Venture Capital 2024 Comparisons

Despite the downfall that was expected for the end of 2022 and early 2023, according to a StartupBlink 2023 report 2023, Taiwan’s start-up ecosystem thrived and experienced an increase in 2023. The growth can be credited to various factors, such as start-up friendly government programmes, the increased investment in start-ups by the National Development Fund (NDF), the continuing promotion of IPO platforms for start-ups by the Taiwan Stock Exchange (TWSE), and active participation and funding from corporate venture capital funds (CVCs).

One of the most notable events was the listing of Diamond Biofund Inc. on the Main Board of the TWSE in 2023, which is the very first listing of a large-scale, sustainable, biotech venture capital fund specialising in biotechnology and medical investments, with focused areas in companies engaging in new drug research and development, high-end medical equipment, innovative medical service technology, medical channels, and agricultural biotechnology, etc. Diamond Biofund Inc. has incubated and invested in more than 20 entrepreneurs and companies domestically, regionally and globally.

The expectation is that in 2024, the venture capital markets in Taiwan will still be strongly influenced by government-supported initiatives that promote start-up and innovation. Some of these initiatives include:

• the continuing promotion of listing on the Taiwan Innovation Board (TIB) by the TWSE since July 2021, with a related relaxation of limitations/qualifications for doing so;
• the lifting of certain restrictions on Taiwanese insurance companies’ investment in private equity funds; and
• new investment opportunities related to the growing use of sustainable energy, both domestically and internationally.

With the relaxation by the National Development Council (NDC) of the restrictions on insurance companies’ investment in onshore private equity funds, it is anticipated that Taiwanese insurance companies will invest in industries designated by the Financial Supervisory Commission (FSC) as permitted industries to be invested in by onshore private equity funds, including green and renewable energy technology, projects under the “Asia’s Silicon Valley” programme, biotechnology and pharmaceuticals, the defence industry, smart machinery, new agriculture, circular economy industries, the information and digital industry, the cybersecurity industry, the precision health industry, and the military industry.

According to a StartupBlink 2023 report, the most notable industries among Taiwanese start-ups were hardware and the internet of things (IoT), healthtech, energy, and the environment.

Venture capital funds are typically organised in the following forms:

• A company limited by shares under the Company Act:
1. decision-making body – the board of directors’ meeting and the shareholders’ meeting (some companies will also establish an investment committee, which shall report to the board); and
2. standard corporate governing documentation:
1. articles of incorporation of the fund; and
2. shareholders agreement among the shareholders.
• A limited partnership under the Limited Partnership Act:
1. decision-making body – general partner and fund manager; and
2. standard corporate governing documentation:
1. partnership agreement among the general partner and limited partners; and
2. management agreement between the general partner, the fund and the fund manager.

Venture capital funds in Taiwan generally follow global market practice in terms of fund economics. Fund Principals (initiators, managers, etc) are usually entitled to the following management fees and carried interest:

• The management fee is charged at a certain percentage, usually 1.5% to 2.5%, of the total fund managed/invested.
• The carried interest is charged at a certain percentage, usually 20%, of the profits of the fund, subject to certain limitations in the event the fund has suffered losses, such as claw-back of the carried interest paid to the general partner in previous years to ensure that the general partner would not receive more than the agreed percentage of carried interest over the life of the fund.

In terms of corporate governance, venture capital funds are not regulated by any laws specific to them. Venture capital funds in the form of a company limited by shares are regulated by the Company Act, while venture capital funds in the form of a limited partnership are regulated by the Limited Partnership Act. Some CVCs established by financial holding companies would be subject to laws and regulations related to such companies.

The following types of VC fund have grown to be a more and more significant part of the Taiwan venture capital market.

Government-Backed VC Fund/Fund-of-Funds

The National Development fund (NDF), established by the National Development Council of the Executive Yuan, Taiwan’s highest administrative body, is very active in investing in entrepreneurs, either directly or through other funds, in order to support finance, technology, talent cultivation and management of new ventures, and to meet the government’s needs around national economic development. One notable example is NDF, which, together with several financial institutions, has established the Taiwania Capital Management Corporation (“Taiwania”), and has been appropriating significant amount of funds to invest in start-ups. Taiwania has raised several funds-of-funds that focus on investment in specific industries such as the internet of things, biotechnology and technology.

