China is flooding Silicon Valley with cash. Here’s what can go wrong.
China is flooding Silicon Valley with cash. Here’s what
can go wrong.
By Elizabeth Dwoskin August 5 at 11:32 PM
SAN FRANCISCO — Mountain View, Calif., start-up Quixey
was the envy of many in Silicon Valley when the company announced a
multimillion-dollar investment from one of China’s largest and most powerful
technology companies, Alibaba.
The $110 million deal — parceled out over two funding
rounds in 2013 and 2015 — was the latest evidence that deep-pocketed Chinese
investors would pay premium prices to get a stake in the region’s hottest young
companies.
But then, something went very wrong: Alibaba stopped
paying, according to people familiar with the matter. The start-up was left in
the lurch, until Alibaba fired back with a hard bargain: We’ll give you a loan
and you must promise not to sue. After a few breathless months of negotiations,
Quixey went through with the new deal. The company said Thursday it had
borrowed $30 million. Those funds came from Alibaba and others under terms that
were worse than the original arrangement, the people said.
At the heart of the bitter, under-the-radar dispute
between China’s online shopping powerhouse and Quixey, whose tech enables users
to search within apps, is a culture clash — one that is emblematic of both the
promises and the perils involved in Silicon Valley’s relationship with China.
Experts say that relationship — always delicate, always mind-bogglingly
complex — has reached a new inflection point, as unprecedented amounts of cash
from China have poured into Silicon Valley.
The flood has had a profound effect on the region’s
start-up boom. Over the past two years, Internet giants such as Alibaba, Baidu
and Tencent — sometimes referred to as the Amazon, Google and Facebook of China
— as well as dozens of private investors, family offices, local municipalities
and state-owned enterprises have raced to capture a stake in the region’s
cutting-edge technologies.
Investment from China into Silicon Valley, excluding real
estate, topped $6 billion by the end of the first half of 2016, with more than
half of that spending taking place in the past 18 months, according to the
Rhodium Group research firm. Investors have been spurred by China’s growing
wealth over the past decade and a government push to develop innovative
technologies — particularly in areas such as virtual reality and artificial
intelligence, where China still lags.
“China realizes it needs a role model to follow as the
country is transitioning from manufacturing to innovation,” said Shoucheng
Zhang, a celebrated Stanford physicist who started a $350 million venture
capital firm two years ago to capitalize on the boom. “This is the new digital
Silk Road.”
U.S. start-ups, for their part, are hungrier than ever
for access to China’s cash-rich companies and newly minted millionaires,
especially in light of a tighter fundraising environment in Silicon Valley.
Chinese investors also can open doors to China’s billion-plus consumers for
services and products that are facing a saturated market in the United States.
Such investments can alter the trajectory of a nascent
company. “Start-up fundraising in Silicon Valley wouldn’t function without
Chinese money,” said Chris Nicholson, chief executive of two-year-old
artificial intelligence company Skymind.io, which has received funding from
Tencent and other Chinese investors. Start-ups that have been rejected from the
clubby venture capital world on Sand Hill Road can still get cash from China,
he said. “It has changed the landscape.”
But there is also distrust on both sides. U.S. start-ups
are wary of hardball tactics and the power that some Chinese players have come
to exert. Some have raised concerns about their innovations being copied, which
has been a long-standing concern for many U.S. corporations partnering with
Chinese firms. As newcomers, Chinese investors don’t want to be disrespected or
treated as naive, or as so-called dumb money, according to executives who work
closely with them.
In interviews, U.S. entrepreneurs said that Chinese
investors often play by unfamiliar rules. Quixey learned that the hard way.
Shortly after the company got its first round of
financing from Alibaba in 2013, Quixey began doing custom work for the Chinese
conglomerate under a separate contract, building specialized technology that
would enable Chinese consumers to search inside Chinese apps in Alibaba’s
operating system, YunOS. (Searching within apps is very different, technologically
speaking, from searching on the Web; even Google has failed to crack the
problem.) The deal stipulated that Alibaba and Quixey would share revenue from
any profits Alibaba made off using the company’s technology in China, according
to people familiar with the matter who spoke on the condition of anonymity to
talk freely about private events.
By early this year, a dispute had arisen. Alibaba claimed
that the start-up had fallen behind on its deliverables; Quixey claimed that
Alibaba owed the company tens of millions of dollars for work rendered for
several months, the people said.
Meanwhile, the expected revenue from Alibaba’s
distribution in China never came, according to one of the people. Alibaba
became frustrated that Quixey wasn’t diversifying its revenue streams, another
person said. At the same time, Alibaba went through a large organizational
shake-up, and start-ups that attempted to work with the company, including
Quixey, felt they were getting bounced around by a dizzying array of politics
and priorities, several people close to the matter said. The problem was
compounded by language barriers, they added.
