By: Julian McIntosh

Protectionist policies are sprouting up around the world.[1] This is in part as a reaction to the COVID-19 pandemic.[2] But these policies have also been driven by the USA-China trade war.[3] The trade war evolved out of a deeply polarized United States political environment.[4] Part of the United States’ push to combativeness stems from a fear of losing its position of technological dominance.[5] This technological boom had been fueled by never seen before venture capital and private equity investment levels.[6] With investors from all over the world pouring in funds in the hopes of strong returns.[7] The requirement for funds to continue the development of these revolutionary startups can be seen as at odds with the protectionist policies that have begun to appear. Conversely, protecting the assets that have been generated by these startups, and not allowing their secrets to be acquired, or partnered with cheaply, can be seen as crucial to national economies worldwide.[8] This blog will outline the US-China Trade War that sparked some of the protectionist sentiment, CFIUS, the United States’ main tool in limiting foreign investment, and finally, what, if any impact, protectionism may have on United States-based startups.

 

The Trade War, Protectionism and Start Ups

The United States finds it in a similar position as two other world powers, the UK and India. The United States is working to directly combat China, much like the policy implemented by India.[9] While, in its current trade agreements with China the United States believes it is providing too much without getting enough in return[10], paralleling how the UK viewed its relationship with the EU before Brexit.[11] But how did this spawn a trade war? And ultimately, what does this have to do with foreign investment or startups?

Trade War

In 2018, the Trump Administration began to levy heavy tariffs against China, as it viewed some of China’s business and trade practices as unfair. [12] The administration did not approve of practices like forcing foreign businesses to “hand over their most prized technology to Chinese companies” to gain access to the Chinese market.[13] The implementation of the tariffs was intended to limit these types of actions. [14] Instead of suspending these practices, China fired back with tariffs of their own. [15]

This path continued through January 2020, when the beginning of a new trade agreement was facilitated.[16] Despite a tentative resolution, the question begs, why did the United States pick this fight?

 

The United States views itself as the world leader in technology, however, China is making an aggressive move to usurp this crown through ambitious initiatives like the “Made in China 2025” program.[17] Additionally, with generation-defining technology in 5G, and renewable energy being contested on both sides, losing any advantage could be a catastrophic setback for either economy.

 

Broadcom and CFIUS

In 2017-18, this lesson played out at the hands of Broadcom. Broadcom is a Singaporean semiconductor manufacturer that intended to purchase Qualcomm, a US-based, fellow semiconductor creator.[18] This was a highly contested acquisition for multiple reasons. First, Qualcomm was at the forefront of 5G technology research. Second, Broadcom was known for purchasing and then severely cutting investment in research.[19]

Following on from policy created during the Obama administration, the Trump administration viewed semiconductors as crucial to national security and crucial to the ability to continue to dominate the tech world.[20] If one of the strongest US semiconductor manufacturers became a foreign entity and slacked off in their research, how would the United States be able to compete with China?[21] Ultimately, the administration overruled Broadcom’s attempt at a hostile takeover, citing national security concerns.[22] To do so, the government leveraged an intergovernmental agency called the Committee on Foreign Investment in the United States (CFIUS).[23]

CFIUS is intended to moderate foreign investment in the United States. To do so, CFIUS has been given control over “covered transactions.”[24] Cover transactions are transactions that fall into two categories: control transactions and other investments.[25] Though CFIUS only covers a relatively small number of transactions, its powers have been greatly expanded through bipartisan effort and ratification of the Foreign Investment Risk Review Modernization Act of 2017 (FIRRMA).[26] Though the ratification was “not intended to serve as the pretext for the creation of a foreign investment blacklist,” the protectionist undertones are clear. [27] The expansion of CFIUS is the strongest protectionist tool that the United States has as it attempts to maintain “American leadership in certain critical technology industries and protect[] against evolving threats to American national security and critical infrastructure.”[28]

Startup Investment and CFIUS

Venture capital and Private equity investment have boomed over the last fifteen years.[29]

This influx of money has created the backbone of the ubiquitous technology companies that we know today. Further, these funds are working to support unicorns like Robinhood, Chime, SoFi, and many others. Such an unprecedented flow of cash isn’t only coming from one source. It is arriving from all over the world as investors attempt to tap into potentially massive returns.[30] Since 2014 non-US investors were involved in about 12% of all US-based private equity investments per year.[31] However, as the purview of CFIUS expands, and simmering tensions between the United States and China grow, it is worth wondering if this trend continues.

One school of thought indicates that Chinese investors will limit their exposure to the US market.[32] Conversely, foreign investment in the United Kingdom during the Brexit process could also be informative.[33] In the UK, despite the ongoing uncertainty of Brexit, there was limited drop in investment. Likely because the UK market is sophisticated and stable as compared to many of its peers. Similarly, the supercharged venture capital and private equity markets of the United States likely could withstand the withdrawal of Chinese investors. However, there is a potential where the looming threat of CFIUS and FIRRMA causes a withdrawal of Chinese and other foreign investors. In turn, leading to the startups that need the money to thrive being starved of those monetary infusions. If this were to occur, the United States would have to heavily consider their current protectionist stance, as it would be limiting their ability to compete for the largest technological prizes.

