Some Silicon Valley start-ups have been affected by the US-China trade war.

• Chinese venture capitalists are retreating from Silicon Valley’s start-up scene.
• In 2019, the number of venture capital deals in the U.S. with at least one China investor decreased to 163 deals and the total investment amount reached $6.5 billion, according to Preqin's private equity data tracking.
• In 2018, there were 236 deals worth $10.8 billion.

uSens, a virtual reality start-up based in San Jose, experienced rapid growth until late last year when the U.S.-China tech cold war caused the company to hit a dead end.

uSens, a start-up founded by CEO Anli He and her husband, CTO Yue Fei, has secured a partnership with San Francisco-based Pico Interactive to bring interactive hands gesturing to its virtual reality headsets. With patented computer vision technology for smart TVs, mobile devices, and cars, uSens has a team of experienced professionals from , , , and $27 million in venture funding in the past three years. The company has scaled up from its living room and a Kickstarter campaign in 2015 to 60 staff in Silicon Valley, three offices in China, and $2 million in revenue.

The venture funding for their startup was provided by a combination of leading U.S. and Chinese venture funds, including IDG Ventures, Fosun Kinzon Capital, Maison Capital, and Lebox Capital.

Despite having a term sheet for a new venture infusion, uSens faces the possibility of shutting down due to its inability to raise additional capital. The start-up's U.S. office was closed, and all employees except for one salesperson were laid off. The remaining staff, including the co-founders, relocated to China.

He recounted the series of terrible events that had occurred, stating, "Now we are merely trying to survive."

The U.S.-China tech cold war has led to investor reluctance, both from Chinese and American funds, to invest more money in her high-tech start-up, as she explained. She noted that it was easy to get capital from China-backed venture capitalists with investment branches in Silicon Valley and a preference for cross-border deals at high valuations. However, many Chinese investors withdrew from the U.S., and U.S. investors followed suit, resulting in a decrease in investment in U.S.-China-rooted start-ups.

In December 2018, Digital Capital Horizon, a venture capital firm run by Stanford physics professor Shoucheng Zhang, withdrew as a potential source of funds for the company after the professor, a friend of the founders, took his own life after a long struggle with depression.

Fallout in Silicon Valley

The flow of China investment in tech companies is being hindered by concerns over national security threats and competition with China for future technology leadership, which is stifling cross-border U.S.-China collaboration that has long fueled next-generation innovations.

The coronavirus outbreak is affecting businesses operating in China by limiting travel.

Jay Eum, co-founder and managing director of TransLink Capital in Palo Alto, California, highlights three obstacles to continued China investment in US tech. Angel investment from China has "completely dried up," while minority investments by VCs have become "extremely difficult." The trend of acquisitions by China's tech giants such as Alibaba and Baidu over the past few years has ended, and most such deals "are not even attempted anymore." In summary, China has "become a negative for all start-ups in the ecosystem. China is off limits."

Numerous U.S. high-tech start-ups with China connections are facing a cash crunch, as they struggle to secure more capital from their previous Chinese sources due to heightened political tensions over China's rise as a tech superpower contender and potential risks to America's global leadership.

In 2019, the number of venture capital deals in the U.S. with at least one China investor decreased to 163 deals and $6.5 billion of investment, compared to 236 deals and $10.8 billion in 2018. This China-to-U.S. venture boom began in 2014, with 157 deals totaling $2.7 billion.

Numerous well-known, privately held Chinese VC firms, including CSC Upshot, ZhenFund, and Kai-Fu Lee's Sinovation Ventures, Chinese conglomerate Tencent, financial institution Ping An, accelerator TechCode in Beijing, angel investors, and state-owned funds such as Shanghai International Group's Sailing Capital, fueled the rush.

The Rhodium Group's new report states that they focused on deep tech sectors crucial to global competitiveness, including artificial intelligence, robotics, autonomous vehicles, virtual reality, and gene editing. However, tech giant Tencent, a major investor in leading-edge U.S. technology companies, has reduced its involvement, as seen in its support of Tesla and Uber.

