South Korea VC: State subsidies

When South Korea goes to the polls next month to elect a new president, promises on job creation and wealth distribution will be repeated time and again right up until the last vote is cast. Each of the three candidates has cited venture capital as a means of achieving this goal.

Geun-hye Park of the Saenuri Party has pledged to attract overseas VC investment into the country to support start-ups; the Democratic United Party's Jae-in Moon has voiced his support for IT, identifying financing for early-stage companies as one of five major policies for the industry; AhnCheol-soo, a software mogul running as an independent, has said he would do much the same.

The general idea is that Korea's technology sector has the capacity for more upstream manufacturers and downstream service providers that can feed off the wealth being created by conglomerates such as Samsung and LG.

The country's venture capital industry is already significant, ranking fourth globally by investment value last year. Given that South Korea's economy is only the world's 17th largest, it seems counter intuitive that the country's VC market is surpassed by only China, India and the US. According to AVCJ Research, $428 million was committed across 74 deals in 2011.

To put that in context, Japan, with a GDP nearly five times that of South Korea, saw venture investment totaling just $273 million.

There is one overarching reason for this disparity: government support. Statistics published by the Korean Venture Capital Association (KVCA) reveal that in the first half of this year more than 25% of the KRW325 billion ($296 million) pumped into venture capital came directly or indirectly from state coffers.

Capital injections

Only one other country really stands up to comparison with South Korea. Israel, the world's 39th largest economy, saw $796 million in venture capital investment last year. Thanks to a kick-start by the government-backed Yozma initiative in 1993, the nation now ranks near the top globally in terms of VC per capita.

"If you look at Israel and Korea they have much in common," says Yoo-shin Jung CEO of Korea Venture Investment Corp. (K-VIC), the largest government-backed investor in the asset class. "Both have highly-educated populations, a lack of neutral resources, small domestic markets and high dependency on overseas exports. It is because we have to develop our own industries and create resources with our own money and that we are so successful in this field."

Since its inception in 2005, K-VIC has invested around $1 billion into 120 venture capital and private equity funds. At the end of June, its Korea Fund-of-Funds was worth KRW1.5 trillion. Alongside the National Pension Service (NPS), Korea Financial Corp. (KFC) and Korean information & Technology Fund (KIF), K-VIC represents the venture capital industry's cornerstone LP base.

KVCA statistics show that government LPs account for 25.2% of the capital entering VC funds in the first half of 2012 with a further 20.9% coming from public pension funds. The private sector - financial institutions and corporations - contributed just under 30%.
In the last decade, the impetus behind government investment has been to drive innovation in the technology sector.

Entertainment, IT and manufacturing received the bulk of venture funding in the first half, with 33.5%, 28.3% and 24.6%, respectively. IT has traditionally been the VC sweet spot. Of the 142 domestic companies that have listed on the Korea Stock Exchange and KOSDAQ since 2008, 67 operated in IT, electronics or computer-related areas. In the vast majority of cases, these firms were suppliers to South Korea's conglomerates, or chaebols.

"As Korea developed its IT sector during the 1960s and 1970s, companies like Samsung, LG and Daewoo have done very well, competing on a global level, so they have had to source their components and technology from start-ups," explains Brian Koo, CEO of LB investments. "The IT venture capital industry has grown up with these global players."

Although several of these chaebols have corporate venture capital units that make strategic investments intended to benefit the parent group, their contribution to the development of the industry domestically has largely been indirect. For example, one of these most recent investments by Samsung Venture was a $5 million commitment to US data-triage start-up Stoke.

"On the one hand chaebols are beneficiaries of technology developed by venture capital-backed companies; on the other hand they support the VC market by purchasing products from these companies," Says Sam Lee, managing partner at STIC Investments.

The fact the entertainment sector now accounts for over a third of venture capital investment in South Korea speaks volumes for the extent of government influence in the market. Among the biggest investors in K-VIC's fund-of-funds are the Korean Film Council (KOFIC) and the Ministry of Culture, Sports & Tourism (MCST).

In December last year K-VIC joined Lotte Entertainment, Route One Films and CJ Entertainment investing $110million in the Sovik Global Contents Investment Fund, the largest-ever South Korean entertainment sector-focused fund. It finances international co-productions and a slate of Korean-language television dramas to be distributed throughout Asia.

"It is because of investment from the MCST that so much is being putting into this sector," K-VIC's Jung says. "It is the reason Korean culture output is so strong right now and I think this trend will continue or improve. It is a good example of how there can be cultural benefit in addition to fund performance."

