Kai-Fu Lee Sinovation Ventures retreats from U.S. amid trade dispute

The brewing trade war between the U.S. and China is starting to have a significant impact on the market — U.S. stocks suffered their steepest drop since January on Monday as investors feared the prospect of higher tariffs.

But in Silicon Valley, that tension has been playing out for months, to the point where many Chinese investors simply aren’t doing deals. One of the most notable departures is Sinovation Ventures, the firm started by former Google China president Kai-Fu Lee, who opened a U.S. investing operation in 2013.

The head of Sinovation’s Silicon Valley office, Chris Evdemon, departed in recent months and informed at least some portfolio companies that the firm was was halting investments in the U.S. as it restructured its fund, according to people familiar with the matter who asked not to be named because the conversations were confidential.

As part of President Donald Trump’s trade dispute with China, the Treasury Department, through the Committee on Foreign Investment in the U.S. (CFIUS), is scrutinizing more Chinese investments and increasingly scuttling deals. Last year, the Trump Administration expanded the scope of CFIUS to include review of non-controlling stakes and investments in addition to outright takeovers.

The effects are being felt in tech start-ups. Ad-tech company AppLovin was set to be acquired in 2017 for $1.4 billion by a Chinese private equity firm until CFIUS stepped in, and CNBC reported in April that a health-tech company called PatientsLikeMe was being forced to find a buyer after the U.S. government ordered its majority owner from China to divest.

Chinese investments in U.S. start-ups have been on the decline since peaking in 2016. Foreign direct investment from China dropped to $4.8 billion last year from $27 billion in 2017 and $46 billion the prior year, according to Rhodium Group.

Perhaps the biggest problem for Chinese firms is that they can’t get into the hottest start-ups because those companies have access to plenty of capital without dealing with the potential hassle that comes with cash from China.

“Even if the CFIUS restrictions are not directly blocking these deals, the environment has changed enough that it’s forcing VCs, specifically Chinese VCs, to retreat themselves,” said Matt Sheehan, non-resident fellow at MacroPolo, the think tank of the Paulson Institute. Sheehan, who studies the ties between China and California, said U.S. start-ups taking Chinese money “see it as just adding risk at this point.”

Sinovation has a particular focus on AI, one of the areas that concerns CFIUS the most because of its potential application to the military.

On the firm’s website, Evdemon is still listed as “CEO of Sinovation North America,” but multiple people told CNBC that he indicated he left for personal reasons. Evdemon’s LinkedIn profile says that he’s also currently a venture partner at Basis Set Ventures, founded by former Dropbox executive Lan Xuezhao. The Basis Set website says Evdemon “was the CEO of Sinovation North America for 9 years.”

Evdemon joined Sinovation in Beijing in 2009, and was one of the six partners named in the latest fund, a $500 million pool of capital raised in April 2018. The others, including Lee, are all based in China. Angela Bao, who had been Sinovation’s other main U.S investor, left in mid-2018 to run the Silicon Valley division of a Chinese education company.

A Sinovation spokesperson declined to comment, and Evdemon forwarded a request for comment to a company representative in Beijing.

Sinovation’s retreat is certainly not all about politics.

Since 2009, when Lee left Google to found the firm, Sinovation has invested the vast majority of its capital in China, where the firm has offices in four cities. Lee, who previously led Microsoft Research, wrote extensively about his bullishness on China in his 2018 book, “AI Superpowers: China, Silicon Valley and the New World Order.” He argues in the book that tech entrepreneurs in China have surpassed their U.S. counterparts, particularly in the area of artificial intelligence.

“I’ve spent decades deeply embedded in both Silicon Valley and China’s tech scene, working at Apple, Microsoft and Google before incubating and investing in dozens of Chinese startups, ” wrote Lee, whose firm manages about $2 billion and counts Taiwanese electronics supplier Foxconn as a top limited partner. “I can tell you that Silicon Valley looks downright sluggish compared to its competitors across the Pacific.”

In an interview in November with Bloomberg, Lee said he was considering scaling back investments in the U.S. if relations between the China and the U.S. continued to deteriorate. He told Bloomberg that 95% of past money was invested in China and going forward “that could easily be 98% or 100%.” He said American policy was forcing his firm to “look for smart, technical Chinese people in America and bring them back to China.”

Now that the U.S. has made it harder for Chinese firms to invest in areas like AI, there’s even less reason for Sinovation to have boots on the ground in Silicon Valley.

Lee’s firm has been on the U.S. government’s radar since at least January 2018, when a unit of the Defense Department highlighted Sinovation in a 48-page report titled “China’s Technology Transfer Strategy,” addressing the perceived need to preserve “our technological superiority and economic capacity.”

The report included a case study on Sinovation and listed four of its investments in areas like robotics, computer vision and virtual reality. It called Sinovation “a great example of an active Chinese venture firm investing in the U.S.”

None of Sinovation’s 40-plus U.S. investments are in companies that have become household names. Among the best known are Wonder Workshop, which makes educational robots for kids, and Fictiv, an on-demand manufacturing start-up. Sinovation still has the ability to make investments in the U.S. and has a partner in China — former Baidu executive Peter Fang — who keeps in touch with the firm’s American portfolio companies, according to people familiar with the matter.

In China, Sinovation writes much bigger checks and has had much more success, backing the likes of bike-sharing company Mobike, facial recognition start-up Megvii, ed-tech company VIPKid and crypto mining equipment maker Bitmain.

Still, there are certain ironies to Lee’s forced retreat from the U.S. For one, he’s from Taiwan and he immigrated to the U.S. at a young age, attending high school in Tennessee and college at Columbia University, before getting his doctorate in computer science at Carnegie Mellon University in Pittsburgh.

In addition to being U.S. educated, Lee provides the types of connections in China that some start-up executives said were extremely valuable when they were looking for hardware partners or potential distributors in a country that’s notoriously difficult for outsiders to navigate. By cutting off access to that sort of strategic help, those founders said the U.S. government is harming its own companies.

Lee also is trying to make clear that when it comes to AI, the old rules of intellectual property no longer apply. One of the longstanding concerns the U.S. has had about China is that it freely steals IP of American companies, whether its devices like the iPhone, handbag designs or trade secrets. But AI doesn’t work that way because nobody owns the algorithms, Lee says.

“A lot of the the fundamental algorithms cannot be patented,” Lee said in an interview on CNBC in February. “They’ve already been put in open source. We find the IP discussions are real but do not pertain at all to AI.”

— CNBC’s Sally Shin contributed to this report.

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