Mohammed bin Salman knows how to command an audience.
One year ago, the charismatic 32-year-old heir to the Saudi throne had four of Silicon Valley’s biggest celebrity investors — Sam Altman, Marc Andreessen, Peter Thiel, and Vinod Khosla — seated couchside around him discussing potential “partnerships” with his country as he invited the foursome to visit the kingdom.
There he was, in photos pushed by his handlers, sans thobe, walking the grounds of Apple Park with Tim Cook and getting an intimate tour of the Steve Jobs Theater. A snapshot later, he’s strolling with Sergey Brin. Then with Bill Gates. All smiles.
The stars he attracted and doors he opened were hardly surprising. Silicon Valley had spent the past decade-plus taking money from people like the Saudi prince, better known by his initials, MBS. After all, who would turn down a meeting with a man who had unleashed billions of dollars into their industry?
Altman and Andreessen would join an advisory board to help build Saudi’s $500 billion city of the future. Thiel and Khosla would sign up to attend the glitzy conference in Riyadh — Davos in the Desert. More smiles all around.
But then, six months later, MBS allegedly ordered the brutal killing of Washington Post columnist Jamal Khashoggi in a Saudi consulate. Statements were drafted. Outrage was professed. Visits were canceled. It looked as though Silicon Valley was having a moment of reckoning over whether taking all this money from overseas dictatorships was really such a good idea.
A small, temporary, fleeting moment.
Because as it turned out, it wasn’t a new moral compass that would put up guardrails against foreign money funding the tech industry. It would be an outsider — the United States federal government — and its target wasn’t Mohammed bin Salman. It was Xi Jinping.
It is China, not Saudi Arabia, that has found itself frozen out of Silicon Valley over the past year, an irony that speaks to who really cares about the foreign money running roughshod through the tech sector: It’s not investors or startups, by and large. It’s the feds.
The new rules of Silicon Valley
It may look to the outside eye that Silicon Valley just prints money, funneled through startups to give you things like cheap Uber rides. But if you trace the money that comes into startups through their venture capital firms — and trace the money that comes into those venture capital firms from their so-called limited partners — one can see the makings of a great gold rush, financed by overseas investors eager to overstuff money into hungry young companies.
Take Y Combinator Demo Day. The iconic see-and-be-seen event for tech investors hunting the next great company was, a decade ago, a cloistered opportunity for the best-connected, elite professionals — friends who knew the equivalent of a secret password — to see a dozen or so startups. It was small enough to fit in a room at YC’s Silicon Valley offices.
Now Demo Day is more like a world’s fair, bursting with hundreds of presentations by foreigners and to foreigners. In the converted parking lot alongside San Francisco Bay where it was held last month, hustling foreign-born entrepreneurs munching on M&M cookies were pitching startups to wealthy investors and government officials from places like Russia, Spain, Germany, Nigeria, Japan, and — of course — China.
THE TRUMP ADMINISTRATION’S POSTURE TOWARD CHINA IS HAVING PROFOUND CONSEQUENCES ACROSS SILICON VALLEY
This is Silicon Valley in 2019 — a playground for foreign countries eager to fulfill their grand strategies. To some extent, this is to be embraced: If the United States has a comparative advantage in tech companies — and if capitalism is global — then it should welcome the transformation of Silicon Valley. America welcomes foreign money in the New York Stock Exchange and Nasdaq; so, too, should it welcome foreign money in US private companies, especially from close partners like Singapore.
But the rise of foreign money has turned Silicon Valley into a geopolitical minefield for venture capitalists and startups, requiring American startups to make judgment calls and react to crosscurrents that would’ve been strange to the industry decades ago.
Who in Saudi Arabia exactly was directly liable for the murder of Jamal Khashoggi?
Was Huawei actually a threat to America’s national security?
“It’s the world of geopolitics coming to venture,” Rob Ackerman, a venture capitalist active in cybersecurity, said. “It’s got a lot more gray than black and white — and we’re all trying to figure that out.”
Or as an American investor now living in Israel, Mike Eisenberg, recalled telling an entrepreneur recently: “You thought you’re in business. You’re actually in politics.”
This was all true even before the force that has reshaped every American industry over the past two years — Donald Trump — exacerbated that reality. Foreign money courses through the Silicon Valley bloodstream, and his administration isn’t happy about it.
But for too long, most people in Silicon Valley have treated foreign cash with a collective shrug, seeing money as money and not truly considering the ethical and regulatory challenges of taking investment from certain foreign countries, Recode interviews with more than 50 venture capitalists, startups, lawyers, and others involved in cross-border investing reveal. Now Silicon Valley is scrambling to assess its own exposure in this new world order.
