We’re struggling as a country to maintain our long-standing global leadership in technological innovation. Twenty years ago, the U.S. accounted for 90% of global venture capital; that number has fallen to 53%. Today, the U.S. market cap of publicly traded companies represents about 36% of total global market cap… down from 45% (as of 2003).
Meanwhile, other countries across the globe continue to seek the intellectual and economic benefits of funding innovation, because with it comes jobs and economic growth. But creating such economic stimulus requires risk capital, which sometimes comes from foreign companies in the form of acquisitions, mergers, and other minority investments. Erecting barriers to the free flow of such capital into the U.S. from foreign companies won’t stop innovation. Rather, the capital will simply flow to those countries that invite foreign investment, enabling the fruits of innovation to be enjoyed outside the U.S.
Other countries across the globe continue to seek the intellectual and economic benefits of funding innovation, because with it comes jobs and economic growth.
And that’s what may be happening right now, thanks to the recent spate of restrictions on trade, foreign investment, and more. Policymakers are currently seeking to significantly expand the scope of the Committee on Foreign Investment in the U.S. (CFIUS) through the Foreign Investment Risk Review Modernization Act (FIRRMA). This bill would expand the scope of what may be reviewed under the rules, including creating unnecessary scrutiny of even minority investments into early-stage technology companies.
Introduced late last year to more aggressively identify and mitigate foreign efforts to acquire U.S. technology and know-how through investment, the bill was born out of a report by DIUx (Defense Innovation Unit Experimental, part of the Department of Defense). The report suggested that Chinese entities’ participation in early-stage and growth venture deals meant China could access know-how into foundational innovations like artificial intelligence, autonomous vehicles, augmented reality/ virtual reality, robotics, and blockchain, “at the same rate as” the United States.
In addition to the CFIUS/FIRRMA legislation, concerns about China’s direct investment into U.S. technology companies as a means of transferring large-scale intellectual property back to China has also led the Treasury Department to consider extra rule-making measures as well.
Of course national security is of paramount concern. But, overly and broadly restricting the movement of foreign capital/investment under the header of national security — even when that capital creates no realistic risk of security concerns — will have adverse effects for our global technological leadership. Restrictions on Chinese investment, for instance, disrupt not just sources of capital for American startups, but their plans to expand, grow, and do new things. Entrepreneurship is an inherently risky endeavor; startups therefore rely on diverse sources of capital (including foreign and strategic investment) to help mitigate that risk and grow. In this way, new barriers — whether through FIRRMA or limiting direct investment as part of trade restrictions — eliminates a viable source of capital, halting certain innovations (and therefore growth) altogether. Ironically, these are some of the very things these policies are intended to protect in the first place.
So what about national security then?
In its current incarnation, CFIUS is already a tool (besides export control) to inhibit foreign technology transfer. Specifically, CFIUS already reviews specific transactions to determine national security implications if those transactions involve the acquisition of a controlling interest by a foreign entity. It was originally designed to protect against foreign investment in U.S. stocks and bonds, and over time has expanded to encompass foreign ownership of critical U.S. infrastructure. For example, it was invoked in 2006 to prevent a Dubai-based company from taking over the management of several ports in the Northeast, Miami, and New Orleans. It was also used in 2012 to unwind an acquisition of land on which a China-based company was building wind farms, because the land was adjacent to a U.S. Navy weapons training facility in Oregon. Most recently, though, it was used to block the proposed Broadcom acquisition of Qualcomm — not because of anti-trust concerns from potential market concentration (both compete in the semiconductor and wireless industries), but because of geography; Broadcom at the time was based in Singapore.
When tools like CFIUS aren’t used for security, but rather for nationalist protectionism under a different name, it becomes a concern for the future of U.S. innovation. Especially since FIRRMA would significantly expand the category of technologies under review by CFIUS to potentially include even minority investments into early-stage technology companies — whether those investments are made directly by a foreign entity into a startup, or whether a foreign entity is a limited partner in a U.S. investment fund.
The underlying assumption there is that foreign companies (and countries like China) could use such minority investments to misappropriate U.S. intellectual property for nefarious purposes. While there are foreign companies and governments who do seek to do us harm, the risk of malfeasance in this use case is very remote. Limited partners in venture funds — whether foreign or domestic — do not get access to proprietary intellectual property, nor do they direct investments. Information disclosures to them are minimal, and largely related only to valuation and accounting-related information that helps them understand their current economic positions in their investments. Furthermore, minority investments are, well, minor; this may seem obvious but needs to be said, because when you have a hammer, everything — even minority investments — looks like a nail.
When you have a hammer, everything looks like a nail.
Perhaps most importantly though, startups themselves (and all companies for that matter) are more motivated than anyone else to protect their own interests. If those companies failed to control access to intellectual property, they wouldn’t profit from their own innovations against their competitors, let alone against foreign entities. Economic self-interest is actually the best deterrent against intellectual property leakage.
The venture industry (note, I’m the current chair of the NVCA) has worked actively with FIRRMA’s sponsors and others to avoid some of these unintended consequences from such legislation, and shares their goals of ensuring that technology not be used to harm our competitiveness or our security while still also protecting U.S. innovation. Unfortunately, clarifying such a bill via rulemaking — especially given its overly broad scope and ambiguity — would cause unnecessary burden for startups as policymakers go through the time-consuming process, procedures, and protocols involved. With startups, speed is everything, and can make a difference between surviving… or dying.
Economic self-interest is actually the best deterrent against intellectual property leakage.
Another concern is that a we’ll-know-it-when-we-see-it approach to assessing what is a “critical” technology will not only be incredibly burdensome and challenging for companies to navigate, but will affect many industries in unintended ways. The “foundational” technologies identified in the DIUx report — artificial intelligence, for instance — are all broad, horizontal platforms for innovators to build on. Because of this, they’re used in a myriad of products, industries, and tools that run our economy. Such foundational technologies pull in large, high-growth swaths of our economy under CFIUS review, potentially throwing a heavy, wet blanket on U.S. innovation.
None of this is to say that we shouldn’t protect critical infrastructure and IP. We absolutely must accept the hard realities and challenges that foreign countries pose to our national security. And it’s true that CFIUS, which hasn’t been updated in over a decade, is an important tool in helping achieve that goal. But we need to do this without chilling foreign investment into the U.S. economy. The startup-investing ecosystem is complex and interconnected, with deep roots nourishing different parts of it; it’s not an accident that this ecosystem has thrived in the United States until recently. We should take care it’s not further disrupted in a way that harms the ability of startups to grow.
Entrepreneurship is now a global competition. Do we want the U.S. to remain the most attractive place to deploy risk capital in search of innovation? Or do we want to incent that capital to flow to non-U.S. companies, spurring innovation in other countries instead? Stopping innovation by restricting the flow of risk capital simply won’t work; rather, to whom the benefits of that innovation accrue is the real question. The innovation genie is out of the bottle and into the world; we should accept the challenge that other countries pose to our leadership — but we should go into that battle in top fighting shape. Not with one hand tied behind our backs.