The national security implications of Chinese venture capitalists are overblown

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The national security implications of Chinese venture capitalists are overblown

Washington — as Washington does — is barreling towards a new reform plan designed to protect American innovation from overseas investors (which should really just be read as the Chinese these days). Earlier this week, congressional committees passed a measure designed to strengthen CFIUS, the Committee on Foreign Investment in the U.S., which we have written extensively about on TechCrunch. The bill would expand the powers of the committee to review transactions in more contexts, beyond its current mandate of looking only at changes in controlling interests.

Washington — as Washington does — has turned the debate, which was once deeply technical about the machinations of a mostly unknown government agency created during the Korean War, into a histrionic fight about the future of American innovation. Along the way, this classic DC dramatization threatens to rollback the robust market of Chinese venture capital flowing to Silicon Valley startups.

Limiting those flows of dollars to U.S.-based companies would be a tremendous mistake. Silicon Valley is the strongest innovation region in the world, and in no small part because of the robust venture capital dollars that fund risky startups to go big. While rules should be enacted to protect American intellectual property, Silicon Valley should be left alone to handle these problems in a more market-centric way.

Unfortunately, the histrionics of DC are already pushing this reform bill too far. To see this in action, let’s look at this in-depth Politico article that has been making the rounds on Capitol Hill this week. It’s title, “How China acquires ‘the crown jewels’ of US technology” already gets at its conclusion, but it is the section on venture capital that left me stupefied. Take this quote:

One major concern among specialists like Ware is that Beijing officials could use early Chinese investments in next-generation technology to map the software the federal government and even the Defense Department may one day use — and perhaps even corrupt it in ways that would give China a window into sensitive U.S. information.

“There’s a tremendous amount of intelligence value there,” Ware said. “All governments desire to know what other governments are doing. And knowing the technologies and how they work I think is a big part of that.”

Here’s the thing — the American government buys a lot of its products right out in the open through the procurement process. It actively signals what it is looking to buy at trade shows and in keynotes to encourage industry to build products that solve its problems. There exists an entire class of DC consultant that will tell you what the government is looking to buy in one, five, and ten years down the line. None of this is secret, nor should it be.

Now, that isn’t to say there isn’t confidential information that can be exchanged during the procurement process with sensitive agencies like the Defense Department. Obviously, integrating software with their existing systems will reveal a lot about the architecture of American national security computing, and the government has an interest in preventing the spread of that information widely.

The solution in my mind is not to block the hundreds of millions of dollars of Chinese venture capital flowing into the Valley, but rather to empower national security agencies to only work with contractors with clean equity. For instance, if a Chinese investor owns 5% of a startup, then that startup could no longer be eligible for sensitive government contracts. Clear rules here empowers startup founders to decide whether the capital they take is worth the potential loss of any government contracts that they may become ineligible for. In other words, there is a clear market dynamic that allows participants to decide what the benefit of capital is compared to the risk of intellectual property theft.

The other concern from Washington is that Chinese venture capitalists will get access to technical information as part of their investment. Again from Politico:

But Bryan Ware, CEO of Haystax Technology, which works with law enforcement, defense and intelligence clients on securing their technologies, cast some doubt on the idea that the owners of tech startups would naturally refuse to share details of their technology with their investors: “If you’ve got a Chinese investor and that’s the lifeblood that’s going to allow you to get your product out the door, or allow you to hire your next developer, telling them, ‘No, you can’t do that,’ or, ‘No you shouldn’t do that,’ while you have no other alternatives for financing — that’s just the nature of the dilemma.”

Ware’s solution to the dilemma is to just block the venture capital, thereby guaranteeing that the technology wouldn’t be built. You can’t steal intellectual property that hasn’t been invented!

Having worked in venture capital for a number of years, all I can say is that I have never seen venture capital investors ask for a level of technical information on an on-going basis that would be of any use in creating a competing engineering effort. The one time that most VCs even slightly care about the technical side of these businesses is during the due diligence process, when coding libraries need to be checked for copyright and some firms do further technical due diligence on the codebase to verify a team’s competence.

The due diligence tasks can be solved through trusted third-party intermediaries, which frankly is what most firms already use for these processes (there aren’t a lot of investors who also happen to be coders anyway). Furthermore, lawyers already make it abundantly clear about what information an investor can access through an investment, and that language can be even more stringent in cases where a Chinese investor is involved.

Rather than a federal block on investment (or just the friction that an interagency process creates), let the market handle this particular problem. Let me be frank: any CEO of a startup that would give all of their technical information willy-nilly to their investors or customers — Chinese or otherwise — is so laughably incompetent about trade secrets that I can’t imagine their business surviving long-term anyway. Every startup has to make a call on when to share technical details and when not to (for instance, should you share your technical stack with a foreign corporation who wants to buy your product but needs to verify GDPR compliance?), and getting sophisticated about sharing is critical for surviving in the cutthroat Silicon Valley market.

I am focused on minority-stake venture investments in Silicon Valley with this argument. Obviously, the rules can and should be very different in takeover situations, or in bankruptcies where the acquirer will receive the complete technical details of a company. I share the concerns of many analysts around how easy it can be to learn U.S. intellectual property, and I do believe the Chinese have a robust program to exploit the American economy’s openness.

But in our rush to try to plug this flow of information, let’s not lose sight of what actions are dangerous, and which are mutually beneficial for all parties involved. Venture capital gives companies the ability to hire workers (almost always domestically) and build products that can create impactful value for the economy. Washington — as Washington does — is taking these CFIUS reforms too far, and that risks undermining the very region that is the pinnacle of innovation in the world today.

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