Money from two countries in particular has ignited a debate in Silicon Valley about the responsibilities of startups and their investors: China and Saudi Arabia.
The debate around accepting money from China pits two opposing bedrock political beliefs about China against each other: Either China is a highly sophisticated US adversary coyly infiltrating Silicon Valley through communist-aligned actors who arrived here to steal intellectual property or it is just like any other foreign player seeking financial gains — but is being unfairly targeted by a belligerent government that stereotypes all Chinese actors.
Whatever the reality, the Trump administration’s posture toward China is having consequences. Quietly, over the past year, as many as a dozen China-linked firms have scaled back their US investment programs, some dramatically, Recode has learned, due to more aggressive behavior by a regulatory body called the Committee on Foreign Investment in the United States, or CFIUS.
The debate around accepting money from Saudi Arabia is more fraught: Some startups and investors have called on Silicon Valley to find a moral backbone in the wake of Khashoggi’s murder. But by any objective measure, those minority voices are losing. The Saudis have effectively skated by after their existential crisis, successfully handcuffing Silicon Valley with their pocketbooks. The Saudis are still indirectly routing billions of dollars into hot startups, with little public reprimand.
It turns out high-mindedness can’t block foreign money the way the federal government can.
A lucid way to understand Silicon Valley’s money problem
Things can get pretty messy when American companies play with foreign investors.
At Uber, foreign investors from SoftBank, the Japanese telecom conglomerate, because of regulatory concerns may not ever take their two board seats, despite negotiating hard for them after investing up to $10 billion into the company more than a year ago.
At Grindr, US regulators are requiring its Chinese owner to sell the gay dating app over concerns that Beijing could use the consumer data as blackmail.
But to understand just how much foreign money is swimming around Silicon Valley — and how entrepreneurs can get swept up when they wade into the undercurrents of international waters — look no further than the story of a company called Lucid Motors.
Lucid’s story shows the strange challenges American startups can encounter when taking money from non-Americans.
One of the most ambitious startups battling Elon Musk’s Tesla, Lucid Motors has spent the past few years trying to design luxury electric vehicles. And in order to develop the battery and then manufacture the first-class car from scratch, Lucid has had to raise loads of money. That hasn’t always come easy.
And just like many startups with big dreams but small deposits, Lucid Motors has had its prayers answered overseas.
“We are a US company,” the company’s CEO, Peter Rawlinson, told The Verge. “We’re going to make the best car in the world here in the US.”
Lucid may be very proudly an American company, but its investor base has been almost entirely from foreign countries — recently, that’s meant Saudi Arabia, but for its prior decade of existence, China. Despite being based in Newark, California, almost all of its rounds of financing have come at least in part from investors based in Asia.
“Are they an Asian company or a California company?” said one person close to Lucid. “The whole branding is around California. But internally — as they were thinking about [employee] population, building a factory, who do we do joint ventures with — it had a big Asian influence.”
At one point, about half of the company was owned by Asian investors, the person said. And their involvement would lead to a series of highly unusual financial moves that shows the risks for startups in taking money from foreign investors.
The drama centered on a celebrity Chinese billionaire named Jia Yueting, the founder of the Chinese conglomerate LeEco and who first led an investment in Lucid’s predecessor company in 2011. But in retrospect, allowing Jia into the company was a mistake.
Slowly and secretly, Jia began amassing a larger and larger ownership stake in Lucid, in part by buying out at least one other Chinese investor in a private stock deal that the company didn’t — or couldn’t — fully track, another person close to the company said.
At his ownership peak around 2016, Jia had close to a 30 percent position in Lucid, one person said.
And, as it turned out, Jia was also the complete owner of one of Lucid’s closest competitors, an electric vehicle startup called Faraday Future. Jia would become Faraday’s CEO in 2017— posing an obvious and damaging conflict of interest to Lucid, which was hemorrhaging money and exploring a possible sale.
Such a situation would be exceedingly rare in America’s startup ecosystem — where venture capital firms have rules governing conflicts of interest. Jia refused to sell his shares, cueing endless, argumentative board meetings over what to do with the Chinese robber baron. He did not have a master plan but merely sought control.
“You’re thinking, ‘What the hell is going on?’” one of the people close to the company recalled. “It was just a constant distraction.”
Another person described the drama as “like binge-watching a Netflix series.”
