Venture Capital 2024 Comparisons

In 2023, venture capital investments in Korea experienced an overall decrease in terms of size. In general, the sector that attracted most interest in terms of venture capital investments was information and communication technology (ICT), and the largest deal in terms of investment size also occurred in this sector, the series E financing for Klook, a global travel and leisure e-commerce company. Both Korean and non-Korean major venture capital firms participated in this investment, raising KRW276 billion.

Having said the above, venture capital investments in Korean companies in 2023 also saw investments made in more diverse areas than in years past, with fashion-related companies obtaining a considerable amount of venture capital funding from investors. For instance, Piece Peace Studio, which operates business under the clothing brand “Mardi Mercredi”, and Ably Corporation, which operates women’s fashion shopping mall Ably, each attracted an investment of KRW50 billion, ranking fourth in terms of investment size in Korea that year. In particular, Piece Peace Studio stood out for raising a considerable investment for a series A round financing. Major domestic venture capital firms participated in these investments. 

According to the 2023 Venture Capital Market Brief, published by the Korea Venture Capital Association, new funding for venture capital firms in 2023 fell by approximately 50% compared to 2022, while new investments by venture capital firms were down 20.2% year-on-year. In addition, a majority (50.2% to be exact) of the investment recovered by venture capital firms was recovered through third-party sales, whereas 32.3% of such investments were recovered through IPOs. However, compared to 2022, when the investors experienced a significant decrease in the number of IPOs and a corresponding increase in the number of third-party sales, 2023 saw a rebound in the number of IPOs, which returned to a level similar to 2021, whereas the portion of third-party sales has decreased.

According to the 2023 Venture Capital Market Brief, published by the Korea Venture Capital Association, the ICT sector accounted for the highest share of VC investments at 27.0%, followed by the bio/medical sector at 16.4%. However, looking at the trend over time, compared to 2021 and 2022, when there was a high degree of interest in non-face-to-face businesses and the biotechnology industry, investors’ preferences for the biotechnology/medical industry, cultural content businesses, distribution services and the gaming industry have decreased significantly. Instead, “deep tech” start-ups, including companies engaged in AI semiconductors and the robotics business, have emerged as major investment targets. In particular, investments in ICT manufacturing and the electrical, mechanical and equipment sectors have significantly increased.

In Korea, venture capital funds are commonly established and operated in the form of a partnership, trust or corporation. Each form of entity is subject to different regulations, with a different set of incorporation requirements, and there are standardised versions of incorporation documents for each form of entity. For example, a venture capital fund established as a partnership requires an investment partnership agreement to be executed by the partners, whereas a venture capital fund established as a trust requires a trust agreement to be executed with a trust company, an investment agreement to be executed between the general partner and limited partners, and articles of association for the management of the fund. Lastly, a venture capital fund established as a corporation must have in place the articles of incorporation that regulate matters relating to management of the fund.

Fees payable to fund initiators/managers/principals (“Fund Principals”) are usually divided into (i) management or operating fees, and (ii) carried interest. Carried interest is determined on a case-by-case basis, and as a general matter, it is customary for approximately 20% of the excess profit to be paid as carried interest if the internal rate of return (IRR) exceeds a certain threshold, normally 7–8%.

The following key terms pertaining to the relationship between Fund Principals and investors are included in the standardised form of the investment partnership agreement published by the Korea Venture Capital Association, which form is widely used in practice:

• investors’ right to make inquiries and receive responses from Fund Principals;
• investors’ right to receive periodic financial reports from Fund Principals;
• Fund Principals’ obligation to keep fund assets under a trustee’s custody and control; and
• designation of “key persons” who may be replaced only through consultation with (or with consent from) the investors.

