December 6, 2022

Bobbys Brane

Bobbys Brane – Business & Tech Blog

The dilemma of Chinese startups going global • Bobbys Brane

10 min read

One day in 2020, I published an article about a Chinese hardware maker which would have otherwise been a typical funding story. Instead, I got a complaint from its PR asking me to remove all mentions of “China” from the piece. The startup wanted to be called “American” on the basis of its having a small office in California. I declined, insisting on our duty to uncover relevant facts for readers. I never heard from the company again.

That turned out to be just the beginning of a trend in my interaction with Chinese startups that are expanding abroad. “We don’t want to be seen as Chinese,” many of them tell me. My attitude has over time gone from disappointment at companies’ lack of respect for journalistic independence to a growing concern that my portrayal of them might unfairly prejudice their growth. By putting the Chinese label on them, these firms might lose business partners, get stricter oversight by app stores, and receive more scrutiny from local regulators.

What used to be a no-brainer geographic categorization of a company — “it is Chinese/based in China” — has become politically charged. Five years ago, a Chinese firm would be boasting its “successful entry into Europe” as a Chinese firm. These days, with rising tensions between China and the West, many globalizing Chinese companies choose to bury their origin. They worry that their links to home — however it is defined — can be viewed as a national security threat to the foreign market they serve.

“We are going from longing China to longing Chinese, like Eric Yuan.”

As startups build increasingly distributed teams, it’s also become harder to put a geographic pin on them. The world’s largest crypto exchange Binance, which started out in China, famously doesn’t have a headquarters.

“If you look at companies such as Tiktok, Binance, Grab…these startups all started from day one with a global market in mind and built with teams located in multiple jurisdictions. It is really difficult to label them as from a certain country” said Ron Cao, who’s an early investor in Pinduoduo and founder of Sky9 Capital, an early-stage VC with a presence in China, Singapore, and the U.S.

But Chinese startups aren’t just concealing their origin. Many of them are in effect moving legally and operationally to distance themselves from their homeland to reassure foreign authorities that they aren’t beholden to Beijing. The upside of decoupling is companies end up investing more in localization, which is always conducive to overseas expansion. But in the process, they also risk losing some of the advantages of being Chinese.

The journey of becoming less “Chinese” is long and complicated, and the extent to which companies choose to reduce their ties to home is playing out differently across sectors and the stage of their business. But there’s one overarching sentiment shared by the dozen entrepreneurs I spoke to: They have never felt more confident about competing with international rivals, thanks to the talent and knowledge they have accumulated at home. But they are also increasingly daunted by — and weary of the geopolitical uncertainty they face in the process.

Decoupling from home

U.S.-China relations sharply deteriorated under former President Trump’s reign from 2017 to 2021, and President Biden seems to be staying the course, taking a firm stance on China with a sweeping chip ban. Having seen how U.S. sanctions have kneecapped Huawei’s supply chains and the spate of regulatory scrutiny on TikTok in the West, startups fear that they might be the next to get caught between the two superpowers.

Companies play down their Chinese association as a result. In the past, startups might get a pass by simply claiming they are Singapore or San Francisco-based without actually having a meaningful operation in those places. Shein, for example, used to bill itself as being “founded in L.A.” when in reality it started out in Nanjing and Guangzhou as a typical Chinese e-commerce exporter leveraging the country’s robust supply chains.

But scrutiny by foreign politicians and the press are driving Chinese firms to ramp up their overseas footprint, especially when they reach a critical size. Recently, Shein announced plans to open major warehouses in North America. The company has moved most of its assets to Singapore and made the island nation — which is widely regarded as politically neutral — its headquarters.

Sky Xu, the founder and CEO of Shein, is also reportedly seeking Singaporean citizenship. Several entrepreneurs told me that top VC firms in China now provide passport shopping as part of their post-investment service for founders targeting overseas markets in response to a new rule on offshore IPOs: last December, China’s securities authority proposed that a company, regardless of where it’s incorporated, must go through a filing process with the Chinese government if its main management mostly consists of Chinese nationals or executives who live in China, and whose main business operation is in China.

“If you look at companies such as Tiktok, Binance, Grab…these startups all started from day one with a global market in mind and built with teams located in multiple jurisdictions. It is really difficult to label them as from a certain country.”

Getting the overseas legal setup is just the first step. The greater challenge lies in winning the trust of local regulators and customers. The founder of a productivity app that is targeting the U.S. market told me that “everything we use at work is non-Chinese,” so all of its data, internally or those of its end users, are kept offshore. Rather than ByteDance’s Lark and Alibaba’s Dingtalk, the startup uses Notion and Slack for internal communication, AWS for data hosting, and Stripe for payments. The company was founded in Shenzhen but is in the process of setting up a Singaporean company to be its holding entity.

For enterprise software providers, the need to localize is even more pressing. While consumer app developers might gain traction without having to leave their China office, as they can remotely answer user emails  and master search engine optimization to acquire users, building an enterprise business from afar is nearly impossible. For large corporations and even small mom-and-pop shops, business is expected to be done face-to-face. Why would a warehouse in Dallas trust a Shenzhen-based robotics startup to move its parcels?

Localization creates interdependence between economies, which can in turn become a bargaining chip for Chinese firms as they navigate geopolitical complications. “Once you have hired enough employees in the U.S., you have vested interests in the local economy, and your staff and local regulators will speak for you,” reckoned Richard Xu, an investor at Grand View Capital, which focuses on helping Chinese startups go global.

