Chinese state tech investments face higher US barriers

It took Massachusetts-based Nantero nearly two decades to bring its carbon nanotube memory chips to the market. And when it did, Chinese state investors were quick to grab a small slice of the start-up.

In a $30m funding round in April, the privately held company took in capital from China’s largest semiconductor maker, SMIC, and the China Integrated Circuit Fund, a $15bn state investor tasked with helping China’s chip industry outpace the US over the next decade.

The investment in Nantero was part of a record inflow of Chinese venture capital into US technology, an important source of funding for the sector this year.

But national security researchers fear such deals also are being used by state-run Chinese companies to gain access to some of the world’s most valuable early stage technologies — a linchpin issue in the escalating trade and technology war between the US and China.

The Foreign Investment Risk Review Modernisation Act, which took effect in August, pushes back against that perceived threat by empowering the US government to scrutinise and block even small minority foreign investments into sensitive technologies.

“The government is concerned that the minority stakes are a backdoor to the technology,” said Aaron Cutler, a partner at law firm Hogan Lovells in Washington and a former senior staffer at the US House of Representatives.

The changes reflect a vast expansion in powers of the Committee on Foreign Investment in the US, the body responsible for reviewing inbound investments for national security threats. Critics have said the changes will curb the healthy flow of capital into the US tech sector.

In the past, Cfius reviewed only inbound acquisitions in which control of companies changed hands. The new rules give it authority to screen any deal involving “critical technologies”, such as biotech, artificial intelligence and semiconductors.

In doing so, the definition of national security has been broadened to cover the US’s greater interests in remaining competitive in these fields against rivals such as China, which is seeking to supplant America as a world leader in many high-tech areas by 2025.

Lawmakers are concerned that small venture investments might open a window through which Chinese companies can acquire valuable technologies, through board appointments, contact with management and other privileges commonly awarded to investors.

“Even without access to any proprietary [intellectual property], Chinese venture investors can use this leverage to promote technology transfer, for example, by encouraging a start-up to establish a subsidiary or joint venture in China where knowhow is likely to diffuse to Chinese employees and partners,” said Adam Lysenko, a senior analyst at research house Rhodium Group.

Greg Schmergel, Nantero’s co-founder and chief executive, said the Chinese infusion was “a no-strings-attached financial investment that does not grant any access to IP or technology”.

The deal is one of hundreds of similar deals in recent years. Chinese venture capital investment in the US between January and May this year hit $2.4bn and is on track to double the record set last year, according to Rhodium Group. State-backed venture capital investment, while still just a quarter of total investment, is also on track on double.

The new regulations are not expected to be retroactive and the Nantero deal has closed, but it is an example of what an emboldened Cfius will be hunting for. 

Nantero’s fundraising caught the attention of national security researchers largely because the groups the company now counts as investors are the same ones seeking to beat the US on semiconductor technologies over the coming decade.

When Nantero set up a wholly owned foreign company in China in September last year, it chose a sprawling complex that is home to many of the country’s top semiconductor start-ups. That development area is a project of Beijing E-Town, a state-run company that has invested heavily in semiconductor assets around the world.

Notably, in its corporate registration in China, Nantero stated that the scope of its business includes “technology transfer” — a primary target of the new Cfius legislation. Nantero said this was a boilerplate phrase added to the registration document.

Months after the China office was established, investors connected to E-Town joined Nantero’s fundraising, just as the company’s technology was going commercial following 18 years of development.

Those Chinese investors were Shanghai-based China Fortune-Tech Capital and the $15bn China Integrated Circuit Fund. 

Fortune-Tech is controlled by flagship state-owned semiconductor maker SMIC, while the IC fund is controlled by China’s Ministry of Industry and Information Technology. Both are connected to E-Town through investments and are part of a state strategy to wean China off reliance on foreign-made chips.

SMIC, E-Town and the $15bn semiconductor fund have not been accused of any wrongdoing. None of the three responded to requests for comment on the matter.

Some experts say the new US law is unnecessary. “Start-ups have strong incentives to protect their technology, even to the point of denying it to their venture capital investors,” said John Reynolds, a partner specialising in economic sanctions and national security at law firm Davis Polk.

But regardless of the intentions of Chinese investors, future ventures are expected to face much higher barriers in the US. “Essentially, an investment will be deemed to be passive only if the investor can prove that it does not result in any exploitable privileged access,” said Shawn Cooley, an antitrust lawyer at Freshfields Bruckhaus Deringer and a former director at the US Department of Homeland Security.

Deals that once connected state investors such as SMIC to top US tech such as Nantero are expected to become a thing of the past.