CVCs

Through making investments by CVCs in start-ups that are in related industries, leading companies in Taiwan efficiently acquire innovative technologies or achieve supply chain integration, especially in the technology and biotechnology sector. Large financial institutes also, through their CVCs, look for and invest in start-ups that have a potential financial upside.

Green-Energy-Related Fund

The Taiwan government aims to retire all nuclear power plants by 2025 and is actively supporting the development of renewable energy sources such as offshore wind farms, solar power, and other green energy alternatives. Several financial institutions have formed their own venture capital funds with a focus on green energy, and these funds, together with banks in Taiwan, have played important roles in financing transactions in the renewable energy industry in Taiwan.

For early stage and/or small-scale investment, most VC funds would usually only conduct high-level financial, legal and business due diligence in-house rather than engaging external advisors. VC funds usually focus on business and technology due diligence, including the technology to be developed, business model and plan. Legal due diligence is usually not the main focus but the VCs would still pay attention to the agreements with existing shareholders, restrictions on the founders, IP issues, material business contracts and major legal proceedings.

For mid-stage or large-scale investment, most VC funds, the lead investor, would engage external legal counsel to conduct a more comprehensive legal due diligence that covers most aspects of the target company’s operation, including the following:

• corporate and permit;
• shareholders’ agreements;
• material contracts with top ten (or major) suppliers and customers;
• major assets;
• arrangements with founders and employees, including employee stock ownership plan (ESOP) or other incentive structure;
• compliance;
• IP matters; and
• customary public search, including IP and litigation searches
• other industry-specific areas such as data protection policies for companies that collect and process user data to provide data-driven, personalised healthcare management services

The focus of VC funds’ legal due diligence is the following:

• identify pre-emptive rights, warrants or any other right to subscribe/convert into equity of the company that would result in the dilution of the VC funds’ investment;
• identify any preferential right of existing shareholders, such as dividend preference, voting arrangement, etc;
• identify related-party transactions, especially outstanding shareholders loan;
• confirm whether proper proprietary rights arrangement, non-disclosure and non-compete arrangements are in place with the founders and key-employees, especially for technology-based companies;
• identify irregularities in the material contracts;
• identify non-compliance that would expose the target company to material risks; and
• identify industry-specific risks such as personal data protection risks.

The time required for new anchor investors and a growth company to initiate the next round of financing depends on the industry that the target company is in and the life cycle of the product/service of the target company. It could take six months to a year to complete one round of financing.

In practice, after seed round financing, entrepreneurs would seek financing from institutional investors, including venture capital funds. A proper shareholders’ agreement in a customary form would be in place when VCs invest. In a single round of financing, for cost-efficiency purposes, the anchor investor will usually engage legal counsel, on behalf of all co-investors, to conduct legal due diligence and to draft/review the transaction documents.

The commonly seen investment approach by VC funds in Taiwan is the subscription of preferred shares with preference rights that common shares do not have. Due to the relatively strict regulations of the Company Act, many foreign VC funds prefer that start-ups adopt an “offshore holding structure”. This involves establishing a holding vehicle in locations such as the Cayman Islands, British Virgin Islands, Singapore or elsewhere, which holds a 100% shareholding in Taiwanese start-ups. Investing in offshore holding companies provides more flexibility in negotiating shareholders’ agreements, and foreign VC funds (other than PRC investors as defined under Taiwan law) need not obtain prior foreign investment approval from the Department of Investment Review (DIR) of the Ministry of Economic Affairs, previously known as the Investment Commission.

The customary preference rights of preferred shares in the Taiwan venture capital market include the following:

• Information and inspection right.
• Guaranteed board seat or board observer seat.
• Pre-emptive right, which allows preferred shareholders to participate in the company’s new rounds of security offerings on a pro rata basis.
• Anti-dilution protection, which entails adjustment to applicable conversion price for the conversion of preferred shares into common shares upon the occurrence of an event that would dilute the shareholding/value of the preferred shares, such as the target company’s issuance of additional securities at a price lower than the preferred shareholders’ original subscription price.
• Board reserved matters, for which the consent of certain number of directors must be obtained before the company can execute such matters.
• Preferred shareholders’ reserved matters, for which the consent of a certain percentage of the preferred shareholders must be obtained before the company can execute such matters.
• Right of first refusal, which gives preferred shareholders and/or founders the priority right to purchase shares that are offered to be sold by other shareholders on a pro rata basis.
• Right of co-sale/tag-along, which allows preferred shareholders to sell the preferred shares together with the shares offered to be sold by other shareholders, usually the major common shareholders/founders/key employees.
• Liquidation preference, which gives the preferred shareholders the right to be paid before the common shareholders, typically 100–150% of the preferred shareholders’ original subscription price, upon the target company’s liquidation.

