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Team Conflicted Capital Team - 2021 Technology, Innovation & Great Power Competition

  1. Team Conflicted Capital Original problem statement Chinese investment in US start-ups poses a threat to US military capabilities across critical technologies, but the lack of transparency in venture capital makes it challenging to track these threats. Final problem statement Chinese adversarial venture capital investments in US dual- use startups continue to threaten US military capabilities across critical technologies, but the scope of the problem within the USG is relatively small. VCs and entrepreneurs can play a role in addressing the challenge by shunning known sources of adversarial capital. Total interviews completed: 20 Total outreach: >100 contacts Megan Hastings MBA ‘22 Angela Chen MIP ‘23 Zac Blasdel MSx ‘21 Connor Love MBA ‘22
  2. Our journey wasn’t always smooth Overview of our journey 1 2 3 4 5 6 7 8 9 10 Week Team energy Does anyone but the government care? Is this even a problem? Entrepreneurs need better information! Would VCs share information? Smaller scope in USG, but some potential for impact outside the government ???
  3. We originally thought Chinese investment in U.S. startups was a high-priority, widely relevant issue ● We initially thought this was a big, “pants-on-fire”, burning issue ○ Unclassified DoD Industrial Policy brief dated June 2021 described three threat avenues to attack national security and Defense Industrial Base (DIB) ● We focused on “transactional” threats ● However, there was no data readily available to qualify how often transactional threats occurred Starting point for problem
  4. We used cold emails, LinkedIn DMs, and our own connections to “get out of the building” Getting out of the building Our interviews led to many, many discussions - we woke up thinking about the problem (see below) In total, we sent out over 100 requests for interviews
  5. Raj Shah did not believe adversarial capital is still as widespread a challenge in current VC market Heather Richman clarified that CFIUS is voluntary and only applies to specific transactions DIU has only found instances of adversarial capital in 10% of potential partnerships Our understanding of the problem rapidly evolved... Adversarial capital is widespread in the startup and VC ecosystem CFIUS catches the majority of problematic investors Organizations like DIU encounter adversarial capital in almost all partnerships Challenging our assumptions Scope of the problem Affected stakeholders Solutioning Ingoing assumption Insight from interviews This is a 3-sided problem involving startups, VCs, and the government, which all have a role to play in the solution Multiple groups across the DoD look at this challenge daily because it is so widespread This is a government problem and solutions must come from the government Entrepreneurs will accept capital that presents the best terms and are not willing to consider national security risk Philip Clark said this is inherently a government / military challenge to solve through faster-moving and expanded sources of trusted/patient capital DIU’s 2-person Business Intelligence team only looks at foreign ownership as a final step because of manual, time-intensive nature of vetting Colin Supko shared how Trusted Capital is working to rebuild connective tissue with VCs and promote understanding of problem/risks CEO at NSIN Demo Day shared that if founders had the tools to avoid Chinese capital, they would do so; all they can do is ask VCs who their LPs are 4 4 7 3 6 5 6 Week
  6. …And it was a rocky journey at times Current market conditions influence the attractiveness of adversarial capital Team takeaways VCs do not see themselves as part of the solution The USG seeks to work with VCs to expand trusted capital sources, but limited incentives to offer to share information Scope of the problem Affected stakeholders Solutioning 4 4 7 3 6 5 6 ??? How we felt Week ??? In current market, problem is less salient because entrepreneurs have choice Minority investments fall outside of CFIUS’ current scope Foreign ownership has small impact even in USG entities that work with startups like DIU In-depth vetting of foreign ownership occurs in small pockets within the DoD that are limited by manual processes Entrepreneurs would be willing to shun adversarial Chinese capital if they had the tools to do so We were confused about who was tackling this problem in the USG Team discussions The problem is less widespread across the DoD and USG than we expected Some team members thought the USG shouldn’t ask VCs to take action Where vetting occurs within the DoD, there is a need for automated tools Will VCs actually share information about their LPs? ??? Entrepreneurs would be willing to change behavior if given the right information Team debates and discussions Conflicting team views Team confusion/frustration A-ha moment! ??
