China's theft of US intellectual property

Beyond Huawei, Venture Capitalist's Death Hurts China's Technology Quest

The loss of Zhang Shoucheng highlights tensions over Chinese venture capital investments in U.S. technology startups.

By Shuli Ren

China has a wall of venture capital money, including from chipmaker Semiconductor Manufacturing International Corp.

The death of a Chinese scientist in the U.S. has passed unnoticed beside the blizzard of global headlines devoted to the Huawei arrest, yet the tragedy bears upon another important aspect of Beijing's quest for technological leadership.
Zhang Shoucheng, a Chinese venture capitalist, died on Dec. 1, the same day that Meng Wanzhou, the chief financial officer of Huawei Technologies Co., was arrested in Vancouver. 

There was speculation on Chinese social media that Zhang’s death was connected to an U.S. government investigation into his venture capital fund.

Zhang Shoucheng founded a $400 million fund that invests in Silicon Valley startups and was active in "helping" U.S.-trained Chinese researchers to return home.
His death highlights a deep pool of Beijing-backed money that has been passing under the public radar.
Consider the fund Zhang founded. 

Danhua Capital was cited in a report last month by the Office of the United States Trade Representative after an investigation into China’s technology policies and practices.
Through Zhang's Danhua Capital, China is infiltrating Silicon Valley. 

Between 2015 and 2017, 10 percent to 16 percent of venture capital deals counted Chinese as participants.

Infiltrators
The report singled out Zhang’s firm as an example of the new tactics China is using to steal U.S. technology. 

The fund lists 113 U.S. companies in its portfolio, most falling within emerging sectors that the Chinese government has identified as strategic priorities.

At least one has decided to reduce operations in Silicon Valley and open operations in China.
For years, China relied on government subsidies to encourage development of key industries. 

But starting in 2014, subsidies gave way to so-called “guidance funds”, or state-backed funds of funds that act like venture capital and private equity firms. 

As of the first half, various levels of the government had established 1,171 guidance funds, aiming to raise and deploy a staggering 5.9 trillion yuan ($858 billion).
Danhua Capital, also known as Digital Horizon Capital, is a major beneficiary of China’s shift into guidance funds. 

It counts Zhongguancun Development Group, a state-backed investment fund with more than 10 billion yuan in assets, as a major investor. 

The firm invests in artificial intelligence, big data, blockchain and other disruptive technology sectors.

One can see why these Chinese state-backed funds make the U.S. government nervous.
The scale is unprecedented. 

For instance, the $21 billion China Integrated Circuit Industry Investment Fund, established in September 2014 and nicknamed the “Big Fund,” is raising another $47 billion this year. 

In addition, there’s already evidence that shows China is abandoning fund-of-funds best practices.
In a 2014 interview, Zhongguancun, set up in the early 2000s long before the recent explosion of guidance funds, said that it would contribute to no more than 30 percent of the total capital of venture capital funds in which it invested, and that it would not interfere with fund managers' decisions. 

In other words, it would act only as a passive investor.
But the new kids on the block aren’t abiding by the old rules. 

For instance, this May, China's largest chip foundry company, Semiconductor Manufacturing International Corp., partnered with the Big Fund to establish a new 1.8 billion yuan venture capital vehicle. 

The fund is clearly in the driver’s seat: It contributed 49.5 percent of the capital and owns 15 percent of SMIC.
In August, the U.S. government signed an update to legislation for the Committee on Foreign Investment in the U.S., broadening governmental scrutiny to vetting VC-backed, and especially Chinese state-funded, investments in U.S. tech startups.
With Zhang's death, China has lost a valuable connection to the newest technology in Silicon Valley. But my bet is that Beijing won’t ease back on its aggressive theft tactics. 

The wall of money is too big and the strategic imperative to upgrade China's technology is too great.

China's theft of US intellectual property

China's penetration of Silicon Valley creates risks for startups

By Heather Somerville

Stanford University's campus is seen in an aerial photo in Stanford, California, U.S. on April 6, 2016.

SAN FRANCISCO -- Danhua Capital has invested in some of Silicon Valley’s most promising startups in areas like drones, artificial intelligence and cyber security. 

The venture capital firm is based just outside Stanford University, the epicenter of U.S. technology entrepreneurship.
Yet it was also established and funded with help from the Chinese government. 