THE DRAMA AROUND LUCID MOTORS, CHINA, AND SAUDI ARABIA WAS “LIKE BINGE-WATCHING A NETFLIX SERIES”
Lucid did not return requests for comment for this story.
Eventually, after two years of back-and-forth, Jia gave in and sold almost all of his stake, a source said.
“He recognized if we didn’t let an investor in, the company was going to fail. It just got to the eleventh hour — we were losing money and losing employees and we were going to lose everything,” the person said. “He might be crazy but he’s not financially inept.”
End of the story? Nope. One controversial foreign funding source was swapped in for another.
Enter Saudi Arabia.
Buying out Jia Yueting (who is now under investigation by Chinese regulators) and other investors to take a majority stake last year in Lucid Motors was the Saudi sovereign wealth fund, which invested $1 billion into the startup right at the time the SWF was escalating its stake in Lucid rival Tesla. The Saudis’ involvement — instead of the Chinese — has made things “1,000 percent better,” one person said.
There was minimal pushback on the Saudi deal, sources say, which was negotiated for years and struck before the Khashoggi killing that fall. But with a majority stake, Lucid is now one of the crown jewels of the Saudi footprint in Silicon Valley, introducing a whole new universe of ethical and geopolitical questions for the startup.
And still the saga wasn’t over. The Saudis’ investment in Lucid had to be approved by CFIUS, the US government regulatory body that has grown newly aggressive. It dragged on and on — but finally was greenlit this month.
How “America First” struck Silicon Valley
Here’s the thing: Despite Saudi Arabia’s gruesome actions and troublesome human rights record, the country remains a US ally and has never attempted to do the one thing that would raise the ire of the US national security state: steal American intellectual property.
That ignominy belongs primarily to China. And as a result, so does US government scrutiny.
Four years ago, Chinese leadership proclaimed a new 10-year vision to move its industrial manufacturing economy toward expertise in technology and science: Made in China 2025. America’s China hawks, who would become emboldened with the 2016 election of Donald Trump, saw this ambition as a threat.
And they found a weapon: the Committee on Foreign Investment in the United States, an obscure — and, for a long time in Silicon Valley, beleaguered and toothless — agency chaired by the secretary of the Treasury. Republicans shepherded the passage of a bill last summer that significantly beefed up the investigative resources of CFIUS and empowered the body to expand its scope far afield into minority investments like venture capital.
If Silicon Valley wanted to ignore Washington, as it is wont to do, it couldn’t any longer.
The idea behind last year’s legislation to toughen up CFIUS — codified in the Foreign Investment Risk Review Modernization Act of 2018, or FIRRMA — was an attempt to seriously regulate all new money from overseas flowing into so-called “critical technologies.” But you didn’t have to dig for subtext to figure out who was the big bad wolf in the eyes of the bill’s promoters.
“I think not enough focus has been put on China,” Trump said in the Roosevelt Room of the White House last August after it passed. “And that’s been for a long time.”
If Trump’s goal was to erect barriers to protect Silicon Valley “nerds” from China, as he’d later say, it has succeeded beyond his wildest imagination. And that reflects the rhetoric that powered him to the White House in the first place.
“This is emblematic of ‘America First,’” said Jonathan Heiliger, an investor at Vertex Ventures, a firm backed heavily by a Singaporean sovereign wealth fund, Temasek.
If that’s the strategy, it’s working.
How the tech sector got so damn paranoid
Let’s back up for a second and explain how money flows through Silicon Valley’s venture capital ecosystem.
Venture capital firms aren’t themselves flush with permanent cash. They leverage their partners’ connections, experience, and track record to raise millions of dollars every two or three years in a “fund” from what are called limited partners — institutions or individuals that are supposed to have “limited” operational influence in the firm, beyond bankrolling it. (It is general partners — or the VCs — that actually run it.)
The VCs then go out and invest in either a particular strategy or in a particular type of company. While the limited partners occasionally do directly invest in startups, these institutions rarely have relationships with entrepreneurs and so they generally need VCs to do the deals for them.
In return, venture firms charge these limited partners a small percentage of money for overhead and management fees, and they then invest the rest on their behalf into startups — money that can give birth to companies like Instagram, Uber, or Airbnb and create enormous cash windfalls. Of course, most investments fail spectacularly, so the risk is quite high.
“EVERYONE WITHIN CHINA IS BEHOLDEN TO THE COMMUNIST PARTY AND THEIR OBJECTIVES”
And over the past few years, the overwhelming attitude at US venture capital firms toward investments that come from China could be best characterized as a see-no-evil blindness, or late-to-awaken sleepiness. But overnight, a scary new regulatory environment has induced a sudden paranoia.