 

 

[1] Hans Von Der Burchard, Here Comes European Protectionism, Politico (2019), https://www.politico.eu/article/european-protectionism-trade-technology-defense-environment/ (last visited Sep 28, 2020).

[2] The Editorial Board, Covid-19 is bringing out protectionist instincts, The Financial Times (2020), https://www.ft.com/content/ed78b09c-80a3-11ea-8fdb-7ec06edeef84 (last visited Sep 28, 2020).

[3] Zeeshan Aleem, The US-China trade war, explained in under 500 words, Vox (2018), https://www.vox.com/world/2018/7/6/17542482/china-trump-trade-war-tariffs (last visited Sep 28, 2020).

[4] Political Polarization and Growing Ideological Consistency, Pew Research Center – U.S. Politics & Policy (2014), https://www.pewresearch.org/politics/2014/06/12/section-1-growing-ideological-consistency/ (last visited Sep 28, 2020).

[5] Legislation Proposes Sweeping New Foreign Investment Review Authorities, Skadden, Arps, Slate, Meagher & Flom LLP, https://www.skadden.com/insights/publications/2017/11/legislation-proposes-sweeping-new-foreign (last visited Sep 28, 2020)[hereinafter Investment Review].

[6] NVCA Q2 2020 Venture Monitor, Pitchbook, 1, https://files.pitchbook.com/website/files/pdf/Q2_2020_PitchBook_NVCA_Venture_Monitor.pdf (last visited Sep 28, 2020)[hereinafter NVCA Q2 2020 Venture Monitor].

[7] Alex Lykken, US politics aren’t pushing away foreign investment, PitchBook, https://pitchbook.com/news/articles/us-politics-arent-pushing-away-foreign-investment (last visited Sep 28, 2020).

[8] Reform Proposes Sweeping Changes to CFIUS Reviews, Skadden, Arps, Slate, Meagher & Flom LLP, https://www.skadden.com/insights/publications/2018/01/2018-insights/reform-proposes-sweeping-changes (last visited Sep 28, 2020)[hereinafter CFIUS Reviews].

[9] New Foreign Investment Restrictions Imposed by India, Gibson Dunn (2020), https://www.gibsondunn.com/new-foreign-investment-restrictions-imposed-by-india/ (last visited Sep 28, 2020).

[10] Aleem, supra note 3.

[11] Timothy B. Lee, Why Britain voted to leave the EU, Vox (2016), https://www.vox.com/2016/6/25/12029962/why-did-britain-leave-the-eu (last visited Sep 28, 2020).

[12] Aleem, supra note 3.

[13] Id.

[14] Id.

[15] Id.

[16] US-China trade war in 300 words, BBC News, January 16, 2020, https://www.bbc.com/news/business-45899310 (last visited Sep 28, 2020).

[17] Aleem, supra note 3.

[18] Donald Vieira et al., Broadcom’s Blocked Acquisition of Qualcomm, The Harvard Law School Forum on Corporate Governance (2018), https://corpgov.law.harvard.edu/2018/04/03/broadcoms-blocked-acquisition-of-qualcomm/ (last visited Sep 28, 2020).

[19] Id.

[20] Id.

[21] Id.

[22] Id.

[23] CFIUS: Common FAQs by Startup Founders and Investors, Fenwick & West LLP , https://www.fenwick.com/insights/publications/cfius-common-faqs-by-startup-founders-and-investors (last visited Sep 28, 2020).

[24] Id.

[25] See Id., (explaining control transactions means any merger, acquisition, or takeover by any foreign person or entity that could result in foreign control of any U.S business. Other investments means an investment by a foreign person or entity in certain unaffiliated US business that are involved in critical infrastructure, critical technology, or the maintenance or collection of sensitive personal data of US citizen).

[26] CFIUS Reviews, supra note 8.

[27] Id.

[28]  Investment Review, supra note 5.

[29]  NVCA Q2 2020 Venture Monitor, supra note 6 at 5.

[30] Lykken, supra note 7.

[31] Id.

[32] PYMNTS, Chinese Investments In US Plummet, PYMNTS.com (2020), https://www.pymnts.com/news/investment-tracker/2020/chinese-investments-in-us-plummet/ (last visited Sep 28, 2020); James Thorne, China’s biggest private companies warm to homeland IPOs as US trade tensions muddy the waters, PitchBook, https://pitchbook.com/news/articles/china-private-companies-public-offering-trade-tensions-US (last visited Sep 28, 2020).

[33] Leah Hodgson, No-deal means no deals? How Brexit could impact UK private equity, PitchBook, https://pitchbook.com/news/articles/no-deal-means-no-deals-how-brexit-could-impact-uk-private-equity (last visited Sep 28, 2020).