A Thought on the Measures to Develop a Virtuous Cycle in the Venture-Startup Funding Ecosystem

Transcription

1 A Thought on the Measures to Develop a Virtuous Cycle in the Venture-Startup Funding Ecosystem Park, Yong Rin* A virtuous cycle in the startup-venture ecosystem is important for building a creative economy led by startups and ventures. Recently, in an effort to accomplish this, the Korean government announced the Measures to Develop a Venture-startup Funding Ecosystem. This will address structural problems that clog up the flow of investments in Korea s venture ecosystem and build up infrastructure to facilitate the circulation of investments in startups and ventures. The Measure presents a clear policy goal of securing a virtuous cycle of business creation, growth, exit, and reinvestment in the ecosystem, and this distinguishes it from previous measures of this kind. To achieve the goal, policy financing should be used to prime the pump to induce private sector participation. Also necessary is efficient implementation to prevent overlaps and conflict of interest. On June 5, 2013, the Korean government unveiled the Creative Economy Action Plan and Measures to Establish a Creative Economic Ecosystem (the Action Plan, hereinafter). Earlier on May 15, 2013, the Measures to Develop a Venture-Startup Funding Ecosystem (the Measure, hereinafter) was announced to address imminent challenges for a creative economy. It is well known that the creative economy is the government s idea of an economic structure where creative ideas meet information and communications technologies (ICT) to establish All opinions expressed in this paper represent the author s personal views and thus should not be interpreted as Korea Capital Market Institute s official position. Ph.D., Research Fellow, Financial Services Industry Department, Tel: , yrpark@kcmi.re.kr 1

2 startups, new industries, and new markets, which in turn will create quality jobs. For the past four decades, the Korean economy grew based on follower growth strategy before it reached the limit because of the recent global financial crisis and the growth of emerging industrial economies. Against the backdrop, the new administration is pursuing a paradigm shift with leader growth strategy based on innovative technologies and creative ideas. Because creative financing, which injects capital into the venture-startup ecosystem, is critical in a creative economy, the recently announced Measure was designed to eliminate problems that are blocking the realization of creative financing. In detail, the Measure tries to address the market s structural problems to create a virtuous cycle in Korea s venture-startup funding ecosystem, as well as to build up infrastructure necessary to facilitate the circulation of investment capital. As noted by the Measure, Korea has faced challenges in circulating investment capital within the venture ecosystem for the past 15 years despite persistent efforts to establish a sound, vibrant business environment for venture firms. The government efforts in previous years focused on growing venture capital, rather than diversifying funding sources in the venture ecosystem. From the perspective of the overall venture ecosystem, firms face different risks depending on the stage of development (birth, growth, maturity), and it is essential to provide the right kind of risk capital corresponding to the risk level of a firm and establish an exit market. In Korea, startups, once they spend all their seed money, have difficulty receiving venture capital investment, and even many of the startups rely on loans. In this regard, the fact that the Measure contains diverse incentives for the 1 st generation venture entrepreneurs and angel investors to invest in startups is encouraging. More importantly, this helps successful 1 st generation venture entrepreneurs to reinvest their capital in the venture ecosystem, and to mentor startups based on their business experience. The survival and growth of a startup depend on many factors: not only capital and technological development, but also many corporate management elements including marketing, manufacturing, purchase, business strategy, human resource management, legal affairs, accounting, etc. But most venture founders, strong in technological development are weak in other areas. Hence, 1 st generation venture entrepreneurs can be the most suitable investors who can pass on business experience and know-how to the next generation venture entrepreneurs. According to the Measure, if an investor reinvests the proceeds from successful exits in other venture firms, capital gains tax will be deferred until the reinvestments are exited. In addition, the government will establish a junior enrichment fund to help 1 st generation venture entrepreneurs create funds to invest in junior startups. 2

3 With regard to angel investments, the Measure provides stronger tax benefits. The tax deduction imposed on angel investments of up to KRW 50 million is increased from 30% to 50%, and the 30% income tax deduction is applied to investments exceeding KRW 50 million. Also, the ceiling on the deduction from taxable annual income is raised from 40% to 50%. Furthermore, in order to encourage 1 st generation venture entrepreneurs to continue to invest large amounts of capital in startups, the government will support R&D investment of the startups that these 1 st generation venture entrepreneurs invest through the angel matching fund by up to KRW 200 million. These startups will also be certified as venture company by the Korean government. Another problem is that Korea s venture capital relies on KOSDAQ IPOs and currently the M&A market is barely active. This is not the case in other nations where investments in the venture ecosystem are usually exited through M&As. Through the Measure, the government provides aggressive tax benefits for Technology Innovation-type M&As in an attempt to improve the M&A market as an exit market. Technology Innovation-type M&As are defined as mergers and acquisitions of companies whose R&D investment is over 5% of annual sales and the M&A price is over 150% of the assessed value based on the tax law. In other words, the tax benefits are applied not only to direct investments in R&D, but also to the M&As of R&D-intensive firms. This is similar to the corporate finance practice where M&A is generally recognized as an alternative investment to R&D. For this type of M&A, the government will provide the acquiring firm with a 10% corporate tax deduction for the value of the technology 1) it acquires through M&As. Together with this, the shareholders of the acquired firm are exempt from the gift tax if the M&A transaction does not involve individuals with special interest related to the M&A transaction. To boost the IPO market, a primary exit market for venture capital, the government will open KONEX market in July 2013, and also overhaul governance and operation of the KOSDAQ. Also important is to facilitate the creation of new businesses by inducing talented individuals to start new ventures, and building the overall social atmosphere where failed entrepreneurs can return to the market and restart businesses. This is well reflected in the Measure as one of the policy goals. Korea s venture ecosystem so far did not allow proper business incubation and could not sufficiently support the growth of startups. To address the issue, the government will launch a 1) The value is assessed by an outside appraisal expert. Otherwise, the value is calculated based on the following equation: [the acquisition value (the value assessed by the tax law x 1.3)]. The acquiring firm can choose between the two values. 3

