Korea eyes Western model for funding ecosystem

2013-05-26 14:52

Korea eyes Western model for funding ecosystem

By Kim Da-ye

The word “venture” is in vogue again. Tech start-ups thrived in the late 1990s and early 2000s. Internet portal Naver, game developers Nexon and NCsoft, and set-top box manufacturer Humax are the so-called first-generation ventures from this era. Along with the worldwide burst of dot.com bubbles, the domestic venture culture disappeared, and Korea Inc. became dominated by large conglomerates.

The wide distributions of smartphones and ubiquitous connectivity in the past few years have reignited interests in venture firms. The trend is, however, limited to creating apps and mobile games. For a real start-up culture to form, ventures should also look into other serious areas of technology and science such as medical equipment, biotechnology and clean energy. The new government says it is determined to turn the trend into a second venture boom.

The Park Geun-hye administration isn’t the first one serious about doing so. Fostering start-ups for creating jobs for the youth has been a political agenda in many developed economies.

In Korea in 1998 and 2005 under former Presidents Kim Dae-jung and Roh Moo-hyun, massive state funds were formed to cultivate ventures. Despite the venture boom under former President Kim, the past policies have been criticized for being too government-centric.

The current government’s proposal under the paradigm of “creative economy” tries to mimic Western models seen in Israel and the U.S. It advocates greater involvement of the private sector in funding and mentoring start-ups, and re-investing their profit into other promising venture firms, in effect creating a self-sustaining start-up ecosystem.

Creating funding ecosystem
“The biggest factor for vitalizing start-ups would be liberation from the fear of becoming delinquent. If entrepreneurs are guaranteed to make three attempts, the number of the start-up candidates would jump up more than five times,” said Lee Min-hwa, a professor at the Korea Advanced Institute of Science and Technology, on his Facebook page on May 15. Lee is also the founder of Korea’s first venture, medical equipment maker Medison.

In the past, Korean ventures have relied heavily on loans. According to the government, small- and medium-sized enterprises secure 99 percent of their funding by taking loans. When their businesses fail, entrepreneurs have difficulty getting back on their feet because they’re branded as delinquent borrowers. The Korean custom, which requires entrepreneurs’ family members, relatives and employees to stand collectively liable for the loans, makes the situation worse.

The Park Geun-hye administration defined the paradigm of its economic policy as “creative economy” and said that start-ups will play a crucial role here. The problem that the government addressed first is the lack of a funding ecosystem for ventures.

On May 15, a comprehensive blueprint for the funding ecosystem was announced. The basic idea is to emulate that of Silicon Valley in the U.S. where investors such as venture capitals and angel investors not only fund start-ups but also guide them. The investors recoup their input when the ventures are acquired or listed in the stock market. They will then re-invest their return into other start-ups. The Korean government pays particular attention to the two areas that Korea lacks — angel investors, preferably who are founders of successful ventures, and the mergers and acquisitions (M&A) market to make it easier for investors to exit.

To meet those goals, the government came up with some detailed plans in the May 15 manifesto. For the early stage of the blueprint, the government plans to introduce a legal system for crowdfunding this year. Crowdfunding means to raise funds — usually online — from a mass of individuals.

To encourage wealthy individuals and successful entrepreneurs to turn into angel investors, a new tax regime will exempt 50 percent of the investment into ventures worth up to 50 million won and 30 percent of that exceeding 50 million won from the investors’ taxable incomes. The maximum amount of the income exempt from taxation is half. The government boasts the rate matches those of the state of Virginia in the U.S. and Singapore and is higher than Japan’s 40 percent.

For those qualified to be “professional angel investors,” the government will match their investment into research and development — up to 200 million won per company. Professional angel investors have to be already successful venture entrepreneurs who have the capital, experience and know-how.

Another big plan will be creating a “Future Creation Fund” worth 500 billion won that consists of 350 billion won from the private sector and 100 billion from the government. Two-hundred billion won from this fund will be spent on the early stage of the plan in three years.

For the middle stage where venture firms develop and investors exit, the government believes vitalizing the M&A market is the key. While global corporations nowadays acquire technologies instead of developing them on their own, such transactions aren’t common in Korea. In fact, it is known that large corporations sometimes rob small- and medium-sized subcontractors of their special technologies. In order to change such an environment, when a venture is acquired, the government will exempt 10 percent of what its technologies are worth from the buyer’s corporate tax.

Furthermore, when small and medium businesses are acquired by large corporations, they won’t be considered their affiliates for three years. Affiliates of large corporations face various regulatory barriers under the fair trade law.

Another way of recouping investment is getting a venture firm listed in the stock market. At this moment, the KOSDAQ market — the Korean equivalent to NASDAQ for the firms too small to go public in the main bourse — is too heavily regulated for investor protection after a long string of firms have gone bankrupt and have become involved in frauds.

