BUYER’S remorse is often experienced in Silicon Valley by investors who plough money into risky startups only to see them fail. Some technology entrepreneurs are now suffering from seller’s remorse. They are those whose young companies have grown big in part thanks to Chinese financial backing, but now feel under scrutiny because of an escalating fight between the two tech superpowers.

One entrepreneur who took money from Danhua Capital, a Chinese venture-capital firm based near Stanford University, for example, only recently learned that the firm was established with help and funding from China’s government. “You’re going in blind. If there are issues down the line you may not know who you’re dealing with,” he laments.

FIRRMA treatment

In coming days President Donald Trump is expected to sign into effect the Foreign Investment Risk Review Modernisation Act (FIRRMA), which establishes more vigilant reviews of foreign investments into American companies, including startups, on national-security grounds. While Mr Trump and China continue to spar over trade tariffs, FIRRMA reflects a fight over Chinese investment in American technology startups that is less visible but which nonetheless may have serious consequences for Silicon Valley.

Big deals with national-security implications have long been scrutinised. America’s powerful Committee on Foreign Investment in the United States (CFIUS) has reviewed attempts by foreigners to take controlling stakes in domestic firms where their presence could weaken national security. But minority investments in startups went unremarked, though the firms may hold sensitive innovations in areas such as robotics, artificial intelligence (AI), biotechnology, 3D printing and more.

China is not mentioned in FIRRMA but is the main target. In recent years China’s government and several firms have backed more than a dozen accelerators that cultivate startups and have opened “corporate innovation” centres in Silicon Valley. Baidu, the Chinese tech giant that is considered closest to the government, runs a centre focused on AI, and ZGC Capital, a group directly funded by Beijing’s government, has opened an innovation outpost. Next year a Chinese firm will open Oceanwide Centre, the second-tallest building in San Francisco, a symbol of China’s ambition to play a role in America’s technology capital.

But China’s main influence comes from investing directly in startups. Estimates are hard to obtain, because venture-capital investments are private and notoriously opaque. But according to an analysis by the Defence Innovation Unit Experimental (DIUx), a group founded by America’s Department of Defence (DoD), in 2015 Chinese investors put $3bn-4bn into early-stage venture deals. Many prominent startups, including the ride-hailing firms Uber and Lyft, the messaging app Snap, virtual-reality firm Unity Technologies, cancer-testing firm Grail, financial-tech firm Sofi, augmented-reality firm Magic Leap and others, have taken Chinese money. From 2015-17, according to DIUx, China contributed 13% of total funds into American venture-capital-backed companies and ranked only second to Europe as the largest foreign source of capital for startups.

Some investors are simply seeking strong returns in a big market outside mainland China. Yet American politicians fret that distinguishing private Chinese capital from government funds is hard and that more is in play than profit.

Series C is for China

That is because China’s sovereign, provincial and local governments, state-owned enterprises, firms and individual investors often form their own funds and pool their money in each other’s investment vehicles. Many Chinese funds also have Western-sounding names, such as Westlake Ventures, which is owned by the city government of Hangzhou. SAIC Capital, backed by a Chinese state-owned car company, has its office on Sand Hill Road, the main thoroughfare for illustrious venture-capital firms.

Chinese money has come with extra perks for entrepreneurs. The investors usually agree to higher valuations to get access to deals. “We’re outsiders. We don’t have the years of connections we can offer to entrepreneurs, so we have to offer them something else,” explains one. The Chinese have also been more willing to invest in more speculative technologies that are less likely to accrue big financial gains in the near term but require lots of capital.

Until recently startup bosses treated Chinese funds like any other. Aside from a few cautionary tales, Chinese money was broadly welcomed. Now defence experts worry that investors are not seeking financial returns so much as insight into the plans of startups. A recent report by DIUx, entitled “China’s Technology Transfer Strategy”, analysed this; its findings catalysed the FIRRMA legislation. Investing several billion dollars is ultimately “a small price to pay to see a significant share of American startups’ innovation,” says Michael Brown, ex-boss of Symantec, a cyber-security firm, and co-author of the DIUx report.

Putting money into startups in sensitive areas, some analysts believe, may also be a way to keep them out of the reach of America’s military. The DoD does not use technologies supplied by young companies that have foreign investors, for fear they could share or steal information or secretly offer a backdoor into computer systems. That theory may be unproven, but startups are just one domain of an escalating fight over technology. Mr Trump has made Chinese theft of American intellectual property a theme of his presidency. Industrial espionage is also getting more attention: in July American authorities charged a former employee of Apple with trying to flee to China with information about its self-driving cars.

Passage of FIRRMA will give CFIUS new discretion to review property transactions, minority investments in companies that supply “critical technology” and firms that hold “sensitive personal” data on American consumers. But no review will be triggered by passive investments in companies that do not come with board seats or access to material, non-public information, so lots of investments in startups will not be scrutinised. There is also ambiguity about what will be considered a “critical technology”. According to Rhodium Group, 15-25% of Chinese venture deals will be reviewable under the new regime, but if a broad definition is adopted, that could rise to 75% of deals. It is likely that America will continue to identify and add new sensitive technologies to its list over time, says Christian Davis, a lawyer with Akin Gump.

Chinese investors are thinking up coping mechanisms. According to one executive who makes tech investments on behalf of a large Chinese company, they could simply try to hire a team instead of investing in their startup, or ask them to move to Canada before an investment is made. Other investors are planning to take their money elsewhere (though other countries are tightening up their screening mechanisms, too). “If the environment is not friendly for us to invest in America, then it costs us nothing to pull out and do more in Europe and Israel,” says the boss of a Chinese venture-capital firm mentioned in the DIUx report. “Tense” is how one participant summed up the mood at a gathering in June near Silicon Valley, called the US-China AI Tech Summit. Several high-profile Chinese tech bosses and government officials cancelled.

Given the past interest of Chinese investors in frontier technologies, startups working on hardware, biotechnology, quantum computing and other areas that require “patient” capital could suffer. That is probably what worries Valley-watchers the most about the recent shift. If America makes life difficult for Chinese investors, the government should provide some sort of improved tax treatment or otherwise encourage more American investors to step in, argues Matt Ocko, co-founder of DCVC, a venture-capital firm. “Startups already deal with so much uncertainty,” adds Roy Bahat of Bloomberg Beta, an investor. “Anything that reduces their options or increases their risk makes them more likely to die.”