For Chinese Tech Startups, Beijing Fills a Funding Void Left by VCs
Previous efforts to inject state money into favored industries have yielded mixed results
By Liza Lin and Rebecca Feng
Oct. 3, 2024 11:00 pm ET
Chinese leader Xi Jinping has pledged to nurture promising companies in sectors including AI.
A sharp drop in venture-capital funding for Chinese startups is leading Beijing to be more involved in grooming the country’s tech industry, a strategy that threatens to handicap China’s efforts to catch up with Western technologies in the long run.
Private venture-capital investment—including U.S. money, which helped turbocharge China’s technology boom before the pandemic—has dried up after investors lost faith in China’s economy and moved to steer clear of geopolitical tensions. Early-stage funding levels are at their lowest in nearly a decade, with the decline especially dramatic among foreign funds.
Overseas and domestic venture-capital funds invested about $6.4 billion in China this year through early October, a decline of 40% from the same period last year, according to Dealogic. Foreign investors, which invested an average of about $14 billion a year between 2018 and 2022, contributed almost nothing in 2023 and so far this year.
In response, Beijing is getting more involved through a variety of funding vehicles that further entrench the state in China’s tech scene. Investors say government funds now provide the bulk of investment into tech startups, with the number of state-sponsored incubators multiplying as China tries to thrive without American money and technology.
Chinese banks, many of which are state-owned, are stepping up lending to startups at the state’s urging. Historically, Chinese banks avoided supporting startups, which often lack traditional forms of collateral needed for large loans. Now, more Chinese banks are accepting patents and trademarks as collateral, an unusual method of financing that allows them to proceed with lending.
Such intellectual-property loans in China grew more than 40% annually in three years to $117 billion in 2023, according to the China National Intellectual Property Administration. They grew another 57% year over year in the first half of this year.
“Government financing is stable capital and often available in larger sums than what the private sector” can offer now, said Han Shen Lin, China country director at the Asia Group, a strategic consulting firm. “The challenge is that government entities rarely have the skill sets to identify technology winners.”
Government funds typically have a low tolerance for loss and are often reluctant to back the type of moonshot companies China needs to push its innovation barriers, instead preferring to channel money into safer bets, according to investors.
Previous Chinese efforts to inject state funding into favored industries, such as semiconductors or airplane engines, have yielded mixed results. In some cases, billions of dollars has been wasted or siphoned away through fraud, according to Chinese officials.
The heavy hand of the state has already threatened to slow advances in artificial intelligence because AI startups must adhere to China’s free-speech restrictions.
“China’s innovative edge risks severe erosion” as foreign money for its tech companies dries up, Gavekal Dragonomics, a research firm, said in a recent report.
China’s State Council, the country’s cabinet, didn’t respond to questions. In a high-level meeting in September, the council emphasized the importance of venture capital for innovation, promising to solve bottlenecks in the fundraising and exit of startups.
Silicon Valley model
Chinese leader Xi Jinping has vowed to nurture promising companies in capital-intensive sectors including semiconductors, AI and biotechnology, areas that he sees as critical for the country’s growth. Such sectors require massive amounts of capital.
Until a few years ago, private money was flooding China. Such big names as Sequoia Capital’s China arm and SoftBank Group bankrolled startups in areas from e-commerce to ride-hailing, drawn by China’s large consumer market and the prospect of billion-dollar exits.
In 2021, venture-capital funds invested $42 billion and struck more than 2,400 deals in China, Dealogic data shows. Numerous Chinese startups were becoming unicorns—privately held companies worth more than $1 billion—feeding the perception that China was overtaking the U.S. as the world’s tech hub.
Geopolitical tensions snuffed out some of the interest. China’s regulatory clampdown on such private-sector companies as Ant Group and a stagnating economy further damped sentiment.
“A lot of money has gone back to the U.S.,” said David Yin, a partner at GSR Ventures. Yin said investing in China has become tougher compared with a decade ago, when such companies as Alibaba Group Holding, Tencent Holdings and Pinduoduo changed the way consumers shopped and interacted.
Chinese authorities have frozen domestic initial public offerings to support a tepid stock market, closing off a traditional avenue for funds to exit investments. Although the market rebounded over the past week after a blizzard of new economic stimulus, strategists are unsure whether the rally can last.
Companies raised only $6.8 billion from the domestic stock market in initial public offerings through September, an 85% year-over-year drop and about one-fifth of the funds raised by companies listing in the U.S., according to the financial data provider Wind.
Enter the state
The Chinese state is now gradually taking over funding—and even exits—of tech startups.
In April, the People’s Bank of China set up a roughly $70 billion relending facility to encourage banks to lend to science and technology companies, with a fifth of the amount set aside for startups and growth-tech companies.
Chinese banks are framing their efforts as a public duty. Bank of China, one of the country’s largest banks, said in its annual report that it granted more than $200 billion in credit lines last year to about 68,000 enterprises to “promote major technological breakthroughs.” A bank in southwestern China has said it went as far as helping a small tech company register patents to obtain an intellectual-property loan.
State-owned companies with minimal tech connections are joining the push. Kweichow Moutai, a leading producer of baijiu, a liquor served at state banquets, and its smaller rival Luzhou Laojiao recently made investments in chip-related companies.
A chip made in China by Semiconductor Manufacturing International Corp.
To overcome the bottleneck in IPOs, Chinese local governments including Shanghai have set up secondary funds to buy out early investors.
Successes and failures
China’s government has had success nurturing some tech companies. Its so-called Big Fund for semiconductor investments, which was launched a decade ago and recently raised about $48 billion in its third installment, helped support China’s top contract chip maker, Semiconductor Manufacturing International Corp., in its early days. State funding was critical in the growth of Contemporary Amperex Technology, the world’s biggest maker of electric-vehicle batteries, and has helped Huawei Technologies survive after it was put on a U.S. trade blacklist and its revenue fell.
Chinese state investment has also yielded duds and other headaches. In 2022, several semiconductor executives were detained over corruption allegations involving Big Fund spending.
In August, the northern Chinese province of Shanxi released an audit that found government investment funds were set up without following proper protocols, or were subject to mismanagement and fraudulent behavior. About $1.34 billion of funds was at risk of losses because of bad investments, the audit revealed.
Uneasy partnerships
Chinese state funds often have priorities—such as boosting employment or aligning with other government objectives—that are different from those of private investors and startups. Additionally, Chinese state funds generally have shorter investment horizons and have a much lower tolerance for losses.
The loss of state-owned assets in China could be considered a crime, punishable by up to seven years in jail. Officials at state funds could lose their jobs for incurring investment losses. Some state investors attach more strings to protect their investments, such as requiring company founders to guarantee loans personally.