The redemption right may be negotiated on a case-by-case basis, while the valuation adjustment mechanism is not commonly used in Taiwan venture capital investment.

The typical key documents for a financing in a growth company are a share subscription agreement, a shareholders’ agreement and the amended constitutional documents of the target company reflecting the investment terms.

For international VC funds or for investments in the offshore holding entity of a Taiwan-based company, the commonly used forms are the Cayman Islands or the British Virgin Islands model forms. For local VC funds’ or CVC’s investments in a locally incorporated entity, it is common that investors and the target company would prefer using a relatively concise form of investment agreement that is comprised of the provisions relating to share subscription and shareholder rights.

The preferred shares subscribed by the VC investors are usually attached with the liquidation preference right that allows the preferred shareholders to be paid, typically between 100% and 150–200% of the subscription price they originally paid, before the common shareholders, during the target company’s liquidation process.

Preferred shares conversion mechanisms and anti-dilution provisions are popular provisions to protect VC investors’ rights. An anti-dilution provision is an adjustment to applicable conversion price for the conversion of preferred shares into common shares when the target company issues new shares at a price lower than the preferred shareholders’ original subscription price. Under the Company Act, existing shareholders are entitled to the mandatory pre-emption right over new shares; nevertheless, it is still common for transaction documents to stipulate the investor’s pre-emption right over new shares.

Venture capital investors typically have certain rights over the management of the target company, including information and inspection rights, a guaranteed board seat or board observer seat, and the ability to participate in or control the company’s decision-making process in relation to the board and shareholders’ reserved matters. These reserved matters typically pertain to key issues that could significantly impact the business or operation of the company, such as:

• amending the constitutional documents;
• financing;
• implementing an ESOP;
• engaging in mergers and acquisitions;
• dissolution and liquidation; and
• entering into key licensing agreements.

Additionally, certain matters are reserved for the board or shareholders’ vote for governance purposes, such as related-party transactions or agreements with founders or key employees.

A target company’s and its major shareholders’ standard representations and warranties generally relate to the following:

• valid incorporation and existence and capitalisation of the company;
• completing/obtaining necessary corporation actions/government or third-party consents;
• no breach of legal or contractual obligation/no termination of material contracts;
• full disclosure of financial information;
• no material legal proceedings;
• ownership of or right to use all IP rights and assets necessary for the business operation;
• entry into of necessary proprietary rights/non-disclosure/non-compete agreements;
• compliance in all material aspects; and
• full and accurate disclosure of information material to the investors’ investment.

A target company and its major shareholders shall adhere to a set of standard and crucial covenants and undertakings from the execution of the transaction documents till the closing of the transaction. These obligations include refraining from taking major actions, such as borrowing money, disposing of material assets, ceasing any existing business, or taking any actions that are out of the company’s ordinary course of business. In addition, they shall take all measures to fulfil the conditions of the transactions and to ensure their representations and warranties remain true and correct up to the closing.

The most prominent project is the Business Angel Investment Programme launched by the NDF with an aim to establish a sound start-up investment mechanism to improve the angel investment environment in Taiwan.

The details of the Business Angel Investment Programme are as follows.

• Its term runs from May 2018 to 31 December 2025.
• The total amount of funds allocated to the programme is TWD5 billion (around USD167 million).
• The investment is structured as a subscription of equity in eligible start-ups by the NDF, together with angel investors and domestic and foreign institute investors.
• Eligible start-ups include:
1. start-ups registered in Taiwan or overseas start-ups whose main business operations are in Taiwan;
2. those established for less than five years;
3. those with a paid-in-capital or fundraising size of less than TWD100 million (around USD3 million); and
4. with the consent of the NDF’s investment review committee, start-ups which do not meet the above restrictions.
• The NDF has the following investment caps:
1. its fundraising per start-up shall not exceed TWD20 million (around USD670,000), which can be increased to TWD30 million (around USD1 million) if the start-up meets certain requirements;
2. its total investment per start-up shall not exceed TWD100 million (around USD3 million); and
3. its and other state-owned entities’ accumulative shareholding in one start-up shall not exceed 50%.