Trump crackdown

The Trump administration's increased scrutiny of Chinese investment in U.S. start-ups slowed the flow of funds last year, particularly in critical technologies such as artificial intelligence and autonomous navigation that could be used for military purposes. Despite this, the Rhodium Report has not found any conclusive evidence that Chinese venture capitalists in the U.S. have led to the leakage of sensitive U.S. technology to China, which could harm national security.

The Trump administration's November 2018 pilot regulations expanded the scope of foreign investment transactions reviewed by CFIUS, requiring notifications and clearance for transactions in emerging technology sectors such as AI, autonomous vehicles, robotics, and augmented reality. As a result, start-ups are facing greater scrutiny by Washington, D.C. regulators, and China venture investments and acquisitions in the U.S. are being closely monitored.

The Rhodium report notes that the stepped-up scrutiny of deals involving minority stakes below 10% has been extended to include venture deals, many of them from China. The vetting process now includes detailed information on venture fund structures and board seats, leading to greater caution by U.S. venture firms about inviting limited partners with Chinese citizenship.

In August 2018, lawmakers enacted new export controls to enhance national security safeguards under the Foreign Investment Risk Review Modernization Act. The act expands and strengthens the powers of the President and CFIUS to review and act on national security concerns related to foreign transactions involving emerging U.S. technologies such as machine learning, advanced battery technology, gene editing, nanotechnology, and augmented reality that could be compromised through joint ventures with Chinese firms.

The uncertainty surrounding the definition of emerging and foundational technology has caused delays and halted funds to cash-strapped start-ups. The final regulations by the Department of the Treasury will take effect on February 13, 2020.

CFIUS is currently reviewing a 2017 acquisition by Musical.ly, a Shanghai-based social media service, of TikTok, a short video app.

A fractured relationship

The growing emphasis on national security and competitive threats has resulted in a separation of venture capital firms and their investments along the Pacific coast, with China on one side and Silicon Valley on the other. This has led to a decline in long-standing co-investment and collaboration, ultimately slowing down the pace of technological innovation.

U.S. tech start-up founders are carefully considering accepting Chinese venture capital and are weighing their options for offshore corporate structures to avoid being labeled as Chinese companies. Ben Sun, CEO and founder of medtech startup Evoco Labs in Menlo Park, has a head start in raising capital and is now considering his best options for sourcing venture money, which he might have accepted China VC in the past.

The venture capital and angel investment for U.S. start-ups with China connections has been affected. Several prominent U.S.-China venture and angel investor firms have withdrawn from U.S. investing and returned to Beijing, including ZhenFund with $1 billion under management and Sinovation Ventures with $2 billion.

ZZ Ventures, a San Francisco venture shop that invests in technology start-ups and is backed by real estate developer Zhongzhi Enterprise Group, has shut down and is selling most of its U.S. portfolio companies. Former managing director Tracy Wang is staying put in the San Francisco Bay Area and plans to soon launch a new, U.S.-focused fund called Agate Capital Partners.

As U.S.-anchored venture firms with Chinese limited partners become more cautious about accepting more money from China for new funds, further capital crunches have emerged. New restrictions have been put in place that prevent foreign limited partners from weighing in on prospective deals, accessing investment data, and allowing only U.S. citizens to become leading partners at venture firms on American soil.

Start-ups that previously relied on Chinese capital in the U.S. are now exploring alternative funding sources. Thomas Gaynor, a partner at DLA Piper in Silicon Valley, notes that U.S. VCs are capitalizing on the funding gap while corporate VC arms from the Pacific Rim are also entering the market.

Japanese conglomerate and its $100 billion Vision Fund are major sources of funding, having invested $80 billion in three years and planning to raise another multi-billion fund. Corporate venture capital, led by giants like Google, Intel, and Salesforce, is experiencing a surge, reaching a 15-year high in 2018 and almost double the number of deals from the previous year, according to the National Venture Capital Association.

While U.S. venture capital remained stable in 2019 with 4,633 deals worth $105 billion, China's venture capital experienced a decline to 3,348 deals and $49 billion from a high in 2018 of 5,356 deals and $107 billion, according to Preqin.

In the past year, China and the U.S. were close in terms of spending on start-ups within their respective countries. However, a growing gap is emerging between these two superpowers due to China's economic slowdown and the ongoing U.S.-China tech war. As a result, start-ups are being affected.