How Will Increased Chinese Funding Affect Israeli Entrepreneurs?
The tense relations between China and the U.S. increased Chinese cash flow into Israeli tech. But local courting of Chinese money has its risks, including the chance for foreign government involvement
Tensions between the U.S. and China are raising questions about the latter’s growing global influence. The U.S. Congress is currently deliberating whether to forbid the use of federal funds to buy buses and rail cars made by Chinese companies, such as CRRC in Chicago. The concern is that the Chinese will use the access to install spyware in the vehicles. It might sound like the plot of a spy novel, but then again, the anti-Chinese sentiment is growing in the U.S. is reaching near-Cold War level.
In Israel, such concerns have yet to lead to policy changes: Haifa’s new port will be operated by a Chinese corporation, while Israeli public transportation company Egged Israel Transport Cooperative Society Ltd. has partnered with another Chinese company to run Tel Aviv’s light rail. Simultaneously, China became one of the biggest investors in Israeli tech.
Data collected by Israel-based market research firm IVC Research Center Ltd. shows that in 2018, Chinese investors made direct investments in 12% of local funding rounds, compared to 7.5%-9% in the previous three years. Over the past five years, direct Chinese investments in Israeli tech totaled $1.5 billion across 300 companies, according to IVC. Tens of millions of dollars of Chinese money were invested through Israeli venture capital funds.
In many aspects, the Israeli tech industry has benefited from the trade war, which reduced American appetite for Chinese money. Chinese investors turned their eyes to other leading tech markets, Israel included, on the lookout for new technologies they could import. But the trend poses risks to Israeli entrepreneurs, who are still very much connected and dependent on the U.S.
The first wave of Chinese investors came to Israel a decade ago, and in hindsight, not all were suited to the local market, Aaron Mankovski, managing general partner at Pitango Venture Capital, told Calcalist in a recent interview. Around 2005, most of Silicon Valley’s biggest funds started to set up subsidiaries in China and sink a lot of money into them, but today most of those subsidiaries are gone because the Chinese have venture funds of their own, he said.
The second wave of investors tried to emulate the American model, Mankovski said. “With the Americans, it started with U.S. funds investing in Israeli companies that also helped them enter the market. In China, that didn’t happen—eventually, a partnership is something that innately has a conflict of interest: if I have a Chinese partner who is interested in a startup’s operations in China, they will not be enthused by my desire to invest resources in a place like Brazil.” This wave, too, weeded out some of the interested parties.
There were many Chinese companies with no connection to tech that wanted to invest in Israel, out of a wide-spread Chinese belief in Jewish genius, Mankovski explained. According to him, those investments had no long-term vision, but were made because venture capital investments were “sexy” at the time. “The current generation is much more knowledgeable: strategic investors like Alibaba, financial investors and holding companies, many of which have a mandate to make investments that will result in the import of technology into China.”
Chinese investors are varied, said Omer Ben-Zvi, partner and head of China practice at Israel-based law firm Shibolet & Co., who assisted many Israeli and Chinese companies. “Alibaba’s lawyers are young people with a master’s from Harvard, with better English than mine and international experience, and they get things done. In small-scale companies and funds, in comparison, people sometimes hardly know any English.”
Ben-Zvi says corporate investors like Alibaba and Tencent are looking for very specific companies, and he can’t really see them investing in Israeli technology that isn’t suitable for the Chinese market. “The leading trend is big companies that want products that are synergetic with their core business,” he said. “Alibaba, for example, will invest in search engines.”
According to Richel Liu, the founder and CEO of Rimonci Capital, the tendency of Israeli entrepreneurs to seek investments from giant companies is not necessarily the best thing when it comes to Chinese investors. Rimonci, which focuses on optics, made six investments in Israel to date, among them in 6 Over 6 Vision Ltd., Belkin Laser Ltd., and Eyeyon Medical Ltd. “Most Israeli entrepreneurs want to work with a big name, but that is not always the most suitable partner,” she said.
Big corporations are not always the most dedicated partners, while smaller companies and funds provide much more assistance in the Chinese market, Liu said. “In the medical industry there is a lot of regulation and it isn’t easy, you need to sit down with the entrepreneurs and explain the differences. In China you must find a good local advisor who can provide important insights. A really good company doesn’t need to worry about the money, but about marketing.”
What are Chinese investors looking for in Israel? According to Liu, while Israel is not a large market, it creates products for large markets. “We like entrepreneurs capable of evaluating both themselves and their competition, and of course, the technology itself matters.”