Whether that paranoia is merited depends on where you stand in the broader political debate in the United States about China’s aspirations. Some advocates for Chinese direct investment see the new rules as plain racist, treating all Chinese the same — whether they hail from mainland China, Hong Kong, or Taiwan — and see the federal government as making no distinction between Xi Jinping’s authoritarian government and a wealthy businessman merely seeking to invest in financial returns.
“I’m really not making a distinction there, because everyone within China is beholden to the Communist Party and their objectives,” said Michael Brown, the former CEO of Symantec and a leading voice among Silicon Valley’s China hawks.
But few Silicon Valley heavyweights — not even Brown — mention humans rights concerns or a clash of cultures when making the argument to rein in China. The concern over taking Chinese money is rooted primarily in CFIUS — and, for some, in the underlying reason for that governmental scrutiny in the first place: intellectual property theft.
That explains why FBI officials are popping up in Silicon Valley: Agents have been meeting with investors in recent months to warn them about the dangers of their startups taking money from China, according to two people familiar with the outreach.
“The FBI works with companies to raise their awareness of potential economic espionage or theft of trade secret threats from criminal or state-sponsored groups,” the FBI told Recode in a statement when asked about the visits. “Our goal is to make companies aware of risks and equip them with the tools necessary to protect themselves from anyone who may be a threat to their intellectual property.”
FIRRMA, though — not the FBI — is the tip of Washington’s spear.
Thanks to FIRRMA, CFIUS review can now kick in not only when a foreign investor owns most of the company but when the investor wields some decision-making power in the company, even if that investor owned very little of the company stock. If that startup uses “critical technologies,” it would trigger the company and foreign investor to file for a review as part of the deal, and that could take weeks, if not months, for any kind of answer to arrive.
Anything that might be construed by someone — anyone — in the government as “critical technology,” the phrase targeted by the new law, is a no-go. And because the law is written so vaguely — with 27 categories encompassing everything from “biotechnology” to “battery manufacturing” — venture capital firms are being exceedingly conservative. It’s even worse if the startup is in frontier technology, like robotics or drones. Investors with foreign ties tell Recode that they now essentially consider wide swaths of the technology sector to be effectively off limits.
And, lo and behold, the chilling effect is real. Investors are advising their startups to be ultra cautious about taking money from foreign sources — especially from Chinese funders. Some in Silicon Valley have even undertaken projects to identify all venture firms primarily backed by the Chinese government — crafting their own private investor blacklists. The US federal government has also sponsored two reports trying to track the Chinese footprint in the Valley — one authored by Brown, which was pivotal in encouraging FIRRMA’s passage, both fans and detractors admit.
One investor said his firm advised a portfolio company with offers from multiple Chinese investors to lead a funding round to allow only one of them to participate in the financing — and not as the lead investor. A second said his firm recommended to a CEO that going through CFIUS review in order to take Chinese capital was simply not worth the headache.
Ilya Golubovich, who runs a fund that is two-thirds backed by limited partners from Russia and the former Soviet Union, said that after FIRRMA, his firm has decided to divest from a few of their portfolio companies in aerospace, one of the listed sectors. “I would have liked to have stayed in those companies,” he said. “We made the decision as a firm that aerospace was not an area that we want to touch given the CFIUS sensitivity.”
The feeling is mutual. One venture capitalist active in financing companies in frontier technologies said he now assumed that his portfolio companies could never raise money from foreign investors going forward. “It’s almost definitely going to be fruitless, and you’ll have all this brain damage [from the attempt] — so you just assume it’s not worthwhile to pursue Chinese money,” he said. “It sucks but I understand the reason.”
Eisenberg, who sits on the board of WeWork, said that some VCs have gone further, with friends having told him they will not invest in startups that have any Chinese firms on the “cap table,” or list of previous investors.
This red fever has gripped founders, too, who have enough to worry about even before being thrown to the wolves of global politics.
Put yourself in the seat of a startup CEO — say, squabbling with a co-founder, dealing with a customer reneging on a contract, or preparing to take on more outside investors. Accepting money from a Chinese investor — which could mean waiting months for CFIUS to review a deal, and with the specter that the deal might be imperiled altogether — could not be less appetizing.
One venture capitalist said she’s been asked two or three times by founders recently about whether she has any Chinese limited partners (she does). Another venture capitalist told Recode that some companies are now asking investors to sign side letters affirming that certain information won’t be shared with their limited partners.
