Startups should be wary of knowledge theft disguised as investment

Foreign governments are increasingly using venture capital to spy on American companies and steal their intellectual property, or IP, according to the National Counterintelligence and Security Center, a federal agency. While private investment from abroad is essential to sustaining American startups and innovation, it’s also a method that other countries—most notably China but also Russia, for example—are using to damage the U.S. economy and compromise national security.

Michael Casey, director of the National Counterintelligence and Security Center, discussed the issue with “Marketplace Morning Report” host Sabri Ben-Achour. Below is an edited transcript of their conversation.

Sabri Ben-Achour: Would you like to explain to us how this type of espionage works?

Michael Casey: Sure. The classic example is you’re a startup, you’re desperate for money, you want to grow, and an investor comes in and says, “Hey, I’m thinking of investing a lot of money. Can I see your intellectual property to make sure I’m making a smart investment?” And then all of a sudden they take it and disappear. There’s a couple of different ways that that could happen, but that’s a typical example. And then your investor goes and starts their own business, and it competes with you in some foreign country.

Ben-Achour: This threat has been around for a while, these kinds of practices. But the NCSC issued an updated warning to the startup community this summer. What prompted it?

Casey: Well, we continue to see growth in this area. Our adversaries have changed tactics over time. As you can see, this is nothing new. They’ve actually been doing this for a while. But we’re seeing them doing it more and more. And they’re also trying to hide some of their investments. It’s not happening directly from the adversary’s country or through someone who is clearly connected to the adversary’s country anymore. But we’re seeing it through third countries or even masking themselves as US companies.

Ben-Achour: Can you give examples of what this looks like and name companies that have experienced something similar?

Casey: Sure. There’s a classic example, a company called Smith’s Harlow, which is a British engineering company, if I’m not mistaken. And there was a foreign investor who wanted to buy the company for, I think, $10 million. And they actually put down a down payment of $3 or $4 million, at which point Smith’s Harlow showed them all of their intellectual property.

The investor pulled out of the deal, Smith’s Harlow lost the British military contracts – because they had a foreign investor – and now they’ve lost their intellectual property as well. And they’re going bankrupt. I think that’s a pretty classic example of how it works.

Ben-Achour: And I guess we should say that showing an investor a certain amount of IP is kind of a normal thing in the startup world, right? You just don’t expect them to run away with it.

Casey: Absolutely. I mean, I think we would say, Note 1: Know who you’re talking to. Do your due diligence on the people who come in and offer to invest in your company. And then, 2: Think about the risk you’re taking when deciding how much IP to show. That’s not a warning, “Don’t take risks.” That’s a warning, “Please take smart risks.”

Ben-Achour: On the other hand, these investments are structured to avoid a certain amount of scrutiny. They can come from intermediaries in completely different parts of the world. How does a startup anticipate that? To weed out, you know, legitimate investors from suspects?

Casey: I’ll admit it’s a tough one. I think if your investor comes in and has a complex ownership where it looks like it’s an investment through a broker-dealer — where the company, when you Google it, looks like it moved to the United States after being in Hong Kong only a year ago — those are all kind of red flags. But I think a lot of these companies have either venture capital firms or private equity firms associated with them that have also invested. And I suspect those people don’t want their investment to disappear either, and that would be helpful in that regard.

Ben-Achour: Do you think people realize the scale of industrial espionage, especially that coming from China?

Casey: I think they’re starting to. I think when we and others started warning about this — whatever it was, five, seven years ago — the reaction was usually, “Oh, really, is this happening?” And now it’s much more, “Tell me how this is happening and tell me how I can protect myself.”