DeepSeek is a soul-searching moment for China's struggling VC industry

If something like DeepSeek could happen without VC funding, why does VC have to exist at all?

DeepSeek is a wake-up call for the US. But in a more subtle way, it’s also a wake-up call for China, especially China’s venture capital industry.

A prominent fact about DeepSeek is that it’s a self-funded venture by a quant billionaire with no outside venture capital. This gives our struggling VC industry another soul-searching moment: if something like DeepSeek could happen without VC funding, why does venture capital have to exist at all?

In this article, I will talk about the crisis China’s VCs are facing and how the VCs could adapt. Morever, since China’s government is now the main funding source for our VC industry, I will also discuss what this might mean for government policies at the end.

Venture capital doesn’t necessarily equate to innovation or entrepreneurship

Long-term readers of this newsletter must know venture capital is a key topic here. We first wrote about why and how our VC industry was dying early last year, chronicled the Chinese government’s desires to revive this industry, and discussed how industry participants devised innovative new ways to cope with the challenges.

One of the recurring themes we touched on was that we should not equate “venture capital” with “innovation and entrepreneurship”.

Venture capital is related to innovation, but not all of the innovation. In an article in my personal newsletter refuting one of the FT’s takes, I pointed out that:

VCs (in its traditional sense) are indeed dead... But that doesn’t mean people are not creating businesses anymore. People are just not creating businesses that require VC money to survive. People are creating businesses that rely on good old cashflows to survive.

and that:

So, what this FT story tells is just that the old "2VC" model, which was not healthy anyway, was over, and I am not quite sure it's a bad thing either… the work, the triumphs and the anxieties of actual business owners trying very hard to cope with the challenge of our time is reduced to nothing. It seems as if we don’t exist. That our successes and failures are still to be judged by whether VC investors like us.

So, what happened to DeepSeek proved my thesis above: VC and innovation are related but not necessarily related.

Sometimes, these two are even contradictory. In fact, our VC crisis is even deeper: had DeepSeek received VC funding, it might not have been as successful as it is today.

Had DeepSeek received VC funding…

DeepSeek has a singular, pure mission: to develop AGI in China. However, this mission highlights a fundamental tension with traditional venture capital investment models, where the primary goal is financial returns within specific time windows.

If DeepSeek had taken VC funding, its mission would likely have been compromised. The pressure to deliver returns would have pushed the company toward user growth and revenue metrics, potentially derailing its core objectives.

China’s VCs are in a difficult position these days. They're passing on profitable projects and being pushed toward hard tech investments by the only funding source in town, the government. Yet truly revolutionary technology often doesn't generate quick returns, leaving IPOs as the only possible exit strategy for them.

DeepSeek's choice to open-source its technology is particularly noteworthy. Under VC funding, this decision would have been virtually impossible to maintain, at least not in China, where investing in open-source projects is almost unheard of. Yet, it's precisely this open-source approach that has established DeepSeek's credibility and influence in the field. After all, even with this open-source attitude, the DeepSeek team suffered so many unfair and untrue criticisms that they used sanctioned GPUs, that they stole from OpenAI, and that it was a propaganda trojan horse. Had Liang Wenfeng chosen a closed-source approach, the project might have been thrown into the dumpster by an uninformed public.

It's crucial to recognize that venture capital is a relatively young industry - just over 20 years in China and less than 50 years in the US. The traditional VC model works best for projects with clear commercialization paths, and/or clear IPO potential (since there aren’t so many M&As in China), and/or an actual need for outside capital.

However, this model isn't suitable for ventures that do not require external funding and/or truly foundational innovations with unclear commercialization paths, and DeepSeek just happened to embody both of these characteristics.

Inadvertently, DeepSeek may have pioneered a new funding model in China beyond traditional equity and debt financing: self-financing, which may be an inspiration for other Chinese high-net-worth individuals who want to pursue great dreams.

The path forward: how should China’s VC industry adapt to a post-DeepSeek world

So, does it mean China’s VC industry is doomed? Not at all. Just like the total withdrawal of VC funding from the US, this may just be another push for the industry to evolve into a healthier state.

For many years, VC industries have operated with a herd mentality. When P2P lending was hot, everyone jumped into P2P. When O2O was trending, everyone pivoted to O2O. When SaaS became popular, companies were rebranded as SaaS. When AI gained traction, everyone claimed to be doing AI. Now that DeepSeek is making huge waves, ironically, many Chinese companies are rushing to integrate with DeepSeek and promote their connections.

If investing is merely about following trends, why not let retail investors manage their own money? What's the point of having investment professionals at all?

Following trends often leads to investing at peak valuations, ultimately destroying shareholder value. The past successes of China’s venture capital industry could be mostly attributed to our great “Beta” - meaning we got lucky for living in a great era with across-the-board growth - but very few were because of an exceptional Alpha.

I believe that as the pace of change accelerates, it becomes ever-crucial to differentiate one’s positioning and deeply cultivate one's own circles of competence. Success comes from digging in and becoming a domain expert about what we are passionate about and truly understand, while AI will eventually replace anything shallow. (This applies not just to VCs but to all businesses.)

When others aren't paying attention, and only a few are doing the “DeepWork”, there will be less competition, and eventually, the spotlight will turn to them.

For instance, a good friend of mine is a VC investor in consumer markets. For the last few years, he stayed focused on consumer investments even when they were out of favor. Besides, he also began organizing many successful industry tours and has built a very successful podcast program with more than 300,000 followers. He faced little competition and is quietly building more strength in an overlooked space.

The key is to survive first, nurture our work daily, maintain our emotional well-being, and wait patiently for our moment to bloom.

Implications for China’s government

DeepSeek also has huge implications for the Chinese government’s attitude toward innovation as well.