It’s arguable that this paranoia is merited in this new era of US-China relations — a time when Tesla is suing a former employee for allegedly stealing intellectual property and passing it to a Chinese rival, and when a Chinese woman approached Trump’s Florida estate carrying a USB drive packed with malware. More than 90 percent of economic espionage cases brought by the US government over the past seven years have centered on China.
To be sure, some founders report strange experiences.
One high-profile startup founder told Recode that in 2016 he was negotiating a deal with a state-backed Chinese entity for a strategic investment. But during the diligence process, the founder said, the Chinese investor asked for last-minute stipulations ensuring it would have access to customer data and other intellectual property. The deal fell apart.
A second founder told Recode that he walked away from a $35 million investment from a Chinese tech giant amid concerns that the firm was trying to absorb their intellectual property. He passed on signing definitive documents after the diligence process.
“They were clearly documenting and trying to internalize everything they could,” he said.
And even when you take Chinese money, the paranoia doesn’t abate: A founder who took money from a Chinese internet giant said foreign potential customers of his would sometimes oddly question whether his company was a front for corporate espionage by the Chinese government. He didn’t know what to say.
The rise of Chinese zombie funds
In this new world order, investors with Chinese or other extensive foreign ties have two options: flee America or freeze out the non-Americans.
So as Silicon Valley CEOs run away from Chinese firms, most Chinese investors aren’t foolish enough to pursue them. Few deals have actually fallen through, bankers and venture capitalists say. Both sides are, increasingly, just avoiding one another altogether.
The problem is that Chinese investors already struggled with adverse selection or, to put it a less elegant way, the perception that they’re bottom feeders. A cultural disconnect and a lack of connections has generally meant that a CEO taking Chinese money is indicating to the market that her company has struggled to raise money — and that’s especially true now in the FIRRMA era.
One China-backed investor said he had not issued a term sheet (an offer to lead an investment round) in the United States since the new FIRRMA rules went into place in November. But he is much more actively scouting deals overseas — including, ironically, back in China.
And as many as a dozen China-linked firms have scaled back their US investment programs, some dramatically, Recode has learned.
China’s retrenchment from Silicon Valley has been quiet, subtle, and hard to track. It is driven as much by regulation as it is by psychology, with several Chinese investors telling Recode that they just don’t feel welcome to make investments in a country where they feel like an enemy.
“We’ve seen some foreign folks pause on investing, even if not closing up shop, where people don’t say what the reason is,” said one senior foreign investor in the United States, “but you know the reason.”
FIRMMA has been an equal-opportunity offender: Internet giants worth hundreds of billions of dollars like Alibaba are scaling back their investing programs; so, too, are under-the-radar names that are substantially backed by the Chinese government.
That has spawned a rapidly increasing number of what could be called zombie funds: Chinese-backed entities that are effectively dead, even if still technically operating.
Take WestSummit Capital, which was set up with $300 million from China’s sovereign wealth fund a decade ago, investing in startups like the gaming platform Unity. The firm has reduced plans to back US-based companies in the wake of both FIRRMA specifically and fraying US-China relations more broadly, sources say, and in recent years has lost some of its personnel that worked on American investments. The firm is now instead focusing on other parts of the world, and a source said it has had to labor to raise money from investors outside of Chinese state capital.
The $800 billion state-owned China Investment Corporation at one point hoped to open an office in Silicon Valley. At around the quantitative peak of Chinese venture investment in the US, in 2016, CIC’s seniormost leadership came to Silicon Valley and embarked on a tour to meet with famous venture capitalists like Andreessen Horowitz’s Marc Andreessen, Benchmark’s Bill Gurley, and Social Capital’s Chamath Palihapitiya.
But the office plan — a physical manifestation of the Chinese state’s desire to back Silicon Valley companies — has been scrapped, sources say. CIC is now planning to be “extremely cautious” in the United States more generally, almost certain to forgo making any direct investments in Silicon Valley startups for the foreseeable future.
And some of the attention lavished on them by top firms is almost laughable in the rearview mirror. CIC still holds on to limited partner stakes in a few funds, like the once Kremlin-backed DST Global, the private equity giant Silver Lake Partners, and the cross-border investor DCM Ventures, according to a person with knowledge of CIC’s activities. But no reasonable investor would want money directly tied to the Chinese state right now.