Quixey considered suing Alibaba, but decided it wouldn’t
be worth it, the people said. Few start-ups can afford a costly lawsuit against
their main customer and investor. The tumult led to missed revenue targets and
the departure of key executives, while the company’s founder stepped down as
chief executive.
“We do, of course, value our relationship with Alibaba —
they’ve been an integral partner and investor,” said Quixey spokesman Scott
Samson. He declined to comment further.
Alibaba declined to comment, citing a policy of not
discussing current investments.
Quixey aside, many investors said the Silicon
Valley-China relationship, while full of opportunity, is also rife with
cultural misunderstandings. Many partnerships fall through as a result, said
Jay Eum, managing director at TransLink Capital, a Palo Alto, Calif.-based
early stage venture capital firm that specializes in helping start-ups work
with Asian technology conglomerates. (Eum’s firm is an investor in Quixey, but
he said he was speaking generally.)
“While the promise of a China partnership is exciting and
looks good on paper, the actual reality requires trade-offs,” Eum said.
In China, where there’s less rule of law, a powerful
government relentlessly pushing for growth, and enormous competition among
companies, brass-knuckled business tactics are more common, said Thilo
Hanemann, an economist at the Rhodium Group.
“Sometimes these tactics are not misunderstandings but
reflections of cultural norms of how business is conducted in China. The
Chinese investor may ask for terms that would be considered overly aggressive
in Silicon Valley, but these terms would be considered fair in China,” said
Connie Chan, a partner with the venture capital firm Andreessen Horowitz who
focuses on China.
It’s not uncommon, for example, for an investor to take
ideas from one start-up and then turn around and invest in a rival, experts
said.
Nicholson, the Skymind.io chief executive, said many U.S.
start-ups cannot afford to walk away from a bad deal. “As a founder, your job
is to keep your baby alive, so you can’t always afford to ask too many
questions when someone comes along with terms that might not be perfect,” he
said, while emphasizing that his own experiences with Chinese investors had
been extremely positive.
Overall, entrepreneurs and investors said Chinese investment
had opened many new doors. For CloudFlare, a Web performance and security
start-up that had pulled out of China in 2011, an unusual partnership with
Baidu in 2015 put the company’s technology in the hands of millions of Chinese
consumers. For Artsy, an online art marketplace, investors from China helped
the company grow its market in Hong Kong. Magic Leap, a virtual reality darling
that received a large investment from Alibaba this year, was invited by Alibaba
to give a keynote presentation in front of hundreds of Chinese engineers at the
conglomerate’s Maker’s Fair in Shanghai.
Chinese investment in Silicon Valley stretches back at
least three decades. But 2014 is considered a tipping point. That year, deals
began to rev up in a big way: Chinese investors took part in 101 deals — more
than triple from two years earlier, according to the research firm CBInsights.
The actual number is likely to be larger since many investments aren’t made
public.
Like the U.S. real estate industry and the bond market,
Silicon Valley has been the target of growing classes of Chinese uber-rich who
are looking for opportunities to grow their wealth outside the country. Recent
instability has pushed money out of the country even more quickly, according to
Rhodium.
Alibaba’s spending spree has included $795.5 million in
Magic Leap, $500 million in the e-commerce site Jet.com, along with
unspecified multimillion-dollar investments in Snapchat, ride-hailing service
Lyft and e-commerce start-up Shoprunner. Last year, Baidu led a $1.2 billion
fundraising round in Uber and put the finishing touches on a glossy new Silicon
Valley campus — a move intended to anchor the company’s growing number of
investments in the region and attract engineering talent that is still hard to
come by in China. Tencent, which owns WeChat, the most popular messaging
application in China, has a quieter presence, investing small amounts in
hundreds of companies and vetting technologies in the areas of gaming, mobile
money and artificial intelligence.
“We’re looking at companies that provide strategic value
to us — and building cool new technology for the China market,” said Alex
Tze-Pin Cheng, general manager of Baidu U.S. Like other Chinese investors,
Baidu has developed ties to the influential venture capitalists on nearby Sand
Hill Road, Cheng said.
Fyusion founder Radu Rusu, whose recent deal will put his
company’s 3-D photography technology on millions of Huawei smartphones, said
the arrangement would be transformative for his 40-person start-up. Like other
founders who had Chinese investors, he said it was remarkable how quickly a
deal went down. “Definitely much faster than any U.S. company I’ve dealt with,”
Rusu said. “They were very aggressive — like there’s no time to waste.”
In the near term, Quixey and Alibaba are patching up
their disagreements. The start-up has built new technology to search within
apps and is talking to a fresh set of potential customers and partners, people
familiar with the matter said.
Quixey is no longer building technology for Alibaba.
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