Wu Xiao is turning down dollars.
For the past three years, the Nanjing-based entrepreneur has only taken Chinese money for his blockchain start-up, and he intends to continue rejecting foreign investors.
He described his stance as a “strategic choice”. “If we are foreign-funded, then we might not be able to provide service to some domestic developers,” said Wu. “We may gain some opportunities, but also lose some.”
For Chinese entrepreneurs in an increasing number of sectors, the currency they choose to raise from venture capitalists is a growing point of consideration. There are early signs that the preference for renminbi, long dominant in politically sensitive sectors, such as defence, is now expanding.
So far in August there have been 23 renminbi fundraisings and no dollar deals for internet start-ups, according to Pedata.cn, a Beijing-based financial data provider.
While a seemingly trivial decision, raising renminbi or US dollars, the dominant two currencies funding the country’s mass of start-ups, sets entrepreneurs on a path to two very different outcomes.
For renminbi-financed start-ups, it is simple. Entrepreneurs establish Chinese entities that investors can directly buy into and they generally aim for public listings on the country’s domestic exchanges, or occasionally in Hong Kong.
Raising dollars, in contrast, forces internet start-ups to create an offshore structure called a “variable interest entity” (VIE) to bypass China’s foreign investment restrictions in the sector, and if all goes well, sets them up for an initial public offering in the US or Hong Kong.
But China’s sweeping crackdown on tech companies is changing the calculus for some founders and investors.
During a turbulent July, some of China’s largest tech companies, including the ride-hailing app Didi, were hit by investigations over how they hold and use data, forcing them to halt new user sign-ups.
Beijing later said any company with more than 1m users that planned to list overseas must first undergo a cyber security review. The storm has unsettled foreign investors and halted the flow of Chinese companies looking to list in the US.
“If you have a lot of data and personal data, that is really sensitive right now. People are very concerned about investing in these companies,” said a Beijing-based lawyer who asked not to be named. “Will VIEs be allowed in the future, it is unclear.”
The complex VIE structure has long existed in a regulatory grey area, highlighted last month by China’s new rules for for-profit education companies which barred foreign investment, including through the VIE structure, and also mandated “rectification” of existing VIEs.
Some investors say China’s new national focus on data, with the prospect of a new data security law and expanded protection for personal information, is already leading to changes in the funding ecosystem.
“Whenever there’s data, entrepreneurs are hesitating to take dollars,” said one Shanghai-based venture capitalist. “For the deal flow we have coming in, we’re studying how to categorise different types of data” to assess its level of sensitivity, he said.
A partner at a renminbi fund said he had seen a spike in demand. “A lot of start-ups, led by consumer goods companies, have turned to us since US IPOs became impossible in the wake of the Didi incident,” he said.
But other investors, such as Duane Kuang of Qiming Venture Partners, say they have yet to see a noticeable change in preference for renminbi over dollars. “Dollars don’t necessarily mean US IPOs, as long as the HK IPO window stays open, it will remain viable to take dollars,” he said.
While Qiming invests more dollars than renminbi, it has long had funds in both currencies. “Currency preferences have fluctuated back and forth over the past decade, over the last 10 to 12 months perhaps the preference for renminbi has grown slightly,” said Kuang.
He noted Qiming had put renminbi into start-ups in sensitive industries such as information security or healthcare companies dealing with genetic data based on the entrepreneur’s request.
The Beijing-based lawyer added that US dollar funds had raised billions for China investments this year and last and would need to put that money to work eventually, even if some groups such as SoftBank had held back to assess the regulatory environment.
They likely will not face challenges deploying it. Several early-stage entrepreneurs who spoke with the Financial Times made clear getting funding of any currency was their only priority.
For the past three years, dollar funding accounted for about 70 per cent of Chinese internet start-ups’ total fundraising haul, with the remainder raising renminbi. In July and August, as regulators kicked off investigations into Didi and halted US IPOs, that flipped so renminbi accounted for 70 per cent of internet start-ups’ investment haul and dollars accounted for 30 per cent, according to Pedata.cn.
Sensitive industries have historically soaked up the bulk of renminbi funding. Almost 90 per cent of semiconductor funding last year was renminbi denominated, biotech was almost 60 per cent and investors say aerospace is entirely renminbi based, while dollars flow into consumer and enterprise internet companies.
The latter also happen to be the areas of tech bearing the brunt of China’s regulatory crackdown, as officials sour on the country’s large, highly profitable internet platforms such as Alibaba and Tencent, and focus on catching up to the US in hard tech. Investment flows have also begun to track Beijing’s preferences.
Beijing Fund Town, a government-backed community for investors, even held a seminar in recent weeks to help start-ups and investors learn their options for dismantling their offshore structures.
“There are lots of companies especially in hard tech and healthcare considering unwinding their VIE structures right now,” said a lawyer in Beijing who specialises in the practice but asked not to be named.
“After the draft cyber security review came out, lots of entrepreneurs have been coming to ask me how to do it,” she said. “It didn’t start the trend . . . but it’s sped it up.”
But unwinding a VIE is no simple task. Start-ups must either be in a sector that allows foreign investment and then must set up a joint venture company or find new investors to buy out their dollar shareholders.
Xiao, the blockchain entrepreneur, said being an entirely domestic company without a VIE structure had already paid off. “For some government tenders or banks, they don’t want foreign invested companies coming in as some projects may involve secrets. There are also projects that want to contract with pure domestic entities,” he said.
He hopes his company can be the first blockchain company listed on Shanghai’s Star Market, China’s answer to Nasdaq.
By Ryan McMorrow, Nian Liu and Sun Yu in Beijing