The recent bankruptcy of online auction house Auctionata Paddle8 and the very public failure of the UK’s ‘challenger’ Tandem Bank to close its Chinese-investor round share one trait: both were affected by Chinese investors who failed to fund at the last minute. In the case of Auctionata, the failed Chinese investment dates back a couple of years, and wasn’t the cause of bankruptcy. In Tandem’s case Sanpower’s failure to fund £29m led directly to handing back a key banking license since it could no longer take deposits legally, damaging Tandem’s prospects significantly. In the US, China’s LeEco has just cancelled a $2B takeover of smart TV maker Vizio, after heralding how strategic the deal was only a few months ago.
But at the same time, Chinese tech investing has stepped up significantly. In 2016 Chinese investors poured $46B into US tech companies, 3x the previous year’s numbers. Alibaba led an $800m round for Magic Leap, $200m into Snap pre-IPO, and $250m into Uber competitor Lyft. In Europe Chinese companies have controversially bought key assets such as German robot firm Kuka for over $5B, while pan-Asian firm Softbank secured ARM for $36B.
Yet even in this flurry there is controversy. Germany’s chip equipment maker Aixtron first lost a major order, saw its valuation crater, then was under agreed offer from Chinese firm Fujian Grand as its rescuer. Except there could be a clear linkage between the cancelled customer order and the subsequent offer; as the NY Times has reported, two different Chinese companies may in fact be coordinating efforts, leading to a far cheaper $750m price tag for Aixtron. Ultimately the deal was blocked by the US CFIUS review, ending for now a hugely damaging story line for a once-great German hi-tech company.
So are Chinese tech investors cash rich saviours of international tech, or untrustworthy ‘all talk no action’ investors?
The answer is both, but the nuances are important.
- Capital available for investing in key tech assets outside China to advance the industry back home is huge; Chinese abroad grew from $3B to $103B in 12 years from 2002-2014
- For example, Asian investors influenced or led 1/3 of all larger tech financing rounds in Europe in 2016, reflecting both Chinese desire to find the best tech abroad and the lack of locally available capital
- Many of the largest European tech M&A deals last year were driven by Chinese or Asian buyers, including Tencent’s $9B purchase of Supercell and Softbank’s $36B purchase of ARM.
- Yet there is a consistent trend of Chinese investors engaging with companies, doing due diligence, and then pulling out late, sometimes last-minute, in funding rounds
- At the same time, state industrial policy can determine whether deals happen or not. Chinese government capital controls, tightened recently to prevent capital fleeing the country, have scuppered deals. Western companies are unused to such a strong governmental influence that can literally make or break deals, and therefore usually under-estimate it.
- Culturally, there is a gulf between experienced Chinese CEO’s and Western tech CEO’s. It starts with education and upbringing. Mao’s ‘successful’ Cultural Revolution destroyed the educated classes in a whole generation in China, so many leading Chinese CEO’s come from very humble, under-educated backgrounds relying on hustle and scrap rather than polished negotiation. They view term sheets, price negotiation, and due diligence in deals very differently than Western CEO’s and investors. While that is changing with the current generation’s education levels, it still creates a gulf in behaviour. The definition of when a deal is ‘done’ and what constitutes ‘negotiation’ and ‘agreement’ can differ markedly between 50+ year old leaders in China vs the West.
- Finally, Chinese views of ‘intellectual property’ can differ markedly. In a country which has established great prosperity by out-executing other economies, execution counts far more than IP ‘rights’ and ‘protections.’ So for some Chinese investors its entirely legitimate to do technical due diligence to learn more about a western tech company’s key technology, and learn how to execute successfully without needing to complete the deal.
What can US and European tech companies do to address these issues?
- Assume a higher failure rate for ‘serious Chinese interest – it’s just an unfortunate fact, prepare accordingly
- If you don’t meet the senior decision maker, assume it won’t happen – many large Chinese companies remain controlled by one person or family, and if you haven’t engaged and gotten sign off from that level, usually you are nowhere
- You may need deal protection before closing – escrow fees, good faith deposits and similar ‘down payments’ before due diligence, while relatively rare when dealing with western investors, may be required in choosing a Chinese investor to proceed to close with, just because an ‘agreed deals’ means something very different to both sides of the table
- Macro issues can kill a specific deal – as we have seen, tightening capital controls have led to a number of deals at late stage failing to complete, and changes in government policy or attitude (positive or negative) can determine if money is invested or not
- You may have to avoid going exclusive – since exclusivity again can mean different things in China than the US, it may be a requirement for a western tech company to maintain its options till literally the last minute
There is no question Chinese investors are far more active in US and European tech now than even 2-3 years ago.
But for many it remains a mixed blessing, and needs to be treated as such.