4 joint program with well-performing business incubators and venture capital to provide support for high-tech startups. Also noticeable in the Measure is that it attempts to improve the quality of domestic venture capital by inducing more overseas venture capital (including Korean venture capital operating overseas) to participate in the Korean market. When Israel launched Yozma Funds, it required all venture capital funds invested by Yozma Funds to be invested by at least one overseas venture capital. This was to provide the underdeveloped venture capital industry in Israel with opportunities to learn advanced investment practice of overseas venture capital. The Measure is unique compared to previous policies because it presents a clear goal of creating a virtuous cycle of business creation, growth, exit, and reinvestment from the perspective of overall venture ecosystem. To do so, the Measure emphasizes the role of policy financing in the case of market failure. First of all, the Future Creation Fund will be established with the public-private investment of KRW 500 billion, where KRW 200 billion will be invested in enterprises at their infancy, and KRW 300 billion in venture firms at the growth stage for M&As. Also included in the Measure is the creation of the Growth Ladder Fund (KRW 2 trillion of public sector and private sector funds) which will be used as financial support in the growth and exit stages, e.g., intellectual property right protection, M&A, IPO, and reestablishment of new businesses. The Measure will also introduce guarantees: customized guarantees for convergence industries (KRW 300 billion) and M&A guarantees (KRW 100 billion). So what should be the major considerations in maximizing the effect of the Measure? First and foremost, efficiency in using policy financing is important. Basically, policy financing is injected to overcome under-investment, or in other words, market failure. The problem is that policy financing is often regarded as easy money especially when public funds allocation and investment are determined by the government or other public organizations. When a private firm manages public funds on behalf of the government, this is less likely to be a problem. Hence, it is necessary to have detailed standards and implementation guidelines in investment management, and this should help distinguish good startups and investors from bad ones. For instance, an acquirer and acquiree of a venture or startup have an incentive to collude with each other and fix the price at a higher level for higher tax benefits allowed for Technology Innovationtype M&As. This, of course, should be prevented. That incentive exists because the Measure allows for the acquirer to select between the two pricing options (one assessed by an outside organization, and the other computed by a set equation). Also, it is desirable to let private firms manage public money as long as the policy goal is not undermined. 4

5 Second, as policy financing is supplied to the whole venture ecosystem from business creation, growth, exit, and reinvestments or comebacks, the conflicts of interest may develop between the stages. For example, if the government investments at the growth stage are eventually exited through another exit-related fund created by the government, this is unlikely to enhance investment capabilities of private sector. Furthermore, some of overlaps in policy financing along corporate life cycles are observed. Thus, it is necessary to clearly and efficiently determine how to allocate the public funds. Third, in principle, the venture-startup ecosystem should be led by the private sector and market. This is the only way to secure its sustainability and dynamic nature. It is recommended that the government provide an incentive-compatible platform to attract startups, venture firms, and investors to the market, create a virtuous cycle, and ultimately build up a private-oriented venture-startup ecosystem. Most importantly, policy financing should focus on its pump-priming role, which means that policy financing should be used to foster the private-led venture-startup ecosystem. If this is realized, then policy financing can be phased out. Fourth, the Measure increases tax breaks for angel investments significantly. However, they should be raised further to the level of other nations considering Korea s low angel investments. A gradual increase is desirable because of limited tax sources. For example, it is desirable to ease the current limit on income deduction (50% income deduction up to KRW 50 million, and 30% for investments exceeding KRW 50 million). The venture-startup ecosystem is the blood vessels for Korea s startups and venture firms. Establishing a free-flowing funding ecosystem without clogging up the investment flow is the only way to help startups and venture firms lead Korea s creative economy to achieve growth and job creation. Due to its comprehensiveness, the Measure is a major stride in the venturestartup ecosystem compared to previous policy measures. And it is hoped that this will help startups and ventures to truly lead the creative economy, and that policy financing will help accomplish this goal. 5