Or even indirectly, to be honest. Firms like Danhua Capital, which recently rebranded as DHVC, has become persona non grata among Silicon Valley investors, sources say, who worry that their involvement in a deal would imperil its chances at closing. Danhua is one of 59 firms backed heavily by an investment arm of the Beijing government — one step removed from President Xi — according to one federal government report.
Despite its dreams of becoming a bridge between the two continents, Danhua has essentially gone quiet, sources say, with minimal recent investments. That’s especially true since Zhang Shoucheng, a famous Stanford physicist and the firm’s founder, died by suicide in December, just weeks after Danhua was identified in that government report.
“If you’re an entrepreneur and you have choices, why would you take money from them? Unless you’re a masochist,” said one venture capitalist active in China. “I don’t know if Danhua is good or bad. That’s not for me to judge. The fact is that they pose a risk for not closing. That is a risk to my company.”
“IF YOU’RE AN ENTREPRENEUR AND YOU HAVE CHOICES, WHY WOULD YOU TAKE MONEY FROM THEM? UNLESS YOU’RE A MASOCHIST.”
Even the Chinese internet giants — Baidu, Alibaba, and Tencent — which have seemed impervious to regulation with their armies of highly paid lobbyists and lawyers, are struggling to adjust to the new reality. While they’re not packing their boxes just yet, observers say the trio has generally slowed down their investment activity and hiring plans, with an unusually high number of investor departures since the beginning of the year.
Investors and other staffers have been gradually leaving Alibaba’s San Francisco office, dropping from about as many as 25 three years ago to about 15 today. Alibaba’s US investment team has seen a similar fall-off as it drastically scales back its American investment program, according to people close to the firm, with some investors described as just bored.
The internet giant recently put about $100 million recently into Quibi, Jeffrey Katzenberg’s media startup, but it is in general retrenching from Silicon Valley in part because of CFIUS concerns — as exemplified by its blocked acquisition of Moneygram by the US government. It would also make sense that billionaire founder (and Communist Party member) Jack Ma would not want to depart from the lead of the Chinese government, which is obviously at odds with the Trump administration, one source said.
Alibaba declined to comment.
Tencent, however, clinched the most notable deal since the expanded CFIUS regime went into effect, leading a $300 million round into the social media firm (and consumer data-soaked platform) Reddit earlier this year. That deal is not expected to be subject to CFIUS review, three people familiar with the matter said.
It’s not as though all these Chinese investors are now suddenly twiddling their fingers. Venture capitalists in other parts of the world — like India, Israel, and Southeast Asia — report more Chinese investors approaching their companies than ever.
“People are saying, ‘The US doesn’t really welcome our money,’” said one Chinese-backed venture capitalist. “So we need to stop investing in the US.”
The data is beginning to bear this out: The Rhodium Group, which studies Chinese venture investment into the United States, shows a modest drop so far in these deals in the US since the passage of FIRRMA — falling in both the total number of rounds featuring a Chinese investor and in the estimated Chinese investment of the deals since the legislation was passed in August.
Driving that decline, according to the data? Chinese investors with any ties to the state, who have barely done any disclosed deals in the US since last fall.
The dragnet widens
The other option for venture firms that are backed by China is to try and run away from their Chinese limited partners. But that’s not easy either. And if China hawks are really trying to eradicate foreign money in venture capital, they should probably focus on these limited partners— the money behind the firms. Limited partners, or LPs, in funds are almost never public, and in fact are often legally required to never be disclosed.
There is some debate among lawyers about how exactly CFIUS affects them. And because of that ambiguity, paranoia reigns here, too.
Veronica Wu, who runs Hone Capital, said while her current fund is almost entirely backed by Chinese entities, she expects only about 10 percent of her next fund’s money to come from China. Wu said CFIUS concerns certainly “accelerated” the change.
Another venture capitalist said she expects many of her China-based LPs to not reinvest when she raises her next fund.
But here’s what China hawks won’t be happy to hear: Limited partners who are not on an investment committee tend to receive very little information about their venture firm’s portfolio companies. Sure, they’ll meet some at the annual meeting. They’ll receive valuation marks in quarterly reports. Maybe a venture firm will introduce a CEO to a limited partner who is making a social visit to town.
Several China-backed venture investors laughed when asked whether they ever share any portfolio company intellectual property with LPs.
Still, limited partners are also seeing a tightening of the noose by their paranoid American managers. Mainline firms are being much more cautious about accepting foreign LPs.
For instance, lawyers who are experts on CFIUS say it’s not clear whether a firm with money coming from a substantial base of foreigners, but ones without clear decision-making power, could invite CFIUS scrutiny. But they’re still counseling their clients to segregate foreign LPs into a separate group — ensuring that they don’t have governance rights and precluding them from any investment decisions, for instance — so they don’t run afoul of the new law.
