In the U.S., CFIUS is bringing new levels of scrutiny to M&A's, especially those involving foreign capital. But national security needs to be balanced with the benefits of investment capital coming into the country.
Much has been said in recent years about jobs shifting overseas in what many economists are calling “the hollowing out of America.” Increasingly, the country’s economy is focused on high-end services—legal, medical, engineering, design and IP—while the market for the blue collar manufacturing jobs that were once a staple of our economy has hollowed, as trade agreements, the internet and offshoring shift them to other regions.
This evolution of the national economic landscape has caused a reaction from policymakers whose citizens have been affected by the shift. In the U.S., the Committee on Foreign Investment in the United States (CFIUS) is bringing new levels of scrutiny to mergers and acquisitions, especially those involving foreign capital. That scrutiny is heightened for countries like China, which is perceived to have motivations beyond the standard economic drivers.
It’s tough to fault the government for focusing on national security. But national security needs to be balanced with the benefits of investment capital coming into the country. Without it, local economies end up paying the price. Without new investments, innovation stagnates, industries consolidate, and ultimately, there is less competition and fewer jobs.
Part of the issue can be attributed to a misunderstanding of the aim of the investments under review. Understandably, people fear outsourcing of jobs. But offshoring of an assembly line manufacturing job is about cost. Foreign investments in technologies like semiconductors and software is different—it’s about innovation and expertise.
In this regard, the Unted States has significant advantages in today’s global economy—those high-end services, design, engineering and IP jobs reflect the critical assets behind the company’s potential. Western countries are also filled with strong, smaller companies that have good technology, effective management and solid fundamentals. But many are struggling to keep up within the limitations of their own markets and against larger competitors.
Without outside investment, smaller companies will continue to struggle—we often see firms spending 20–25 percent of their revenues on R&D, an unsustainable rate that puts their survival in question and makes them vulnerable to acquisition by larger competitors. Once acquired, their IP is folded into the parent company’s portfolio, and jobs are streamlined into a single organization. The premium of the acquisition is justified through cost cutting and synergies. Jobs suffer. Innovation suffers.
Foreign investment works differently than this type of domestic acquisition, especially when it comes to mature capital such as that infused by a private equity firm. Since firms in the tech sector today require a strong ecosystem of talent to succeed, they have to be seen as fixed assets. Sure, you can box up the conference tables and office chairs and ship them overseas, but the talent that makes the company valuable is largely going to stay in their current homes and communities.
So how does a private equity firm achieve its returns? By helping the company grow into new markets and continue to innovate. This is done both by making the necessary investments to sustain the company’s R&D and by opening up new markets.
Today, this is especially important when it comes to the market in China—as the world’s second largest economy, China is looking to meet its own domestic requirements for chips and other basic materials to fuel their emerging innovation ecosystem. Policymakers may bemoan Chinese investment in U.S. companies, but those same investments can provide access and acceleration for small and medium-sized firms to gain a foothold in the largest, fastest growing electronics market on earth.
For a lot of Western companies, it can be challenging to penetrate the Chinese market. Providing that opportunity can not only drastically increase their customer base, but in the case of the U.S. especially, help reverse the country’s growing trade deficit.
For U.S. companies in need of a capital infusion, the current situation puts them in an ironic predicament—whereas China is the market globally that will generate the most new value in the coming years, the perceived threat it poses is causing a protectionism that’s locking companies out of this vast and fertile opportunity. Particularly in technology, a “Made in the USA” label belies the fundamental international nature of the industry. Global supply chains fuel the technology ecosystem as a whole—isolating one element simply means customers will go elsewhere.
If this wave of protectionism continues, we are forcing the domestic Chinese players to come up to speed and, once again, Western companies will see their competitive advantages slipping away. Indeed top companies in China like Alibaba, Baidu and DJI are already world leaders in areas like payments, artificial intelligence and drone manufacturing.
Allowing the right kinds of foreign investment can help Western companies become players in this exploding market, continue to compete and reap dividends from China’s vast innovation ecosystem. But ultimately it’s up to policymakers to make smart decisions that allow a constructive flow of capital and keep the economic engine primed.
-- Ray Bingham is co-founder and partner at Palo Alto-based Canyon Bridge Capital Partners, a global private equity investment fund focusing on the technology sector. He has considerable experience in identifying growth and mature technology firms for investment, giving them new life and helping them to reach their full long-term growth potential.