Domestic venture capital funds are regulated under the Venture Investment Promotion Act (VIPA), which was enacted and came into effect in 2020. VIPA brings together regulations on venture-related investments that used to be dispersed across several pre-existing pieces of legislation, including the Act on Special Measures for the Promotion of Venture Businesses and the Support for Small and Medium Enterprise Establishment Act. Compared to previous regulations, VIPA partially relaxes regulations on investment in venture companies in order to promote such investments by private investors. In addition, to cultivate an environment favourable to venture capital investment that conforms to global standards, VIPA allows for the execution of a simple agreement for future equity (SAFE) with a venture company. Such agreements, though widely used in venture capital investment in the United States, were not previously recognised under Korean law.

In Korea, investment of government funds in venture companies and start-ups, through the formation of a fund-of-funds, and with the aim of fostering the growth of venture companies and start-ups, is active. A fund-of-funds is a parent fund that invests in one or more funds formed by private venture capitalists aiming to invest in SMEs and start-ups. A fund-of-funds is formed with government funds sourced from the Ministry of SMEs and Start-Ups, the Korea SMEs and Start-Ups Agency, the Ministry of Culture, Sports and Tourism, the Korean Intellectual Property Office and other government departments and agencies. A fund-of-funds invests in other funds established using venture capital, and the latter invests in venture companies/start-ups. In most cases, the main investment by a particular fund-of-funds will be restricted to a particular sector.

In most cases, venture capital fund investors conduct a level of due diligence similar to that conducted for a typical M&A transaction. In the case of targets that obtain venture capital investments, funding typically occurs over multiple rounds, so at each stage, it is necessary to take a close look at the terms of the investment agreement(s) executed in the previous round(s). In addition, due to the nature of venture capital investments, target companies are often start-ups that are tech-focused or based on online platforms, so IP and personal information protection are often key areas of focus in due diligence.

It usually takes two to four months (including due diligence) for each round to be closed. However, it is difficult to determine a uniform timeline because the progression of a deal differs for each investment, depending on various factors and requirements (the size of the investment, whether existing investors participate in the new round with multiple investors, whether joint counsel is used, whether the consents of all existing shareholders are required, etc).

Venture capital firms prefer to invest in redeemable convertible preferred stock (RCPS), which is a type of preferred stock with both redemption right and conversion right, or convertible preferred stock (CPS), which is a type of preferred stock with conversion right only, at an early stage of a company’s development. In addition, venture capital firms often make investments in the form of convertible bonds or bonds with warrant.

Securities with these characteristics are preferred at an early stage because they provide better opportunities to (i) secure exit by providing the holder with a priority in payment of distributions in the event of liquidation or occurrence of a redemption-triggering event, and (ii) realise the upside potential of the target company with the right to convert securities into common stock.

Historically, there was no standardised form of agreement for venture capital investment in South Korea. As a result, in many cases (especially if start-ups did not hire professional legal advisors, which was often the case), investment agreements and other legal documents were often poorly drafted or created by the investors themselves without assistance from lawyers. There was therefore  a demand for improvement in the quality of investment agreements, and, as a result, the Korea Venture Capital Association, in collaboration with the Korea Business Angels Association and the Korea Accelerator Association, prepared and published a standard set of venture investment agreements to be used for different stages of investment (early, mid-term, and late investments). At present, venture capital firms in Korea tend to enter into investment agreements by using these standardised forms, which are then customised to meet the needs of a given investment.

In general, venture capital firms try to secure downside protection through liquidation/dividend distribution preferences, conversion rights (including customary adjustment to conversion price), redemption rights, anti-dilution protection, consent rights over material matters, put options against the major/controlling shareholder of the target company, and information rights.

Both anti-dilution protections and pre-emption rights are frequently used. Venture capital firms may secure the right to consent to the issuance of securities, or include the issuance of securities at a price lower than their subscription price as a ground for adjusting the conversion price, or secure the right to subscribe for new shares issued by the company pro rata to their relative shareholding ratios (“pre-emption right”).

As a general matter, the following rights are usually granted to venture capital investors in relation to the company’s corporate governance.