Several firms that raised new funds after the CFIUS rules went into effect in November tell Recode that they have tightened their legal language to make sure certain limited partners cannot gain what is known as “non-public material information” about their portfolio companies. Or, to put it another way, the sort of sensitive stuff you can’t find with some Googling. But investors are nervous about what qualifies as that type of intel, so they’re adopting an extremely conservative position, said Jeff Farah, the general counsel for the National Venture Capital Association.
“People are scratching their heads saying, ‘Well, one of my portfolio companies is doing well’” — maybe they’ve passed some technical milestone, maybe they’ve passed a clinical trial — “and there’s now all types of nerves of what information they can share with LPs,” Farah said.
Even foreign investors who have no China connections suddenly have to jump through hoops that they didn’t have to six months ago. The National Venture Capital Association has been fielding calls from VCs who are concerned about money they’re hoping to raise from investors in Japan, Europe, or South America.
That’s because while CFIUS is primarily scrutinizing Chinese money under FIRRMA, all venture capital firms with foreign cash — from anywhere — are theoretically subject to the enforcement regime.
Some venture capital firms over the past few months even hired high-priced special counsel to advise them specifically on CFIUS issues — representation they didn’t need before — according to a firm that hired one of these firms.
And foreigners not from China are suddenly finding themselves caught up in the CFIUS dragnet. A firm with three general partners — two Americans and one citizen from the United Arab Emirates — that is active in CFIUS-covered sectors recently forced its UAE partner to resign from future funds.
And one foreign-born (but non-Chinese) venture capitalist who has lived in the United States for two decades said that both he and his business partner recently had to apply for naturalization in order to qualify under FIRRMA as a non-foreign general partnership, a designation that depends partially on the citizenship status of the firm’s partners.
“It basically is having us choose and make an important personal decision because of this change,” the VC said.
This isn’t really what policymakers had in mind. After all, there are a bunch of serious, well-intentioned foreign-backed VC firms and limited partners that are now under scrutiny just for being non-American.
Take GIC, for instance, the Singaporean sovereign wealth fund. GIC is almost indistinguishable from any American venture firm in Silicon Valley, startup observers say. They’ve been investing in Silicon Valley for 30 years. Their connections to Asia are a plus. And their investments in elite venture firms like Lightspeed have given them enviable access that makes them more similar to the Sand Hill stalwarts they back than a sketchy foreign player hunting aimlessly for the next hot deal.
The firm is increasingly acting like any other VC firm, too. At a glitzy party to conclude its Bridge Forum, in its third year, top-tier investors accepted GIC’s invitation to munch on canapes of scallops and barbecue pork buns as they listened to a string quartet and posed in front of a mural featuring San Francisco landmarks. It was just like any other overproduced, true-to-stereotype VC party.
And in ways like that, GIC role models what the Chinese, Saudis, and other newcomers to this shore have tried and failed to do: blend in.
“If you’re newer, you may not have as rich a reference list who can say, ‘I’ve known them for X number of years,’” said Jeremy Kranz, the co-head of GIC’s tech investing practice. “We do want to do things with our strategy that are hard to replicate.”
How the Saudis have escaped the fate of the Chinese
Middle Eastern investors are dealing with the same CFIUS issues that the Singaporeans, Chinese, and other foreigners are. But they have an additional challenge that is as much political as it is human: Some in town just think they’re evil people.
Over the past decade or so, Middle Eastern oligarchs have quietly untapped their spigot of cash and let it flow into Silicon Valley.
Here’s why: The economies of countries like Saudi Arabia and the United Arab Emirates revolve around one precious, depleting resource — oil — and the nations’ ascendant, younger leadership has leaned into the future by acquiring shares in American companies like Uber and Magic Leap. Less risky than betting the house on petrocarbons, the thinking went.
And in a Silicon Valley lousy with startups and venture capital firms, all trumpeting the next disruptive billion-dollar idea, the Middle Eastern investors’ arrival has generally been embraced. “Dumb money,” the thinking went.
Deals featuring a Saudi Arabian investor hit $5.3 billion in 2016, according to CB Insights, across 19 different deals.
The Saudis planned to follow Mubadala, the sovereign wealth fund of Abu Dhabi, in opening high-end offices in the heart of Silicon Valley. Middle Eastern investors have successfully cozied up to blue-chip venture capital firms like Sequoia Capital, Thrive Global, and Data Collective, offering them access to startups that they couldn’t make inroads with on their own.