And it is not alone.
More than 20 Silicon Valley venture capital firms have close ties to a Chinese government fund or state-owned entity, according to interviews with venture capital sources and publicly available information.
While the U.S. government is taking an increasingly hard line against Chinese acquisitions of U.S. public companies, investments in startups, even by state-backed entities, have been largely untouched.
That may well be poised to change as the U.S. Congress finalizes legislation that dramatically expands the government’s power to block foreign investment in U.S. companies, including venture investments.
The new law would give the U.S. government’s Committee on Foreign Investment in the United States (CFIUS) wide latitude to decide what sorts of deals to examine, eliminating certain ownership thresholds, with a particular focus on so-called “critical” technologies.
“The perception is that a lot of the tech transfer of worry to the U.S. security establishment is happening in the startup world,” said Stephen Heifetz, a former member of CFIUS and now a lawyer representing companies going through CFIUS review.
The latest version of the bill exempts “passive” investors, which would cover many of the limited partners that back venture firms. 

But limited partners that have some control over the business, or firms whose managing partner is a “foreign person”, could be subject to scrutiny.
The university endowments and family offices that traditionally provide most of the money for venture firms are usually one of many limited partners and have minimal if any involvement in the startups they help fund.
Chinese entities also sometimes take a passive role in big venture funds. 

But venture capital sources say that Chinese government funds often play a more influential role in the smaller venture firms they back by providing a greater percentage of their funding. 

That empowers them to request information about startups or help them to open offices in China -- potentially opening those startups to CFIUS review.
The possibility of a regulatory crackdown has caused unease in the startup world. 

Venture firm Andreessen Horowitz is counseling startups that if they raise money from a China-backed investor, they put themselves at risk of government scrutiny.
“The window for some startups to raise money from China may be closing,” said Chris Nicholson, co-founder of AI company Skymind, which has raised money from Chinese Internet group Tencent Holdings Ltd and a Hong Kong family office.

SENSITIVE AREAS
Until recently, the original source of funds for venture investments has not been an issue in Silicon Valley. 

Venture firms are not obliged to disclose who their investors are and entrepreneurs rarely ask, leading some dealmakers to question how CFIUS could keep tabs on startup investing.
Danhua Capital, which is backed by the Zhongguancun Development Group, a state-owned enterprise funded by the Beijing municipal government, has holdings in the most sensitive technology sectors.

Its investments include data management and security company Cohesity, which counts the U.S. Department of Energy and U.S. Air Force among its customers.
Drone startup Flirtey, which in May was selected by the U.S. Department of Transportation to participate in projects to help the agency integrate drones safely into U.S. air space, is also part of the Danhua portfolio.

Shoucheng Zhang, Danhua’s founder and a Stanford University physics professor, declined to answer specific questions from Reuters. 

In an email, he said: “Most of our (limited partners) are publicly listed companies in New York or Hong Kong stock exchanges. We will of course fully comply with any legislations and regulations.”
Cohesity declined to comment. 

A spokeswoman for Flirtey said Danhua’s minority investment did not come with any information rights.
The practice of investing through layers of funds, known as funds of funds, can make it all but impossible to know where money is coming from. 

Westlake Ventures, backed by the Hangzhou city government in eastern China, invests in at least 10 other Silicon Valley venture funds, including Palo-Alto based Amino Capital.
Larry Li, founder and managing partner at Amino Capital, said he took the money that was on offer when he launched his fund in 2012. 

He said he felt his firm wasn’t the kind of known quantity that could tap the big pensions and endowments.
“We weren’t going to the Harvard endowment or Yale endowment; that’s like mission impossible,” Li said. 

“You need to have some special source of funds to get started.”
China-backed funds include Oriza Ventures, which belongs to the investment arm of the Suzhou municipal government, and has backed AI and self-driving car startups. 

SAIC Capital, the venture arm of state-owned auto company SAIC Motor, has invested in Silicon Valley autonomous driving, mapping and artificial intelligence startups.
Even well-known startup accelerator 500 Startups raised part of its main fund from the Hangzhou government.
500 Startups and Oriza declined to comment, while SAIC did not respond to a request for comment.
Capital controls have slowed the flow of Chinese money into the United States since 2016, but sources say venture investments have been more resilient than sectors like real estate, in part due to the Chinese government’s focus on improving its domestic high-tech industry.

‘CROWN JEWELS’
U.S. politicians were galvanized by a Department of Defense report released last year that warns that Chinese venture investors are accessing “the crown jewels of U.S. innovation.”
The report helped guide Sen. John Cornyn, a Texas Republican who sponsored the Senate version of the CFIUS reform bill, people with knowledge of the matter said. 

A spokeswoman said Cornyn “is especially concerned with Chinese state-backed venture capital investments.”
For now, at least, President Donald Trump has backed away from his declared intention to clamp down on a wide range of Chinese technology investments through a special emergency order, saying he would leave the job to CFIUS. 

But if Congress fails to pass the bill quickly, Trump said he would use his executive powers.