Right to Appoint Director(s)

The venture capital investor will have the right to nominate a certain number of directors, and the parties to the investment agreement with the investor (typically the target company and the largest shareholder) will be contractually obliged to appoint person(s) nominated by the investor as director(s) by voting accordingly at a general meeting of shareholders. In Korea, directors of a company are listed in a company registry (which is a publicly available document), and there is no nationality or residency requirement for directorship. Also, investors often seek and obtain the right to nominate an observer to the board of directors. For reference, in Korea, an observer is, unlike a director, a de facto position, which has no legal basis in the Korean Commercial Act.

Consent Rights Over Material Matters

The type of material matters over which the venture capital investor has a consent right may vary depending on the negotiation of the parties involved, but in general, they usually include amendments to the articles of incorporation, changes in capital structure, fundamental changes in the company’s organisation (such as dissolution, liquidation, merger, division, division and merger and business transfer), issuance of new securities, grant of stock options, and significant transactions (ie, those with a value exceeding a certain threshold).

Information Rights

The right to receive important financial/operational information of the company, and the type of information that the investor has the right to receive may vary depending on the negotiations of the parties involved, but they often include financial statements, business plans and budget plans at certain intervals.

The representations and warranties, covenants, and indemnity clauses and mechanisms observed in a financing round are similar to those included in an agreement for a typical M&A contract. Certain caveats to this are set out below.

Representations and Warranties/Covenants

A venture capital firm may not make representations, warranties, or covenants in the investment agreement, or make only fundamental representations and warranties (eg, incorporation or due authorisation) and basic covenants (eg, confidentiality obligations). However, if the investor is required to obtain any particular regulatory approvals (eg, clearance of merger filing or foreign exchange filing) in relation to the execution and performance of the agreement, the agreement will include representations, warranties and/or covenants related to obtaining such approvals. Target companies usually provide a fairly detailed set of representations and warranties relating to their operation and businesses, including financial statements, labour, intellectual property, real properties, etc. 

Recourse for Breach/Violation

If the target company breaches any of its representations, warranties or covenants, in the case of an investment in RCPS, the company may be obliged to effect an early redemption of the RCPS as a result of the breach. In such cases, the penalty rate will apply in addition to the default interest rate until the redemption amount is fully paid. In addition, the company may be required to pay penalties to the venture capital investor in addition to compensation for damages resulting from the breach. In some cases, the investor may become entitled to exercise a default put option against the largest shareholder in the event of a breach.

There is no meaningful incentive programme for investors who make equity investments in SMEs and start-ups in Korea; instead, the Korean government provides support through providing funds for (i) investments in funds-of-funds and (ii) the expansion of investment in SMEs and start-ups.

A fund-of-funds is a fund funded by the Korean government that is mainly intended for investment in certain sectors. Specifically, a fund-of-funds is managed by Korea Venture Investment Corp., an institution established by the Korean government in accordance with VIPA. Korea Venture Investment Corp. selects a general partner, causes the general partner to form a fund with funding received from a fund-of-funds and capital received by the general partner from other investors, and the fund then makes investments in a certain sector. The investment targets of a fund-of-funds will vary depending on the fund in question, but they mainly include early-stage start-up companies, privately held SMEs and venture companies, and there are cases in which concentrated support is given to investment in a particular sector as needed.

Key characteristics of tax treatment relevant to venture capital investments are as follows:

• Tax benefits at the investment stage – If a resident or a domestic corporation (other than venture investment companies) invests in start-up companies, venture companies, private equity funds specialising in start-ups and venture companies, or a start-up investment association, a certain percentage of the investment amount is eligible for a tax deduction (for residents) or tax credits (for domestic corporations). However, tax benefits are given only for investment in new stock within a certain period of time, and no special tax benefits are allowed for investment resulting from the sale of existing shares.
• Tax benefits at the exit stage – In principle, capital gains tax is levied when a resident transfers shares, but a tax benefit is granted to exempt capital gains tax on investment in certain venture companies and venture investment companies.
• Others – Special measures exist for the exemption from corporate income tax if a venture investment company invests in stock of certain venture companies.