  7. We identified a solution by focusing on relevant personas DIU Business Intelligence team Entrepreneur Venture capitalist Personas Role Challenge Need Conducts diligence on foreign investors’ ownership or control as last step before DIU begins partnership with startup Makes decisions about which investments to accept with simple background checks Decides which LPs to accept as backers of fund with each new fundraise 2 people complete highly manual process, with little coordination across DoD Automated tool that flags potential adversarial capital that can be shared within DoD In a downturn when entrepreneurs have fewer options, foreign investors may be more attractive or offer better terms than U.S. investors VCs may not know where LPs’ money comes from, or if linked to state-backed entities More advanced tool to vet potential investors and identify whether any are considered “adversarial” More advanced tool to vet potential investors and identify whether any are considered “adversarial” Converging on a solution
  8. Our proposed solution is an automated tool that meets needs of entrepreneurs, USG, and investors ● At first, we debated trade-offs between usefulness, buy-in, and feasibility ● We set the criteria that any realistic solution needs to be: ○ Better than the status quo (manual/inconsistent diligence) ○ Understood as “worth it” to entrepreneurs and investors ○ Balance requirements and available data with ease of use and overall ecosystem benefits Refining our solution ● An automated screening tool and database can solve for investor, entrepreneur and USG needs in a single platform ● Includes details available on investors’ location, links to state actors, shell companies, other investments to inform decision-making ● AI-generated risk score would flag companies, investors, and LPs as high-, medium-, or low-risk ● Data pulled from Pitchbook, Carta, CB Insights, LinkedIn, news reports / open source, and voluntary information Our criteria Proposed solution
  9. There are many potential cons that may limit adoption Pros and cons of our solution Pros Gives dual-use entrepreneurs a greater chance of scaling with clean capital Augments existing USG efforts Could allow slower-moving USG capital allocators to close faster Keeps the clean/adversarial capital distinction front of mind for entrepreneurs and investors Cons Voluntary with potentially limited buy-in Unknown to what extent VCs would vet/disclose LPs Wide range of understanding of scope of problem (hot air? ) Founders of dual-use tech may already self-select for trusted capital
  10. We do not recommend building out this MVP Ourselves Next steps ● Where we started is not where we ended ● We fundamentally know two things: ○ Chinese adversarial capital in US backed technology companies exists and it poses a potential threat our nation’s national security ○ BUT it is not as big of an issue as we first thought ● There are many outstanding questions we do not have answers to: ○ Do market conditions (cash-rich funding environment) solve this problem? ○ Are the Chinese just bad venture capitalists? Are they putting their money in the wrong companies? Should we let them keep wasting money? ○ Do regulatory bodies like CFIUS and the SEC solve this problem simply by scaring founding teams from taking Chinese money? ○ How should we think about ‘politicizing’ this problem? When does China fear-mongering produce inefficient uses of government agency time/energy/funds? ● From here we recommend working with relevant government agencies and public- private partnerships to educate decision makers on what we learned, but we do not recommend building out this MVP ourselves
  11. Appendix
  12. Interviewee List ● Philip Clark, Chief of Staff, 8VC ● Heather Richman, Founder, Defence Investor Network / FOCOM ● Steve Blank ● Raj Shah ● Captain Colin Supko, CFIUS ● Oriana Mastro, FSI Professor ● Trea Stephens, anduril /founders fund ● Ian Owen, Jaia (NSIN Demo Day Start Up) CEO ● Dean Zody, Ghostwave (NSIN Demo Day Start Up) CEO ● Mike Brown, Director, DIU ● Pavneet Singh, Fellow, Brooking Institute (Co-author of report w/ Mike Brown) ● Matt Turpin, Fellow @ Hoover, Senior Advisor @ Palantir ● Barry Eggers, Lightspeed Founder - VC ● David Ulevich a16z ● Andy Ku, Partner, IQT ● Tai Ming Cheung, UCSD Professor, Director, UC Institute on Global Conflict and Cooperation ● Linda Lourie, Assistant Director for Research and Technology Security at White House Office of Science and Technology Policy
  13. We tested our solution with all three stakeholder groups Government users validated need for this solution: ● We validated a need for this solution with Mike Brown, Director of DIU ○ We were unable to speak with DIU’s Business Intelligence team directly ● We also shared our draft solution with Heather Richman Entrepreneurs expressed a willingness to use this solution: ● Ghostwave, Jaia CEOs at NSIN Demo Day VCs are still skeptical about sharing LP information ● “I haven’t seen Chinese investment into any fast-growing technologies that have national security significance - almost all of the adversarial capital that I’ve seen has been into companies that quite frankly were never likely to work.” - Tier 1 VC Testing our solution