintaining housing prices is an overriding imperative for China and it could affect policymaking in other arenas.[14]

As previously mentioned, since VC funds with greater committed capital typically perform less due diligence and investment screening, the state-owned funds could contribute to a stock market (equity) bubble by investing in overvalued companies and projects. Investing in an overvalued stock means the valuation at which the investment is made is higher than the stock’s fundamental intrinsic value. Equity prices will move towards their fundamental value in the long-run, thus overvalued stocks’ market prices will eventually plummet.

The unsustainability of “Made in China” strategies could manifest itself if it continues to contribute to a stock market bubble, because the bursting of a stock market bubble could cause the Chinese and global economies significant levels of financial distress and turmoil. The U.S. funds that have invested directly in the Chinese equity markets would experience severely negative returns. Since these private equity firms or hedge funds mostly source their capital from large pension funds and mutual funds, a drastic plummet of equity prices will affect these funds and the everyday Americans whose savings or pensions they manage. The U.S. industries that rely primarily on exporting their products to China (for instance, agriculture) would also be affected since China is the third-largest market for U.S. goods and services exports and the potential financial distress will lead to decrease in demand for these exports.[15] The Chinese economy is the 2nd largest in the world, and any major economic shock there would almost certainly cause a global decline, due to the interconnectedness of global capital (similar to how the U.S. financial crisis of 2008 caused global stock prices to go down).

Competitiveness of U.S. Technologies

The increased Chinese investment in the high-tech sector is creating competition for U.S. firms that used to dominate the market and devaluing U.S. intellectual property through alleged theft. The Chinese technology industry is still undergoing rapid expansion as the number of Chinese unicorns (private companies that are valued more than $1 billion) is now more than the number of unicorns in the U.S. (see image below). Additionally, China’s established technology firms Baidu, Alibaba and Tencent (also known as ‘BATs’, often compared to the ‘FANGs’ which comprise Facebook, Amazon, Netflix, and Google) are benefitting significantly from the growth in internet adoption and mobile usage.[16] China also enjoys significant scale advantages over the US, with its large base of 695 million mobile users and 282 million digital natives.[17]

Image: Selected statistics comparing China to the U.S. Source: McKinsey Global Inst...Image: Selected statistics comparing China to the U.S. Source: McKinsey Global Institute

As of late 2018, the Chinese state-owned funds have amassed $1.8 trillion of state money and have invested a considerable portion into early-stage startups.[18] Concurrently, Silicon Valley technology firms are increasingly becoming wary of the potential competition coming from abroad. China has demonstrated its ability to innovate and has developed many leading-edge programs and technologies, which include successful space exploration programs and advanced computing systems. Nevertheless, U.S. research still suggests that, although increasingly less so, Chinese innovation still relies on the technological breakthroughs by U.S. companies: according to the Federal Reserve Bank of Minneapolis, more than half of all technology owned by Chinese firms was derived from foreign companies.[19]

Chinese technology companies are now able to design and produce products that exceed the level of innovation by U.S. firms. In contrast to Chinese firms, U.S. companies have traditionally relied on investment capital from the private sector to fund their product development and growth. A number of Chinese products have successfully penetrated the global consumer market (for example, Huawei surpassed iPhone in 2018 as the world’s second-largest smartphone vendor). Thus, it would be increasingly difficult for U.S. firms to create and commercialize innovative and disruptive products.

Diminishing foreign investments

Foreign investors could potentially be discouraged by the conflicts of interest in companies with state-funding. Jacob Parker, a vice president of the U.S.-China Business Council, suggests that the establishment of government committees would enable the state to influence a company’s decision making.[20] Such conflict of interest could sway an enterprise’s performance, value-creation, and profitability, as Parker suggests that companies’ decisions could be made for political objectives, rather than for business reasons. He notes that for instance, party committees have been installed at many technology firms to review the degree of compliance with national goals.[21] Thus, investors’ sentiment regarding the potential conflicts of interest could discourage the injection of foreign capital into the Chinese economy.

To respond to the increasing state-backed investments in China, the U.S. could further establish foreign policies that target intellectual property concerns. For instance, the Trump administration has been attempting to levy tariffs at a level that is comparable to U.S. estimates of the lost corporate earnings caused by alleged intellectual property (IP) theft and forced technology transfers.[22] Additionally, the resolution to the U.S.-China trade war could not only be affected by the IP disputes, but by the potential financial distress that the Chinese government faces domestically. Such financial distress includes the fact that China’s overall debt rose to 330% of GDP in 2017, and with $5.8 trillion of accumulated debt, de-leveraging attempts (which are efforts by the government to lower debt) could cause the Chinese economy to stagnant. Ultimately, the ability for foreign investors to fund Chinese projects would depend on the state of the Chinese economy.


Ultimately, the $30.9 billion dollars in venture capital funding Chinese firms secured in 2018 is a promising indicator of investor confidence in the country’s products and ability to innovate and compete on the global stage. However, despite new initiatives by the country’s leadership to further attract and retain foreign investment, the quantity of state-backed investments in China and potential of conflicts of interests of these businesses with investors changes the nature of due diligence that must be conducted by fund managers. As the Chinese technology sector is set to further grow, the foreign policy stance adopted by the U.S. government is likely to affect investor attitudes as well as the ability of Silicon Valley to compete with their Chinese counterparts.

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Wharton Public Policy Initiative’s strategies, recommendations, or opinions.




   [3]https://www.researchgate.net/publication/5143673_Venture_Capital_in_China_Past_Present_and_Future, p. 5

   [5]https://www.researchgate.net/publication/5143673_Venture_Capital_in_China_Past_Present_and_Future, p. 5.






   [10]https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2053258, p. 24







   [17]https://www.mckinsey.com/~/media/mckinsey/featured%20insights/China/Chinas%20digital%20economy%20A%20leading%20global%20force/MGI-Chinas-digital-economy-A-leading-global-force.ashx, p. 5







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