As discussed above, the Korean government uses the fund-of-funds structure to create an environment favourable to venture investment in the private sector and to promote investment linked to innovation, especially in SMEs and venture companies. Although there are no restrictions on the investment methods of a fund-of-funds, a fund-of-funds is often used in equity financing for innovative technology businesses, start-up companies, and privately held SMEs. In this way, the government indirectly supports equity financing activities.

The most frequently used method to procure the founders’/key employees’ long-term commitment is the grant of stock options. Under the applicable laws and regulations of Korea, officers or employees must have worked at a company for a minimum of two years to exercise their stock options. A separate stock option agreement can be executed to require a longer period of service as a condition for exercising all or part of the stock options.

In recent years, grant of restricted stock units (RSUs) has been on the rise. An RSU refers to the right to receive treasury shares held by the company if certain conditions are met. In this case, a method typically used is the incremental grant of shares upon the fulfilment of conditions linked to the period of service.

The most commonly used method to align the interests of founders/key employees with the interests of the company is the grant of stock options. A recent development is the grant of RSUs to this end. In both cases, it is common to stipulate that the conditions for exercising/granting stock options/RSUs are linked to the period of service. To take stock options as an example, when a stock option with the right to receive a total of 100 new shares is granted, a condition attached can be that the stock option with respect to the first 50 shares can be exercised after two years of service, and the stock option with respect to the remaining 50 shares can be exercised after four years of service. The conditions for exercising/granting stock options/RSUs can also be linked to other performance indicators.

Under Korean tax laws and regulations, in principle, the difference between the market price of shares at the time of exercising the stock option and the exercise price is taxed as earned income (at the rate of up to 49.5%), but special measures provide for tax benefits with respect to stock options granted to officers and employees of a venture company registered with the Ministry of SMEs and Start-Ups. These special measures include:

• a tax exemption (of KRW200 million per year);
• payment in instalments (for five years); and
• the application of capital gains tax (at the rate of 27.5%) at the time of transfer of shares acquired through the exercise of stock option, rather than tax on earned income at the time of exercising the stock option.

If a company already has an employee incentive programme in place at the time of due diligence, or if a company plans to implement such programme during the investment process, such programme should be recognised as a dilution factor and reflected in the number of shares to be acquired before proceeding with the investment. In contrast, if an employment incentive programme is to be introduced after the venture capital investment has already been made, the programme would be subject to the investor’s right to consent.

Typically, an investor exits through an IPO or third-party sale. Depending on the specific situation at the time of exit, the investor can choose either of these options, or consider a dual track by pursuing both options at the same time. In addition, RCPS investors may consider exercising their redemption rights, or they may exercise a put option, if such options are provided in their investment agreements.

In Korea, when an investor makes a venture capital investment, it is not common for all shareholders to enter into a shareholders’ agreement; instead, it is more customary for each investor to execute an investment agreement only with the company and the largest shareholder/founder without other shareholders. As a result, there is often no one-size-fits-all contractual clause applying to the relationship among all shareholders in the event of an IPO or trade sale. More generally, each shareholder is entitled to exercise certain rights (eg, the right to demand a qualified IPO to be effected within a certain time period and/or a put option) against the company and/or its major shareholder/founder.

It is not common for an investment agreement executed by a Korean venture capital investor to include an agreement to limit the disposal of venture capital investors’ shares, but the investor may sometimes be deprived of certain rights granted under the investment agreement (eg, consent right, consultation right or right to nominate directors) if their shareholding percentage in the company falls below a certain threshold.

According to the 2023 Venture Capital Market Brief, published by the Korea Venture Capital Association, 50.2% of the investments recovered by venture capital investors were recovered through third-party sales, whereas 32.3% of investments were recovered through IPOs. Many start-ups have an IPO as their ultimate goal, and the average time for start-ups to successfully go public is generally thought to be about 10 to14 years. The reason why it takes so long is not due to any legal hurdles, but because it takes a significant amount of time, commercially and practically, for a start-up to grow into a company that satisfies the qualitative and quantitative requirements to pass the listing eligibility review by the Korea Exchange (KRX).

