The South Korean Government and Venture Capital: The Costs of Planned Growth

Posted on by Jonathan Lee

Unlike the U.S. government, the Korean government plays an active and major role in its nation’s venture capital market. Under the “Special Law to Promote Venture Capital Companies (SLPVCC)” passed in 1997, the Korean government is permitted to provide subsidies to select venture capital-backed companies (e.g., companies involved in energy, IT, and electronics), grant tax exemptions to small businesses, and loosen regulatory limits on startups.1 However, though well-intentioned, the law distorts economic incentives, as companies might attempt to enter high-tech industries in which they have no competitive advantage in order to receive government subsidies.2 Thus, incompetent ventures may be propped up artificially, thereby increasing monitoring and screening costs to investors.3 The law also incentivizes venture capital firms to provide debt financing rather than equity by providing government loans to such firms.4

Moreover, by supporting entrepreneurs through such preferential measures, the law mitigates the inherent risks involved in starting a business. For example, any entrepreneur at a public institution who leaves his job to pursue a startup in a high-tech industry is guaranteed his job back during a three-year period.5 Additionally, entrepreneurs receive tax breaks on their office space if at least 75% of the building is also used by other startups.6 Combined with government intervention, South Korea lacks sufficient exit opportunities for venture capital investment to be profitable.7 Again, the government has only promoted the KOSDAQ market as an exit by providing relaxed listing standards and tax benefits to listed companies.8 Thus, venture capital in the country can “no longer be characterized as a high-risk and high-return investment but rather a limited-risk and limited-return investment.”9

Finally, while the Korean Commercial Code governs venture capital transactions, it does not address essential contractual rights and subsequently fails to align the goals of investors and entrepreneurs.10 First, the Code was primarily designed to regulate large companies, not smaller startups.11 Second, the Code’s statutory provisions are mandatory and cannot be contracted around. Thus, a shareholder agreement made privately between entrepreneurs and investors in Korea may be found unenforceable.12 This rigidity only furthers the argument that the South Korean government plays an overbearing role in the venture capital market. There is no organic growth in the market, as everything is seemingly planned by the government architect.

The government signaled its continued commitment to supporting venture businesses but not the venture capital market when it extended the SLPVCC, which was due to expire in 2007, until December 31, 2017.13 Then, in February 2013, South Korean voters elected the country’s first female president, Park Geun-hye. She pledged to continue the government’s active role in venture capital, dedicating $2.97 billion USD toward subsidized loans or state-funded investments in new companies.14

However, the new president also proposed new tax policies to incentivize startup mergers and acquisitions and looser regulations for larger companies to engage in deals with smaller and cash-strapped businesses.15 The government also aimed to increase private individual investment by offering tax cuts and payment deferrals to investors that reinvest their returns into future business ventures.16 Most importantly, Park signaled the potential for additional exit opportunities by introducing both a crowd-funding system (for wealthy individuals) and a third stock market, the Korea New Exchange, primarily for small business ventures. (Id.)) Experts believe the changes will result in a $4 billion dollar increase in venture investment over the next five years.17

It seems these new government policies have been successful, as the number of Korean startups has almost doubled from 15,401 in 2008 to 28,193 in 2012.18 The changes have seemingly motivated private firms to act as well, as one of the largest tech players in the Korean market, NHN, pledged $45 million dollars to support small IT firms and help grow venture startups.19 With such fresh policies, it appears the Korean venture capital market may be equipped to slowly transition away from government-planned growth and incentivize more private players, such as NHN, to change the venture capital landscape.

  1. Haksoo Ko & Hyun Young Shin, Venture Capital in Korea? Special Law to Promote Venture Capital Companies, 15 AM. U. INT’L L. REV. 457, 458 (1999), available at http://www2.law.columbia.edu/course_00S_L9436_001/2004/Special%20Law%20to%20Promote%20Venture%20Capital%20Companies.pdf. ↩

  2. Id. at 472. ↩

  3. Kab Lae Kim, Implication of US Venture Capital Theories for the Korean Venture Ecosystem, 2 J. BUS., ENTREPRENEURSHIP & L. 142, 148 (2008), available at http://digitalcommons.pepperdine.edu/cgi/viewcontent.cgi?article=1025&context=jbel. ↩

  4. Martin Kenney et al., Scattering Geese: The Venture Capital Industries of East Asia A Report to the World Bank 90, 92 (Berkeley Roundtable on the Int’l Econ., Working Paper No. 146, 2002), available at http://www.escholarship.org/uc/item/64j6d0zc. ↩

  5. Ko & Shin, supra note 1, at 478. ↩

  6. Id. ↩

  7. Kim, supra note 3, at 180. ↩

  8. Id. at 186.) Consequently, the M&A, Free Board, and OTC markets are not utilized as viable investment exits. ((Id. ↩

  9. Ko & Shin, supra note 1, at 459. ↩

  10. Eugene Kim, Venture Capital Contracting Under the Korean Commercial Code: Adopting US Techniques in South Korean Transactions, 13 PAC. RIM L. & POL’Y J. 439, 444 (2004), available at http://digital.law.washington.edu/dspace-law/bitstream/handle/1773.1/697/13PacRimLPolyJ439.pdf?sequence=1. ↩

  11. Id. at 446. ↩

  12. Id. at 452. ↩

  13. Kim, supra note 3, at 184. ↩

  14. Kwanwoo Jun & Jeong-yeon Han, South Korea Backs Funding for Startups, WALL ST. J. ASIA (May 16, 2013), http://blogs.wsj.com/korearealtime/2013/05/16/south-korea-backs-funding-for-startups. ↩

  15. Id. ↩

  16. Id. ↩

  17. Id. ↩

  18. Jeong-yeon Han, No Slowdown in South Korea’s Startup Scene, WALL ST. J. ASIA (May 31, 2013), http://blogs.wsj.com/digits/2013/05/31/no-slowdown-in-south-koreas-startup-scene. ↩

  19. beSUCCESS, Korean Tech Giant NHN Launches US $45M Fund to Support Venture Startups, e27 (Aug. 5, 2013), http://e27.co/2013/08/05/korean-tech-giant-nhn-launches-us45m-fund-to-support-venture-startups. ↩

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