CFIUS Big Impact on Chinese Investment and Israeli & American Entrepreneurs

In my 25 years of venture capital, I think I encountered CFIUS regulation exactly zero times. In the last 12 months, it seems to come up in every conversation and transaction.

For those of you who do not know what CFIUS is, you should read up immediately because its importance is increasing rapidly. Under Presidents Obama and Trump, CFIUS has blocked more transactions in the last 2 years than in the last 4 decades combined. Simply, CFIUS refers to a review process that allows the Senate Committee On Foreign Investment in the United States to review transactions by foreign companies in the US. Hitherto, it has examined whether there is a national security threat to the United States from a foreign company acquiring a US company. And, it gives the committee the ability to block the deal.

Recent additions include “The Foreign Investment Risk Review Modernization Act (FIRRMA), passed as part of the annual National Defense Authorization Act (NDAA), [which] brings new transactions under CFIUS’s review authority by enabling the Committee to review deals beyond those involving the transfer of control of U.S. businesses to non-U.S. persons. In particular, the Senate bill would allow CFIUS to review transfers of minority interests in companies dealing in critical infrastructure or critical technology, in addition to a host of other transactions that implicate national security.”

Note the focus on “Minority interests”. The US Government also considered including Foreign Limited Partner interests in PE and VC funds that own an interest in critical companies as part of the review process.

It does not matter if there is a Trump or Obama administration. The US distrust of China is growing and we should expect CFIUS to tighten its oversight in the coming years. Already, I have learned of a couple of $1+ Billion acquisitions by Chinese companies in the US that have collapsed due to CFIUS. I would assume that even clauses that did not pass in this updating of the regulation, could find their way into future versions, including rules on passive investment.

What does this mean for Israeli entrepreneurs? The first thing is that there is now, perhaps, a significant advantage to incorporating as an Israeli company rather than a US one. This should, of course, also depend on other factors such as tax rates, other regulation (fintech for example) and other potential import taxes under President Trump’s new tax plan. The lack of CFIUS review if you are an Israeli company is significant as you think about raising money or selling your company to a Chinese company.

Second, the Senate’s consideration of LP interests as potentially making a company require a CFIUS review should give you pause. You actually should be checking the LP makeup of whatever fund you take money from. If there is Chinese money as an LP in that fund, you may want to think twice. As CFIUS tightens, this could significantly limit your options.

In that regard. this ending note in an article in TheHill should give you pause:

“To close the gap on technology acquisition via the venture capital route, legislative efforts are being devised that will provide added muscle to CFIUS. Rep. Robert Pittenger (R-N.C.) and Senate Majority Whip John Cornyn (R-Texas) have introduced bills to address this concern.” — Arthur Dong, TheHill

Moreover, if you take money from a Chinese company or investor, expect a CFIUS review at some point. I have heard from a number of Silicon Valley VCs that they will not look at a company with a Chinese investor on the cap table (limiting the rights of Chinese investors can help but is not a panacea). Another entrepreneur reported a robust secondary market to buy Chinese investors off of US start-up cap tables.

Third, I expect more Chinese companies and money to come to Israel now since the US is closing the doors. This will, at once, flood our small market with money and also likely increase Chinese acquisitions in Israel. Be aware that taking that Chinese money could impact your ability to sell your company or products in the US going forward.

Fourth, the Israeli government should take a hard look at this. Israel does not have a CFIUS-like procedure. It should. This entire trend has geopolitical implications. If Israeli companies sell critical tech breakthroughs to China, it could anger the USA. Not doing it, may upset Asian markets as targets for Israeli tech. Selling our technology could decrease our qualitative military advantage. All of this requires a hard look and some deep thinking in the Finance Ministry, the Justice Ministry and the Defense Ministry.

As the Chinese proverb says, we are living in “interesting times.” The US considers China a geopolitical risk and a trading foe, having, in their current perspective, winked and nodded for too long as China grew its economy on the US’ back. This will have many implications for tech companies, and consequently entrepreneurs should be paying careful attention and asking hard questions of their investors (potential and current) and themselves about tradeoffs.