Wider objectives

For all the cultural credibility, is government participation in funds fulfilling the broader mandate of creating a venture capital industry that can be sustained by more than just state backing?

Last year, VC investment in South Korea reached KRW1.2 trillion, the highest level in a decade, but this figure is unlikely to be matched in 2012 as deal value came to KRW539 billion in the first half. Furthermore, the number of angel investors has fallen 90% since the height of the dotcom bubble in early 2000.

Another mitigating factor is venture capital investors abandoning the early-stage space for pre-IPO deals, a trend that emerged in 2008 and has since taken a firm hold of the industry. In 2011, 44.3% of VC commitments targeted more mature companies expected to go public within two years, while early- and expansion-stage companies received 29.5% and 26.14%, respectively.

This could be put down to a combination of poor incentives for early-stage deals, risk aversion among investors, and a general attraction to the larger capital commitments and higher IRRs generated by pre-IPO deals. As a result, some industry participants are skeptical about the merits of government participation.

"If you start buying shares at the pre-IPO stage, volume will increase dramatically but you are not pouring cash into the start-ups, you have created speculation versus real cash infusion," says Sung Park, co-founder of Translink, a Silicon Valley-based firm that invests in US tech firms looking to expand into Korea and the wider Asian region. "The government has put in too much money and is speculating, but that is my very cynical view."

However, this trend has not gone unnoticed. Last December K-VIC set up the KRW10 billion Angel Investor Matching Fund, which is intended to support start-up financing by matching up to KRW1 billion of investment made by individual angel clubs and up to KRW500 million for individual angel investors. Six months later it announced the fund would increase to KRW70 billion.

Last year the state-backed Small & Medium Business Administration (SMBA) opened an angel investment support center Seoul's Seocho district.

"The Korean government is trying to do is put money into the gap where there are no private investors and by doing that we are supporting the venture ecosystem," says Jung.

No VC optimists?

Regardless of these efforts, Koo of LB Investments expects many venture capital firms to struggle as the larger players move up to the pre-IPO space and take investors with them. Of the 100 registered VC firms in Korea, he estimates that only 30-40 will be able to raise funds.

This may be good from LP point of view as those larger VCs that survive will have proven track records, making the selection process easier for investors. On the other hand, the market will suffer as a smaller pool of VCs focus on the big returns available from mid-stage, pre-IPO investments. Indeed, average fund size swelled from KRW7.4 billion to KRW180 billion in first half of 2012 as VCs sought more capital for later-stage investments.

"The government cannot support the VC market indefinitely - it should gradually be replaced by the private market, pensions and other financial institutions," says Koo. "If this doesn't happen and there is a contraction in GPs, it would be bad for new technological developments and job creation. It won't happen in three years or five years but maybe in 10 years something like that can happen."

SIDEBAR: Exits - Overdependence on IPOs

Forty companies went public on KOSDAQ in 2011, continuing a year-on-year increase that dates back to 2008. The run is unlikely to continue in 2012. Between January and June there were only three IPOs, consistent with a global trend of weak capital markets. The impact on South Korea's venture capital industry has been far reaching.

While IPOs account for 10% of VC exits in the US, in Korea the figure is closer to 20%. This overdependence on an exit channel that can be highly volatile has long been a concern.

However, David Oh, head of the Seoul office of boutique advisory firm J. Moore & Partners, sees the fall off in IPOs as an opportunity to develop other exit options. "The exit structure depends mostly on IPOs and so the government and other big investors will be looking for alternatives such as trade sales," he says. "Next year the M&A market could be booming."

This is also the government's hope. Korea Venture Investment Corp. (K-VIC), the largest state-backed investor in venture capital, has set up a small- to medium-sized enterprise (SME) M&A matching fund intended to help mid-size companies with domestic and outbound acquisitions.

Meanwhile, the IPO market could be to get boost in from the Korea New Exchange (KONEX), a bourse specially created for SMEs. Announced by Korea's Financial Service Commission, it is intended to narrow the gap between early-stage investment and the point at which a company can seek an IPO.

Yoo-shin Jung, CEO of K-VIC, also sees opportunities for Korean companies on overseas exchanges, notably Japan, China and the US. "Over the next five years I think will see the globalization of our VC market. The government wants to see this development but the priority is supporting local seed and early-stage companies."

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• Topics
• Venture
• Early-stage
• North Asia
• Technology
• South Korea
• Venture
• National Pension Service (Korea)
• LPs
• TMT
• seed