Losing the edge

Decoupling from China has many challenges. Relocating staff and executives often means moving their whole families abroad, and building teams in the West can be expensive. For many globalizing startups, their presence in China is the very advantage they enjoy. Just as China’s cheap, skilled labor allows factories to produce affordable and quality goods for the world, its millions of engineers, who on average earn just a fifth of their American peers in 2022, give Chinese tech firms a cost advantage that translates into cheaper gadgets, better app experience, and lower SaaS subscription fees.

Despite the flurry of skepticism around TikTok’s data practice, the short video powerhouse seems to be keeping its core development force in Beijing for now. If the firm were to set up an engineering army from the ground up in the U.S., its operational costs will no doubt skyrocket.

TikTok could in theory implement data anonymization, that is, to create a system so that engineers in China only have access to data of which identifiers connecting to overseas individuals have been erased. According to a former employee of an American internet giant who worked in both the firm’s U.S. and China offices, “data anonymization isn’t impossible, but it’s extremely counter-productive for developers, which is why many companies aren’t willing to do it.”

“[Chinese startups] are very aggressive with going after market share and have rapid product iterations capabilities. They operate with a highly efficient and results-driven mindset and are comfortable with taking risks because in many ways they come from the world’s most competitive local market.”

Companies stay in China not just for the country’s cheap talent but also for its brain power. The U.S. might still have a lead in fundamental research around artificial intelligence, quantum computing, and other cutting-edge technologies, but in China, one can find some of the world’s best product managers who obsess over user experiences. While Vine pioneered the idea of short videos, it was TikTok that elevated the medium to a global phenomenon.

In their transformation of becoming “less Chinese,” a question that founders keep asking is: how far should one go? While Zoom’s Eric Yuan is hailed as a role model for immigrant founders, his upbringing was thrust into the limelight amid rising U.S.-China tensions. U.S. lawmakers and media raised suspicions that the conferencing giant’s R&D center in China could be used as Beijing’s spying outpost, prompting the founder to issue a statement saying he had long been an American citizen and had no allegiance to Beijing.

Along with pressure from the West, regulatory changes in China are also pushing Chinese startups to drift away. In the last few years, Beijing’s clampdown on Alibaba, Tencent, and other domestic tech giants has dampened venture capitalists’ confidence in the consumer internet sector. New regulations around data practices and industry monopolies mean tech companies no longer enjoy the kind of unfettered growth experienced by their predecessors in the last two decades.

Regulations might also compromise the core of a startup’s servic, a particularly salient issue for content-heavy startups. Game developers need to be pundits of Communist ideologies to ensure their works meet the government’s content guidelines. Social networks are required to run speech moderation systems that are costly and undermine user experiences. Many founders operating in these areas are either pivoting to another sector or switching to overseas markets.

For businesses that aren’t aligned with the interest of the government, even having a physical footprint in China can be risky. “In China, we operate like a semi-illegal, underground business,” the founder of a web3 startup said, asking for anonymity.

Like many other blockchain entrepreneurs, he recently moved to Singapore after China outlawed cryptocurrency transactions, even though his target audience had been global from the get-go. Since rules around the budding industry are ever-changing, “you never know if you’d be the next to be in trouble, especially when it’s an industry flooded with money.”

Longing Chinese

As they march into foreign territory, many Chinese startups are withdrawing themselves from public view — not to hide a nefarious behavior but out of a fear of being misunderstood. They resort to a strategy of “lying low and making money.” The taciturn further widens the gap between them and Western media, meaning American VCs have few ways to learn about them. Despite their international ambitions, many of them feel more comfortable with Chinese media and continue to raise from China-focused VCs, who are happily following the founders abroad.

“In more recent years, we are entering a new phase of entrepreneurship as more and more local startups are building businesses for global markets while leveraging the most strategic and relevant resources globally. In order to support this new phase, successful investors need to have a global perspective and value-added,” said Cao of Sky9.

“Entrepreneurs from China can be very competitive in many sectors globally. They are very aggressive with going after market share and have rapid product iterations capabilities. They operate with a highly efficient and results-driven mindset and are comfortable with taking risks because in many ways they come from the world’s most competitive local market,” he added.

My attitude has over time gone from disappointment at companies’ lack of respect for journalistic independence to a growing concern that my portrayal of them might unfairly prejudice their growth. By putting the Chinese label on them, these firms might lose business partners, get stricter oversight by app stores, and receive more scrutiny from local regulators.

As their money traverses borders to follow Chinese talent and ideas, VCs have a new slogan for their investment thesis. “We are going from longing China to longing Chinese, like Eric Yuan,” said Xu. “Chinese founders need to speak up more and accept that being Chinese is a thing to be proud of. But unfortunately, under the current geopolitical environment, it’s not really achievable.”

There are more encouraging stories, though. I recently met a neural search engine startup called Jina.ai for lunch in Berlin. The founder, Han Xiao, turned up with 10 of his employees, who chatted in English and sat by a long table while Han, who is originally from China, proudly counted the number of nationalities present — twleve.

I was impressed by how globalized the team is, in part thanks to the diverse tech talent in Berlin and Xiao’s experience in Germany. On a daily basis, Jina’s developers in Berlin work closely with the rest of its team in Shenzhen, the Chinese city known for birthing tech powerhouses such as Tencent, Huawei, and DJI. In a way, Xiao has achieved the dream of many Chinese founders — to run a global startup that still gets to play to China’s advantage — without having to cover up their Chinese ties.

“In the beginning, people would still ask if we were a Chinese company, but these questions happen less and less now. I’ve been in Germany for years. Most of our staff are international, and they are the people who represent us in meetings with clients and business partners,” said Xiao.