Venture Capital

Despite global frenzy, investor enthusiasm in China’s AI startups wanes

In 2023, the global frenzy around artificial intelligence, fueled by the advent of ChatGPT, swept across the world. In China, where OpenAI’s chatbot is unavailable, startups and tech incumbents scrambled to develop their own AI models and applications, drawing upon the foundational pieces of the American upstart. Individual AI fans accessed ChatGPT through a web of black market vendors, keeping their accounts alive through often unauthorized virtual private networks.

At a glance, generative AI is in full bloom in China, but a closer look suggests otherwise. Despite the hype, venture capitalists haven’t been as enthusiastic about the nascent technology as one might assume.

In 2023, China recorded around 232 investments in the AI space, a 38% decline year-over-year, according to research firm CBInsight. The total amount raised by China’s AI firms amounted to roughly $2 billion, 70% less than the year before.

Another report by a Chinese database shows a greater amount of funding, though it indicates the same downward trend. According to ITJuzi, China recorded 530 funding events in AI during the first 11 months of 2023, a 26% drop year-over-year.

Those investments earmarked 63.1 billion yuan ($8.77 billion) in total, 38% less than the previous year and significantly smaller than 2021’s peak of 248.78 billion yuan.

The discrepancy in investment sizes between the two reports might be attributed to their different methodologies in counting funding rounds. ITJuzi might have a better grasp of local funding activities than its foreign counterpart, not least because China’s AI startups have become more discreet about their U.S. dollar financings. Many now fear U.S. regulatory scrutiny over American capital flows into their AI businesses.

Taking a broader view, the slowing in China’s AI funding isn’t entirely unexpected given the ongoing sluggishness of global VC investments. However, China’s AI startups face a unique set of roadblocks. American venture capital, which has historically been the major drive of growth in China’s internet sector, has plummeted since the onset of the U.S.-China decoupling. The prospect of listing Chinese tech firms on U.S. stock markets has also dimmed amid geopolitical tensions, so investors grew more cautious about backing hyped-up businesses with no clear exit channels or monetization plans.

Moreover, the capital-intensive nature of AI startups, which cost significant computing power, coupled with their unproven business models, can deter risk-averse local RMB funds.

A handful of Chinese AI startups with pedigreed founders, such as Wang Xiaochuan’s Baichuan and Kai-Fu Lee’s 01.AI, are still able to pull in handsome funding, but the majority of small players are faced with increasingly conservative investors. The mission of developing China’s equivalent of ChatGPT has fallen upon deep-pocketed tech giants who have been hoarding AI chips, while less resourceful startups explore niche industry applications built on open source or the country’s homegrown models.

All the while, the technological prowess of China’s large language models remains in question as developers face a prolonged shortage of AI chips. Amid the escalating U.S.-China tech war, Washington placed an export ban on Nvidia’s high-end graphic processing units to China.

Internally, strengthened regulations have led to higher compliance costs for AI startups. Unlike their larger, better-funded counterparts, many startups lack the financial and bureaucratic resources to acquire the required AI license or meet the country’s internet censorship requirements. Some thus turn their focus to the global market, which introduces a different set of challenges. While regulatory and political uncertainty might be less prominent hindrances, these startups have to navigate new user behavior and an internet ecosystem completely cut off from their home market.

The adventurous AI firms might turn to foreign investors, most likely American ones, for financing and eventually helping with go-to-market strategies. But before they can engage with American institutions, they need to have the appropriate corporate structure, offshore data storing solutions, and even foreign passports for their founders so the Silicon Valley investors won’t worry about violating U.S. restrictions on China-related investments.

With limited funding available, 2024 might be a year of reckoning for many AI startups in China.