When China’s uber-rich zero in on an asset class—be it Los Angeles mansions, French vineyards, or European soccer players—they can quickly drown it in cash. But Beijing can take the punchbowl away just as quickly, as Silicon Valley discovered late last year when China’s central government tightened controls over capital leaving the country.
That move brought outbound capital flows to a near standstill, killing deals that had been inked and throwing cold water on hopes for a China-funded gold rush. But the controls won’t kill off Chinese venture capital (VC) investment entirely. Instead, they’re likely to reshape the profile of Chinese investment in the Valley, trading quantity for quality and scaring away the amateurs that had given China a reputation as a wellspring of “dumb money.”
Between 2012 and 2016, Chinese VC and angel investors poured into the Valley, funding early stage startups and pumping up valuations on hundreds of rounds. According to market research firm CB Insights, 2015 saw 210 recorded deals involving Chinese investors, a five-fold increase from 2012. The total value of the rounds involving Chinese investment (including the contributions of non-Chinese funders) increased nine times over that period to $9.9 billion. Those numbers are almost certainly an underestimate, because many deals—especially those by Chinese investors—go unreported.
Amid the frenzy, one well-known investor in the Valley predicted that Chinese money could “easily go 10x from here—this trickle could become a tsunami of capital.” But just as Chinese activity in the Valley hit fever pitch, Chinese regulators imposed a raft of new rules aimed at halting the flow of Chinese money overseas.
Like President Xi Jinping’s anti-corruption campaign, the crackdown on moving money overseas has been more severe and more sustained than most analysts thought at the time. That’s because Chinese investors typically find ways to wriggle past capital controls. But seven months after the clamp down, controls appear to be holding firm. In fact, several US venture capitalists told me they have yet to hear of a good way to move more money out of China. An employee with the Silicon Valley VC arm of Shanghai Auto—a state-owned firm—told me that even his office couldn’t find a way to get funds over from the China-based mothership.
The controls may be air-tight for now, but their impact varies depending on the profile of the Chinese investor. All venture funding from China is often lumped together as “Chinese money,” but these investors in the Valley can be roughly sorted into three different camps.
In the first camp you have the venture arms of China’s technology juggernauts: Baidu, Alibaba and Tencent. While some Valley insiders say Alibaba lacked discipline in its early moves stateside, these publicly listed companies tend to bring strategic logic to their investments.
The second camp is made up of experienced tech investors in China who have opened Silicon Valley operations. These include Sinovation Ventures, run by Kai-Fu Lee, the former head of Google China, and Bob Xu’s ZhenFund, a pioneering Chinese VC that now makes early-stage US investments out of its Palo Alto office.
As my colleague Joy Dantong Ma has laid out, many of the Chinese players in camps one and two already have sufficient dollar-denominated funds offshore. That means that for the time being they can continue to make investments in the Valley, even while capital is locked up in China. These investors also represent the more patient and strategic end of the spectrum. They may not yet be getting into the top deals just yet, but they’re learning and playing for the long haul.
It’s the third camp that is likely to be hit hardest hit by capital controls. This camp is made up of what I’ll call rogue venture capitalists: wealthy but inexperienced Chinese businesspeople fresh off the plane and eager to take a spin at one of the world’s most lucrative roulette wheels.
Rui Ma, a tech investor in the Valley who previously headed up Greater China and global fundraising for 500 Startups, characterized the archetype of this group as follows: a wealthy man (yes, almost always a man) who built his own company in China’s traditional industries, took it public, and now wants to get in on the action in the Valley. He may have experience investing in traditional Chinese industries, but is new to tech and unfamiliar with venture funds as an asset class.
“In 2016, really everyone I knew had a fund,” Rui told me. “I literally know four grad students at Stanford that told me they hosted some group of rich people and by the end of the trip they were like ‘Here’s some money to invest in other Stanford students.’”
This is the group that has fed stereotypes of Chinese investors as amateurs overpaying on investments.
“Chinese money doesn’t ask a lot of questions,” Hans Tung, managing partner at GGV Capital and a longtime cross-border VC told me. “They are so enamored with the brand and the reputation, their standing in Silicon Valley, that [startups] can encourage the Chinese funds to pay a high price just to have access as an investor.”
For the rogue venture capitalists, currency controls have not only severed access to new funds, but may also have spoiled their appetite for the game itself. Many of these first-time angel investors cut their teeth investing in Chinese real estate, an asset that has appreciated relentlessly for twenty years. The mindset that inculcates is a world apart from the high-risk, high-reward, play-the-odds game of VC funding. For those who haven’t been able to make the necessary mental shift, the returns on a few scattered angel investments (which will very likely be zero) may come as a rude awakening.
This class of undisciplined investors will likely be retreating to mainland markets to lick its wounds. In their place, the better-funded and more strategic Chinese investors that stick around long-enough will eventually make their mark.
“It’s just a matter of time, unless you’re consistently stupid or consistently unlucky,” Rui Ma told me. “As long as you have capital and you’re playing the roulette wheel over and over and over again, you’ll hit something.”
Even dumb money can look real smart when combined with dumb luck. But that requires patience and ample funds, both of which are now in short supply among China’s rogue venture investors.