Since KRX listing is relatively attractive in terms of initial cost and maintenance costs, almost all Korean start-ups established under Korean law choose to be listed in Korea, unless there is a particular need to raise capital overseas.

Recently, an atmosphere of active secondary market trading has taken hold in Korea. Due to the recent downturn in the IPO market, investors’ need for exits through secondary sales has increased. In addition, demand for investment through the secondary market is also increasing, as funds-of-funds have recently allocated their funding to funds that invest through secondary trading.

As secondary sales are often powered by funds-of-funds in Korea, the most important aspect of a secondary market deal is the price negotiation between the seller and the buyer. The seller fund needs to meet the target rate of return, while the buyer fund wants to keep the purchase price low, considering the expected price at the time of exit.

Warranty and indemnity (W&I) insurance policies are sometimes used in these secondary market deals, because the seller is a fund that was not responsible for the operation of the target company and does not want to provide representations and warranties on such matters, nor the corresponding indemnity. Even when the seller is willing to provide such representations and warranties and indemnity, the seller may have been dissolved or liquidated by the time that the buyer wants to exercise this right.

The KRX has three markets: KOSPI, KOSDAQ, and KONEX. KOSPI is the market for blue-chip conglomerates (a company with sales of KRW100 billion or more and that satisfies certain criteria including base market capitalisation of KRW200 billion or more and equity of KRW150 billion or more). KOSDAQ is the market for “medium-sized” companies (ie, a company with KRW5 billion or more in profit from continuing operations before corporate income tax, base market capitalisation of KRW30 billion or more, and sales volume of KRW10 billion in the most recent fiscal year). KONEX is a market for SMEs.

The English versions of the KOSPI Market Listing Regulation, the KOSDAQ Market Listing Regulation, and the KONEX Market Listing Regulation are available here. In addition, the listing requirements for each market are summarised in English here.

The restrictions that, among others, may apply to foreign investment in Korea are set out below.

Sectors in Which Foreign Investment Is Restricted

There are certain sectors where foreign investment is prohibited. These sectors include postal services; central banks; legislative agencies; administrative agencies; courts; prosecutors’ offices; police; fire departments; educational institutions (including early childhood education institutions, primary schools, middle schools, high schools and universities, graduate schools, and special schools); art, industrial, professional, political, religious, labour, and environmental movement organisations; nuclear power generation businesses; and radio and terrestrial broadcasting businesses.

The ratio of foreign investment in companies in certain sectors may not exceed a certain threshold. For example, the foreign investment ratio must be less than 50% in companies engaged in beef cattle breeding, air transportation, and magazine and newspaper publishing.

A detailed list of prohibited or restricted areas is published annually by the Ministry of Trade, Industry and Energy (MOTIE).

Government Approval

A prospective foreign investor in certain restricted sectors must obtain approval from the relevant government agency:

A prospective foreign investor in a defence company must obtain prior approval from MOTIE.

A foreign investor wishing to invest in a company that possesses “national core technology” or to transfer “national core technology” overseas must obtain prior approval from MOTIE. National core technologies include those related to semiconductors, displays, batteries, automobiles/railways, steel, shipbuilding, nuclear energy, information and communication, and biotechnology. The list of national core technologies is published by MOTIE.

Recently, the Korean government has been making moves to strengthen the protection of national core technologies. In relation to this development, discussions are underway to amend the relevant regulations to expand the scope of MOTIE’s prior approval requirement to include investment in companies possessing national core technologies, including domestic corporations controlled by foreigners/foreign corporations, and to apply stricter criteria when reviewing M&A deals involving companies with national core technologies. It is therefore important for potential foreign investors to closely monitor the legislative developments in this area.

Other Sectors

Other than the areas outlined above, foreign investment in Korean companies is generally not restricted. A foreign investor will generally be required to file an investment report or securities acquisition report with the Korea Trade-Investment Promotion Agency or a foreign exchange bank prior to the closing of its investment. The specific type and procedure for filing vary depending on the type of equity acquired and the amount of investment, but such reports are generally considered to be a routine matter.