US Congressional committee targets Sequoia's China exposure

Five months ago, the US-headquartered venture capital firm announced plans to formally separate from its China and India-Southeast Asia operations, with the former subsequently rebranding as HongShan. This predated the issuance of an executive order calling for regulations restricting US investment in China in the areas specified by the Congressional Select Committee on the Chinese Communist Party.

In a letter to Sequoia, the committee described the separation as a step in the right direction but noted that neither entity has given reasons for the move. It added that questions remain as to how the separation may impact flows of US capital into Chinese companies – appearing to challenge the notion that passive investments by US-based LPs in China-focused funds should be exempt from the restrictions.

The letter begins by probing Sequoia’s internal screening process – which is described as too narrowly focused – and the relationship between the different Sequoia entities prior to the separation. “For years, Sequoia’s five entities have shared much more than a name,” it said.

While each one had its investment committee that decided which companies to back, approximately 20% of the carried interest from each deal “flowed back to the top of the Sequoia family, from which it was distributed to senior GPs and used to pay for common expenses,” the letter claimed.

A centralised compliance office in Menlo Park vetted every deal for compliance with US law. Though the overseas arms eventually hired their own legal and finance teams, Sequoia’s CFO and legal counsel retained certain authorities over the foreign entities. Some back office functions were also shared.

These arrangements will cease when the separation comes into effect in March 2024, but the committee suggested that, rather than staunch flows of US capital into “problematic PRC companies,” the separation “may insulate some types of capital flows from regulatory scrutiny they would have otherwise been subject to under the recently released executive order.”

US-based LPs represent HongShan’s single largest source of capital and the separation will not prevent their ongoing participation. The committee believes that HongShan will scrap the internal screening process, potentially resulting in even more investment in companies the US regards as problematic. And once its ties to the US are severed, the firm will not be subject to any US regulatory scrutiny.

“To prevent American capital and expertise from continuing to flow to troubling PRC entities via foreign entities like HongShan, it would be necessary to cover not just the fund-to-company transaction, but also the investment made by the LPs or other entities that are the source of capital in the first instance,” the letter said.

In addition, there are concerns that HongShan will ramp up investments in US-based start-ups because it no longer has to cede ground to Sequoia’s domestic operation. This could accelerate the reverse flow of emerging American technology to China-based venture capital funds, the letter observed.

To this end, the committee has asked Sequoia to name every investment – including those by affiliated investment vehicles or personnel – made since 2010 in Chinese or China-related companies in AI or machine-learning, semiconductors, and quantum computing. It wants to see details regarding follow-on investments in these companies by state-linked Chinese parties as well as Sequoia’s investments.

Moreover, the committee would like Sequoia to specify how many US-based LPs are in HongShan-managed funds and the total amount invested in each fund.

Several China-based Sequoia portfolio companies were identified as contributing to human rights abuses, China’s military modernisation, and efforts to undermine US technological leadership. These include cybersecurity player EverSec Technology, recently listed AI specialist 4Paradigm, drone manufacturer DJI, facial recognition technology developer DeepGlint, and TikTok parent ByteDance.

Sequoia is not the only venture capital firm to separate its US and China operations. GGV Capital, which invests in China out of global funds, will split into Asian and non-Asian entities, while BlueRun Ventures China has sought to distance itself from US-based BlueRun by changing its name to Lanchi Ventures.

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• Topics
• Greater China
• Regulation
• Venture
• GPs
• Technology
• China
• USA
• regulation
• Sequoia Capital
• HongShan
• artificial intelligence
• quantum computing
• semiconductor