To assist with this problem, the government vowed to overhaul the KOSDAQ market and introduce a new bourse called KONEX for the firms too small to get listed on the KOSDAQ. It takes 14 years on average to go public on the KOSDAQ.

Copying Israel

Amid the government’s attempt to emulate the Western model of a start-up funding ecosystem, Israel has received the most attention. Yoon Jong-rok, a vice minister of science, ICT and future planning and former vice president of KT, represents the Park administration’s enthusiasm for the Israeli model, which has received the most attention among the Western models. In 2010, Yoon translated a book, “Start-up Nation: The Story of Israel’s Economic Miracle.” He also advocates the Israelis’ entrepreneurship, education system and start-ups in news columns and speeches. He was an advisor to the president in her transition committee and is known to have recommended Bell Labs President Kim Jeong-hoon as the minister of science.

The general start-up funding structure that consists of angel investors and venture capitals originates from Silicon Valley. In the U.S., the whole system is led by the private sector, and investing in start-ups is considered a high risk, high return investment. In Korea, the government believes it needs to step in at an early stage to draw in the private sector.

The first policy the government is implementing since unveiling a blueprint for creating a start-up funding ecosystem is a copy of an Israeli policy to create “technological incubators.” The state-run Small and Medium Business Administration (SMBA) announced May 19 that it would introduce an “Israeli-style start-up program” that is nearly identical to Israel’s Technological Incubator program.

In this initiative, the SMBA will select venture capitals and angel investors that specialize in the early stage of fostering start-ups. Those selected will work as incubators for six years and be given the right to recommend start-up candidates. The government will choose the final candidates that will receive funding and mentoring from both the incubator and the government.

The chosen start-up will receive up to 100 million won — 15 percent of the approved budget for the project — from its incubator over three years, and the government will match the investment by contributing up to 500 million won — 85 percent of the project budget.

For the 100 million-won investment, the incubator will secure a 40 percent stake in the start-up, which will retain the rest — a majority stake. The government, in return for its investment, will receive 10 percent royalties from revenue generated when the start-up is successful.

The SMBA said in a press release, “The Israeli government invested about $600 million over 20 years through the Technological Incubator program, supporting 1,400 start-ups. More than 50 percent of the start-ups succeeded, and one firm is worth as much as $600 million.” The Korean government plans to select 5 to10 incubators this year and 30 by 2016.

Israel’s Technological Incubator program is only a small portion of the Middle Eastern country the government is trying to emulate. Chutzpah, a Yiddish word for being audacious, for example, is now a trendy word among government officials including Vice Minister Yoon who believes that chutzpah represents Israeli entrepreneurs who are unafraid of launching their own businesses and even failing.

David Park, the founder and CEO of KOISRA, a consultancy that works as a bridge between Israeli and Korean firms, said that Korea should learn two things from Israel — the venture ecosystem and entrepreneurship.

“Israeli entrepreneurs don’t just pursue making money. Their goal is more than that. They aim for disruptive innovation — disrupting existing concept, values and technologies and replacing them with new, more advanced ones.”

Korea should develop its own model

The Korean government shouldn’t imitate Israel as it is, experts say. Vast differences separate the countries. For example, the size of Israel’s territory is almost one fifth of Korea’s, and Israel’s 7.8 million population is easily dwarfed by Korea’s 50 million. Korea also has a bigger domestic market with huge manufacturing industries. Consequently, the goals of start-ups in Israel and Korea have naturally been different.

“In Korea, most start-ups aim to go public while 80 to 90 percent of Israeli counterparts get acquired. They have a different concept, a different mind-set,” said Park.

A senior government official who declined to be named said that the Israeli model would only suit the early stage of fostering ventures.

While Israeli start-ups are acquired by foreign firms or go public on the NASDAQ, the official said that Korean venture firms can grow into mid- and large-sized firms on the back of Korea’s larger economy and industries, while the country can retain home-developed technologies and talents.

The official points out to Germany as a model for the later stage of the plan when venture firms have grown.

Germany isn’t well-known for start-ups, but its small- and medium-sized firms, categorically called Mittelstand, are the world’s leaders in their niche markets. By the German definition, a Mittelstand firm has up to 500 employees and up to 50 million euros in annual turnover.

According to a document by Germany’s Federal Ministry of Economics and Technology, more than 99 percent of all German firms belong to the “German Mittelstand,” which contributes almost 52 percent of the total economic output and employs roughly 14 million people, which equates to about 61 percent of all employees subject to social security contributions.

“We should try emulating the education system of Germany’s engineering schools. And in Germany, large corporations specialize in one area and become multinational firms in that niche. They also have ideal labor-management relations,” said the official.