Ben-Zvi said that a newer trend among Chinese investors in the appearance of financial entities looking to make returns on Israeli investments, but that even those players are looking for startups or technologies that could have large-scale business in China. As an example, he gave Israel-based LiDAR startup Innoviz Technologies Ltd. and its shareholder China Merchant Capital Management Co. Ltd. “Because Innoviz already has an operational base in China, China Merchant Capital sees its added value for the company not just in financial support but in assisting when it comes to breaking into the Chinese market and creating connections with relevant local players.”
Furthermore, not all Chinese investors in Israel are funds or corporations anymore, Ben-Zvi said. Tier 2 service providers are also looking to the Israeli market. “For example, a medical company that started as an appointment setting app and expanded to the field of video conversations between doctors and patients. The company searched for more applications for its platform. Even though it was a company worth $500 million that just recently raised a $50 million funding round for itself, it was an amazing opportunity.”
But the increased interest Chinese companies have shown in Israel is not without its downsides. “The U.S. and China are two oceans, and Israel is the boat stuck in the middle,” Aharon Aharon, CEO of the Israel Innovation Authority, said earlier this year. One of the reasons for concern is new U.S. regulations that mean companies that operate in 27 specific technologies and industries must report any Chinese investment before the deal is closed and CFIUS will have 30 days to clear or reject the deal. The rather vague reasoning is national security.
The U.S. has not provided clear instructions, and knowing what to steer clear of is therefore complicated, Ben-Zvi said. “I’m not telling anyone to ignore the risk; an Israeli cyber company operating in the U.S. shouldn’t take a Chinese strategic investor. But a medical device company shouldn’t panic. I do know of an Israeli cyber company that was about to accept easy money from a China-controlled private equity fund, and its people in the U.S. advised it to cancel the deal.”
“I hope we don’t reach a point where they make us choose,” Mankovski said, “but in the long-term, I don’t think you can ignore the Chinese economy, it is not going anywhere and soon it will be the largest economy in the world.” Anyone looking at CFIUS can see that there are no clear definitions, he said, and that new regulation comes out all the time. “There is no definitive answer, as long as the investor cannot compel business and strategic decisions using money, there’s no problem.” Chinese investors are not looking for power in Israel but for access and the ability to bring companies and technologies to the Chinese market, he said.
Most of the Israeli business sector seems to view Chinese investors as practical investors looking for technologies to import home, and tends to avoid mentions of a possible guiding hand from the Chinese government. But there are those who think otherwise. Chinese involvement carries negative elements that cannot be ignored for long, said Tel Aviv University professor Aron Shai, author of “China and Israel: Chinese, Jews; Beijing, Jerusalem (1890-2018) (Jewish Identities in Post-Modern Society).” Shai, who co-founded the East Asian Studies Department at TAU and is also a guest lecturer at NYU, thinks that Israel needs to set up a CFIUS-equivalent to oversee Chinese investments.
Shai describes a Matrix that has companies like Dead Sea cosmetics manufacturer Ahava—acquired by Fosun International in 2016—on one side, and companies like Israel’s national carrier El Al Israel Airlines Ltd. on the other side. In the middle are companies like food processing company Tnuva Food Industries Ltd., which today is owned by China-based Bright Food Group. “There is nothing problematic with Chinese players buying companies on the axis between Ahava and Tnuva, but they can’t have companies like El Al or (Israeli maritime cargo transport company) Zim, which serve as lifelines during war. The criticism is that not enough is being done, because in many cases the Israeli finance ministry wants those investments.”
The current tension with the U.S. and the restrictions the U.S. placed on Chinese investments have certainly contributed to Chinese interest in Israel, Liu said. Ben-Zvi also said that Chinese investors are looking for alternatives and see Israel as second-best after Silicon Valley. “It is also comparatively less costly,” he said.
Beijing has showed increased openness to the west since the 2008 financial crisis, while simultaneously increasing its in-country control and censorship efforts—something all Israeli companies looking to break into the Chinese market must consider.
“China wants the entire world to be open to it, while it remains closed off. There will eventually be a middle ground, maybe when the U.S. regime changes,” Mankovski said.
Shai is more skeptical. “Thinking there is a difference between a private Chinese company and a government-owned Chinese company is naïve,” he said. “A private company is also completely under the control of China’s communist party. In Israel, the government has no authority to dictate the activity of a private company, and that’s a crack Chinese companies can use.” When the Technion establishes a branch in China, the question that must be asked is if it could not provide the Chinese government with access to problematic technologies, he said.