It was a win-win.
So it wasn’t a surprise that Mohammed bin Salman drew the audience he did when he visited Silicon Valley in April 2018. It was a zenith in tech-Saudi relations.
But then Jamal Khashoggi was brutally killed in Turkey, allegedly at the request of the Saudi royal family.
For the first time since the explosion of Middle Eastern-backed firms, Silicon Valley began looking more critically at the bagmen bearing billion-dollar checks. If the Chinese incursion into Silicon Valley raises questions of intellectual property theft, protectionist regulation, and geopolitical competition, the Saudi spending spree raises questions of ethics, equality, and basic human rights.
“Part of the challenge is that the money has flowed so freely from some of these places — it comes so easy — a lot of times the VCs can get a bit lazy,” said John Vrionis, who left Lightspeed last year to raise his own fund from limited partners like the endowments of historically black colleges. “We want to work for LPs where we’re inspired by what happens in terms of the wealth creation. With the Saudi regime and some of its stance on women and oppression, that’s obviously very different.”
Saudi Arabia still has a half-dozen state-backed firms throwing their weight around the tech ecosystem. They range from the seemingly innocuous King Abdullah University of Science and Technology to the more obviously state-linked Public Investment Fund — all tied to the same royal family.
But thanks to a $45 billion investment in the Japan-based SoftBank Vision Fund, the Saudis have become the most powerful force behind the most powerful venture capital firm in Silicon Valley.
SoftBank, like other international investors, has CFIUS issues as well, but the Vision Fund is a dominant force in late-stage venture capital. It offers a product that basically no one else in Silicon Valley offers: massive checks at friendly, inflated valuations to startup founders so they can stay seemingly perpetually private.
And in the wake of Khashoggi’s murder, the Vision Fund has suffered remarkably little blowback. Almost none of its existing portfolio companies has said a mean word about the Vision Fund or its Saudi backing. The fund has struck multiple billion-dollar deals with some of the country’s most promising startups — even after Khashoggi’s death — with CEOs occasionally telling reporters that they see some distance between the Saudis and SoftBank, whose leaders have lightly chastised the country’s leadership.
Yes, some venture capitalists — such as Wesley Chan at Felicis Ventures and Keith Rabois at Founders Fund — have gone public with Recode and others that they see Saudi cash as blood money and that Silicon Valley should reject it. But here’s the truth that even those aghast at the Saudis’ conduct privately admit: They’re losing the debate.
“There’s a majority attitude which is ‘no comment.’ There’s a plurality attitude which is, ‘all money is green.’ And there’s a more strident attitude that is, ‘I won’t touch money from bad guys,’” said Amol Sarva, the CEO of the coworking startup Knotel. “The problem for the strident attitude — which is the most ethically pure — is it’s kind of hard to keep your word.”
That’s because in the eyes of ethics-minded investors — or in the terminology of their critics, “virtue signalers” — what money in 2019 is really clean?
“The world is so complicated,” said Sarva, with some resignation. “And when you’re dealing with huge-dollar figures, you’re dealing with the big puzzle pieces on the map.”
(Sarva’s startup reportedly is raising money from Kuwait’s sovereign wealth fund.)
If you’re not taking money from Saudi Arabia, is it better to take money from Singapore’s Temasek — generally thought not to be part of Silicon Valley’s foreign money problem — but which some say represents a repressive society that doesn’t tolerate free speech? How about money from Malaysia’s Khazannah, whose sovereign wealth fund, according to a person familiar with the conversations, is sometimes questioned by startups and founders about its ties to the 1MDB scandal? Or how about the Qatar Investment Authority, which is backed by a country with its own checkered human rights record and support for terrorism?
Or maybe venture capital firms shouldn’t take money from the endowments of elite universities that were just implicated in an explosive bribery scandal. No venture capital firm is going to refuse Yale, the most sought-after limited partner in Silicon Valley. That’s just not going to happen.
What the experiences of China and Saudi Arabia show is that foreign money is here to stay in Silicon Valley — until the government decides it really cares and interferes. The venture capital industry will not police itself. And startups have demonstrated little willingness to police the VCs.
But Washington? If the Trump administration really wanted to curb Saudi Arabian influence, the feds could treat the Saudis like it has treated the Chinese. And they’re not.
“It would be nice if capital flowed along with our ethics, but that’s not always going to happen,” said Rob Ackerman, the cybersecurity investor. “That’s just the reality of human nature.”