Despite the Chinese government’s aims to attract FDI in order to build up the domestic economy, FDI’s actual impact on entrepreneurship and net firm creation in China remains uncertain. This paper attempts the first national-scale empirical test on FDI’s effect on small domestic firms in China. Fixed-effects regressions are run on a comprehensive dataset of 214 prefectures in 1999 and 2003. The analysis shows a significant trade-off between FDI and small domestic firms in 1999 that then turns positive in 2003. The remainder of the paper tests three hypotheses to explain this change in FDI’s effect over time and find that competitive shock and FDI preferential policies are the main reasons for the trade-off between FDI and entrepreneurship in China.