China tech further severed from US fundings after Biden ban

President Joe Biden on Wednesday signed an executive order barring U.S. investments in certain tech sectors of China, confirming months of rumors that Washington would ramp up efforts to squeeze China’s tech industry amid growing concerns over Beijing’s military ambitions.

The order authorizes the U.S. Secretary of the Treasury to restrict U.S. investment in three critical categories of Chinese companies: semiconductors and microelectronics, quantum computing, and artificial intelligence that is critical for the military, intelligence, surveillance, or cyber-enabled capabilities as determined by the Secretary in consultation with the Secretary of Commerce and other relevant agencies.

The measure is expected to take effect next year, according to The Washington Post. It also applies to companies in Hong Kong.

“Advancements in sensitive technologies and products in these sectors will accelerate the development of advanced computational capabilities that will enable new applications that pose significant national security risks, such as the development of more sophisticated weapons systems, breaking of cryptographic codes, and other applications that could provide these countries with military advantages,” the document reads.

American venture investment firms first entered the Chinese market in the 1990s, assuming a critical role in funding the country’s burgeoning tech companies and facilitating their global expansion. But this once cordial partnership now faces mounting challenges as tensions U.S.-China tensions escalated in recent years, with both governments actively seeking to disengage their respective technology development from each other.

“The U.S.’s restrictions on its domestic companies’ foreign investments to “decouple” in the investment field under the guise of “de-risking” deviate significantly from the principles of market economy and fair competition that the U.S. has long advocated,” a spokesperson from China’s Ministry of Commerce said in a statement. “The ban greatly disrupts the normal pace of business decision-making, the international trade order, and the security of global supply chains.”

Who’s affected by the investment ban?

American investment firms have been repositioning to navigate new geopolitical complications. Sequoia Capital China, which has raised over $16 billion across 36 funds and invested in over 1,000 companies including behemoths like Alibaba, ByteDance and Shein, announced in June its decision to split its China arm into an independent unit.

Now called HongShan, the Chinese operation greatly slowed its investment pace in recent times, recording just 70 investments during the four quarters between Q3 2022 and Q2 2023, compared to 180 deals from Q3 2021 to Q2 2022, according to Crunchbase. Other China-focused U.S. funds focused have adopted a “wait and see” approach, awaiting further clarification from the U.S. government, several investors told TechCrunch.

Major U.S. endowments and foundations are also halting investments in China, one fund manager told TechCrunch. The venture capital firm is now raising a separate RMB fund to place bets on China’s high-tech firms, while its USD fund is directed only at U.S. companies.

Meanwhile, some Chinese fund managers that previously raised capital from American limited partners are now turning to the Middle East for financing.

Chinese startups are adjusting as well. Those that are targeting Western markets increasingly see the need to establish their controlling entity in the U.S. to attract American investors, according to a dozen founders TechCrunch spoke to in recent months.

This marks a departure from the previous strategy of utilizing a variable interest entity (VIE) structure, which allowed foreign investors to buy into Chinese companies operating in restricted industries. However, even with U.S. investors on board, Chinese-founded startups face challenges in convincing U.S. regulators about the safety of American user data in Chinese hands. One needs look no further than TikTok’s struggles to reassure regulators in the West despite its efforts to build a wall between its user data and China-based teams.