Before the Russian invasion of Ukraine, GCV wrote: “Venture capitalists are being schooled in the realities of hard power”, looking at the impact on VCs of geopolitical tensions.
Just over 100 days into the war, a classic management time to review if objectives have been hit, it is worth seeing how the scorecard reads and, specifically, if venture capital is now a pillar of national importance how the geopolitics might shape the investment flows by corporations and state-owned enterprises.
One of the big developments is the increasing influence of China.
Though Ukraine has fought valiantly, but it is moribund as an economy. Russia’s de facto goal of turning it into a vassal state like Belarus is broadly on track.
Russia, by contrast, has supported its financial position. As the Spectator notes: “Russia’s current account surplus [of roughly exports minus imports this year] could hit $250bn. So the extra money being banked by Russia is almost the same amount as the $300bn of central bank assets and foreign currency reserves that were frozen by the West after the invasion.”
Sanctions might affect Russia but if it has the support of China and other neutral countries it will find a way through.
Longer-term, the clear winner in all of this is China. Russia is becoming a de facto vassal of China in supplying oil and gas and raw materials in return for imports.
The world, therefore, is being remade. This will naturally also affect and influence capital flows.
Overall, the European venture capital ecosystem will be hit by stagflationary conditions — slowing or falling economic growth rates while inflation is rising — but some sectors could see rising allocation. As Pitchbook notes: “As energy prices soar in Europe, governments will be looking for solutions from startups in the alternative energy space. Meanwhile, the threat of cyberwarfare is at an all-time high, and capital allocators’ attention to the information security sector will likely intensify as the war continues.”
Deeptech is the new oil for China
More broadly, the great power geopolitics between the US and China will shape the playing field and corporations are the tip of the spear. At the GCV Symposium, academic Martin Haemmig using his own analysis as well as from Max von Zedtwitz (who was caught by travel restrictions from flying in from the Glorad Research Center) found: “Deeptech VC investing is becoming the new oil for China.”
Last year, China-based semiconductor startups received 6.8 times the amount of investment their American peers took in ($8.8bn versus $1.3bn), Haemmig said. Over the five-year period from 2017 to 2021, Chinese chip startups gained $17.8bn, according to Preqin and Bloomberg data presented by Haemmig, compared to an aggregate $3.5bn for US peers.
Similar patterns can be seen in China’s other strategic industries, such as biotech, robotics and software. There were large rises in investment in these markets last year, while deal values and volumes fell in overall venture market in the country. This year, four of the five largest deals in the first four months were in sectors of strategic interest to the Chinese state, according to Bloomberg.
The big question is whether this state-directed venture investing is well spent. Keith Arundale, senior visiting fellow at the ICMA Centre at Henley Business School of the University of Reading, shared research at the GCV Symposium that suggested Chinese VCs get better returns than US or European ones.
But it remains to be seen if state-directed spending will draw capital away from those who can use it best, or create a demand pull to draw technologies into use more quickly, as arguably happened with electric vehicles through state subsidies.
Venture as soft power
If venture is a “pillar of national importance,” as described by Sebastian Mallaby in his book this year, Power Law, then China has developed its soft power skills well.
The country’s corporate venturing units invested more in southeast Asia and Europe than in the US for the first time last year, according to GCV Analytics data presented by Haemmig.
China-based CVCs invested $5.5bn into both Europe and southeast Asia last year compared to their $4.7bn that went into US-based startups.
American VCs, meanwhile, have curtailed their venture investments in China in the past few years after hitting a high of $19bn in 2018, according to Rhodium Group data presented by Haemmig, meaning that in the first half of 2022, Chinese VCs for the first time invested more in US startups than vice versa.
China has, at the same time, protected its domestic market from foreign startups and corporations. “China creates a de-facto separate domestic market out of reach for many international companies,” Haemmig noted.
In a network effects-driven, winner-takes-all tech market this means that “product features and technologies easily copied across the China border,” such as by Meta’s WhatsApp from innovations developed by Tencent’s WeChat social messaging service.
A new era of corporate espionage
In an intangibles-driven economy, such copying or even corporate espionage could be entering a “new era,” according to the Economist’s article this week. This is part of what is driving the UK to pass new laws to tighten up on the way researchers and even investors interact with potential foreign agents — although those rules may prove difficult to enforce.
The Economist warned that “industries with lots of startups are particularly vulnerable” and gave as an example “the recent sentencing of You Xiaorong, a former chemist at Coca-Cola, to 14 years at Uncle Sam’s pleasure.
“Ms You was convicted of stealing trade secrets relating to coatings on the inside of beverage cans. She used the filched formula to set up her own company in China, with backing from a local partner. Their venture was backed with grants from the Chinese government. Whether or not Chinese officials were aware of the theft is unclear.”
Rise of the Chinese CVC?
China’s leading tech companies were weakened by government backlash, their share prices falling by more than half between January 2021 and May this year.
It has caused a drop in their investing — China-based CVC-backed rounds by value fell 64% to $1.9bn in the first three months of this year compared to the fourth quarter of 2021, according to Haemmig. Last year, CVCs invested in rounds worth an aggregate $24.3bn in China-based startups, he added.
But, we have seen recent rebounds by Alibaba and other China-listed tech stocks. Could we now be about to see a rise in CVC this year from the first quarter lows?
If so, then China will arguably be even better placed in its march to global economic and political dominance last seen with the Yongle emperor and fleets of Zheng He in the 15th century.
