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When China’s government launched a sweeping crackdown on the technology industry over the summer, panicky venture capital investors stopped writing checks and startup valuations began to plummet. It looked like the country’s historic innovation boom was over.
Then a strange thing happened: In just a matter of weeks, the startup machine kicked back into gear. In fact, venture capital investments in China reached $130.6 billion for 2021, according to the research firm Preqin. That set a new record for the country -- about 50% higher than the $86.7 billion total the year before.
The performance is stunning given the devastation wrought on the industry’s marquee players. Alibaba Group Holding Ltd., Tencent Holdings Ltd., ByteDance Ltd. and ride-hailing provider Didi Global Inc. were all battered in turn over the past few months. The entire online tutoring sector, once a hot spot for venture dollars, was forced to turn non-profit. 
Yet entrepreneurs and venture firms pivoted to new opportunities with startling speed. They’ve turned away from softer internet businesses and toward hard-core technologies like semiconductors, robotics and enterprise software. The amount of money going into biotechnology hit $14.1 billion last year, up ten-fold from 2016.
“Investors’ appetite for China tech remains intact. What has changed, however, is where they park their money,” says Jiang Jingjing, a lawyer who specializes in fundraisings at King & Wood Mallesons in Hong Kong. “It has become quite clear that more and more funding has flowed to startups with cutting-edge technology.” 
 
China's Tech Reset
Venture investments recovered from Beijing's crackdown to reach a record $130.6 billion
China is still well behind Silicon Valley in venture investing overall. The U.S. reached its own new record of $296.6 billion last year, more than twice the total for the Asian country.
But in certain fundamental technologies, China has already surpassed the U.S. For example, Chinese chipmakers, integrated circuit designers and other semiconductor startups received $8.8 billion in funding last year, more than six times the $1.3 billion invested in comparable companies in the U.S., according to Preqin data. While President Joe Biden has been desperate to lift U.S. semiconductor manufacturing capabilities, Chinese chip startups have been overwhelmed by funding offers. 
 
“In China right now, it’s getting crazy,” says Yong Luo, a former Intel Corp. engineer who raised money for a new semiconductor startup though he’s probably two years from generating revenue. “The chip sector is really hot.”
 
This is almost precisely how President Xi Jinping’s central planners would have imagined it in their five-year plans. The Communist Party has decried the corrupting influence of games (Tencent) and online videos (ByteDance), while pushing for more resources to be allocated to fundamental research. That shift is aimed at helping reduce the country’s dependence on U.S. suppliers -- a top priority for Xi’s administration after American blacklistings hit key players like Huawei Technologies Co. and SenseTime Group Inc.
In its latest five-year economic blueprint unveiled in March, Beijing sketched out plans to boost national R&D spending by more than 7% annually and singled out seven technological fields in which it hopes to achieve “major breakthroughs.” They include space exploration, brain science and quantum information -- all sectors where American firms now hold sway. The Chinese government is also making big bets on emerging technologies like hydrogen vehicles and biotechnology, while working to help its semiconductor industry narrow the gap with the likes of Intel Corp. and Taiwan Semiconductor Manufacturing Co. 
 
“The Chinese government is very aware of the importance of innovation for China’s future, in particular to cushion the impact of aging and excessive capital accumulation on growth,” says Alicia García-Herrero, a top economist in Hong Kong at investment bank Natixis. “Investment in deep tech is absolutely key.” 
 
There’s no guarantee the strategy will work. China built a generation of technology giants by letting talented entrepreneurs like Alibaba’s Jack Ma and ByteDance’s Zhang Yiming choose their own path to success. Now that private-sector innovation has been subordinated to a much more government-directed model. 
In a sign of the need for caution, the country’s one-time semiconductor champion collapsed in 2021 after years of government financing and political support. Tsinghua Unigroup Co.spent a decade binging on easy credit and buying up foreign assets only to implode as the government recognized its multibillion-dollar debts hadn’t gotten the country any closer to building a sustainable chip business.
Beijing’s crackdown has narrowed the range of sectors considered safe for investment, leading to inflation in startup valuations as venture capitalists all compete for the same kinds of deals. Investors joke about the money lavished on “PPT companies,” or startups with nothing more than a PowerPoint presentation. 
“The acceleration and the pronounced emphasis of the government on these areas has just driven so much capital in this direction,” says Chibo Tang, a managing partner of Gobi Partners. “It has a risk of becoming overheated.”
 
Widening Gap
China has surpassed the U.S. in semiconductor investment since 2018
 
China’s pivot to hard-core tech has been years in the making. It took off in earnest in 2018 after Washington banned exports of U.S. technology to ZTE Corp. The once-prominent telecom equipment giant had to shut down large swaths of its operations -- laying bare Chinese companies’ vulnerability to American political decisions. The effort gained even more momentum with the blacklisting of Huawei, China’s leading maker of communications equipment and smartphones. 
 
Now, China’s enthusiasm for fundamental technology has spread nationwide. In Guiyang city of southwest China, Angelo Yu, founder of Pix Moving, used to scratch his head trying to win over investors who questioned the capital-intensive, time-consuming nature of his autonomous driving business. But with Beijing’s clampdown on internet companies last year, all those doubts suddenly vanished. 
“There is a sea change in investors’ attitude toward deep tech,” Yu said. “In 2020, whether or not we could fundraise was still a question mark. This year, fundraising isn’t an issue anymore. The question has become at what valuation we’d like to raise funding.” 
Easier access to capital, combined with a greater demand for made-in-China tech solutions, has lured more talent to entrepreneurship. One prominent example is Yuan Jie, a professor at the Hong Kong University of Science and Technology. 
The long-time academic spent much of his career helping global giants like Intel advance their chip technology. Now, Yuan has founded Atom Semiconductor Technologies to make his own silicon. Established in late 2020, the startup has completed two rounds of fundraising and quadrupled its valuation, paving the way for Yuan to commercialize his years-long research. 
Beijing-based Sinovation Ventures, a technology venture firm founded by former Google executive Kai-Fu Lee, plans to spend every single dollar it raises this year on investments related to deep tech and life sciences. That’s up from about 10% that Lee allocated to those sectors in 2010. 
 
Gary Rieschel, founding managing director of Qiming Venture Partners, says deep tech startups now account for about 40% of his firm’s portfolio, compared with 10% in 2014. 
“That’s what you’re seeing with all the venture firms now,” Rieschel says. “They’re making those transitions.”