How China is Influencing U.S. Unicorns and Unknowing Investors

China has become an important investor in Silicon Valley startups

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Chinese companies have invested heavily in U.S. startups over the past several years. According to CrunchBase, Baidu, Alibaba, and Tencent have invested billions of dollars into startups like Uber, Lyft, Magic Leap, Tango, and Fab. Rhodium Group estimates that Chinese investments, excluding real estate, into Silicon Valley exceeded $6 billion in the first half of 2016 alone. These kinds of investments are having a big impact on the market and investors.

In this article, we will take a look at how China is impacting Silicon Valley startups, as well as investors that may have unknowing exposure.

Investor Exposure to Unicorns

Many investors have exposure to so-called unicorns – or startups with valuations of more than $1 billion – through mutual funds. For example, the popular Fidelity Contrafund (CFNTX) holds a 0.2% stake in Uber Technologies and other startups like WeWork International. The Hartford Growth Opportunity Fund (HAGOX) is significantly more exposed with about 6% of its net assets coming from pre-IPO companies compared to less than 1% for most other funds.

Mutual funds have had a significant impact on the valuation of private companies. According to PitchBook, startups that received financings from mutual funds saw their valuations more than double over their previous funding rounds compared to a 1.5x improvement for startups that raised cash without the support of mutual fund investors.

The good news is that many of these startups are already well-established and arguably safer bets for investors.

That said, regulators have expressed concern that exposure to private companies could put investors at risk of sudden price declines. After all, private companies are much more difficult to value and are subject to rapid changes in valuation based on their latest funding rounds.

The Hartford Growth Opportunity Fund made it clear in recent statements that private companies were at least partially responsible for its outperformance – but that goes both ways.

China’s Impact on the Market

Chinese companies have taken advantage of a slowing fundraising environment among domestic investors in Silicon Valley. When companies can’t secure the capital needed from Sand Hill, many turn to Chinese investors with deep pockets and potential connections to the world’s largest population. These investors can open doors to Chinese consumers in a market that’s often less saturated than the U.S. market when it comes to new technologies.

Chinese investors have helped drive up valuations in many startups – particularly the unicorns – as they seek exposure to fast-growing markets. At the same time, many startups have complained of China’s hardball tactics when it comes to making investments, as well as expressed concerns over their innovations being copied. Alibaba’s deals with Quixey have become a key case-in-point for these concerns when dealing with foreign investors.

These risk factors could jeopardize some smaller investments in startups, while any shift in control of larger startups could pose problems down the road.

On the other hand, any reduction in investment from China could have a similar effect on valuations since fundraising in Silicon Valley has become more difficult. Investors should be aware of these risks, as well as their own exposure to private companies through mutual funds.

How to Quantify the Risks

Investors should always be cognizant of the holdings of their mutual funds. While Hartford is the only major fund with 1%+ exposure to private companies, these dynamics could change as an increasingly large number of tech companies opt to remain private versus going public. Doing so could force many mutual funds to increase their exposure to private companies in order to maintain their exposure to the tech industry as a whole.

In addition to mutual funds, investors involved in the private markets in any other way should also keep an eye on Chinese investments into their holdings.

The growing ubiquity of crowdfunding has made these kinds of private investments an increasingly popular way to diversify, but these companies require closer attention than many publicly traded companies.

The Bottom Line

Chinese companies have played an important role in funding many so-called ‘unicorn’ startups in the United States. By doing so, they have helped expand private company valuations. The downside is that some companies have engaged in questionable business practices – at least by U.S. standards – and startups have become increasingly dependent on foreign capital. Investors should keep these factors in mind when considering their own exposure.