As of August 2023, the NDF Business Angel Investment Programme has invested in 238 start-ups with an accumulated investment amount of TWD3.28 billion from the NDF and TWD11.7 billion from other co-investors. It is reported that the NDF might appropriate an additional TWD5 billion (around USD167 million) to this programme to incentivise investment in Taiwan-originated start-ups.

The Statute of Industry Innovation provides incentives to individuals investing in start-up companies, as well as creators in academic and research institutions as below.

Tax Incentives for Individual Angel Investors

Individuals who invest a total of TWD1 million in cash in a year in a designated high-risk start-up company that has been established for less than two years can deduct up to 50% of their investment amount from their annual taxable income. The maximum annual deduction amount allowed is TWD3 million.

Deferred Tax for Stock Issued to Creators

Creators (such as academics or researchers) who receive stock from academic and research institutions can hold the stocks until the time of transfer, at which point they will be taxed based on the transfer price or market price of the stocks when they received the stocks if the transfer price is higher, so as to promote the industrialisation of research results.

In addition, according to the Limited Partnership Act, the Statute for Industrial Innovation and the interpretation of the Ministry of Finance, venture capital businesses established under the Limited Partnership Act (ie, in the form of a limited partnership, rather than in the form of a corporation) may qualify for “pass-through taxation” if they meet certain conditions. For example, where the total contributed funds of the limited partnership reach TWD300 million with 50% of the funds being invested in Taiwanese companies or offshore companies whose main business operations are in Taiwan, and 30% of the actual investment is invested in new start-up companies, or the aggregate actual investment amount reaches TWD300 million (whichever is lower). This means that the venture capital business itself is not subject to business income tax, and the capital gains are only taxed as income tax when distributed to the limited partners. This helps to reduce the disparity in tax treatment between venture capital funds in the form of limited partnerships and those in the form of corporations.

However, please note that, pass-through taxation for limited partnerships in Taiwan applies a different tax treatment based on the source of income, which differs from pass-through taxation as commonly seen in other jurisdictions.

In 2021, the TWSE launched the TIB and the Taipei Stock Exchange (TPEX) launched the Pioneer Stock Board (PSB) under the Emerging Stock Market (ESM, a separate new board in addition to the Emerging Stock Board (ESB)) exclusively for qualified investors, aiming to facilitate fundraising by innovative businesses in the capital markets.

Start-ups in the designated core and strategic industries, or in designated innovative industries, could be registered and publicly traded on the PSB without meeting certain requirements as to existence, profitability and dispersed shareholding. In addition, the underwriters and the TPEX provided more assistance to – and supervision over – the start-ups registered on the PSB to address the start-ups’ lack of capital market experience, while only allowing qualified investors to trade shares in companies registered on the PSB. However, as from 1 January 2024, the PSB ceased to exist, and the companies registered on the PSB and ESB were integrated into a single market under the ESM. In response to this change, since 1 January 2024, companies applying to register on the ESM have been able to choose to adopt either a standard public issuance or a simplified public issuance procedure, and the ESM has become open to all investors.

Stocks on the TIB can be traded only by qualified investors that meet one of the following criteria:

• a professional institutional investor or a juristic person with one or more years of experience in securities trading/investment;
• a legally incorporated venture capital enterprise;
• a juristic person with IPO shares at TIB through negotiated sales;
• a natural person with two or more years of experience in securities investment, who has:
1. proof of TWD2 million or more on their financial statements; or
2. an average annual income of TWD1 million or more over the last two fiscal years.

VC investors would usually require founders/key employees to commit to working full time for the target company during their mandate/employment with the company. To incentivise the founders/key employees not to terminate their mandate/employment early, which they are entitled to do, a stock option plan and necessary transfer restrictions may also be adopted.

Statutory employee stocks with transfer restrictions (“employee-restricted stocks”) as stipulated under the Company Act or employee stock options are commonly used to incentivise founders and employees.

Employee-restricted stocks, as stipulated under the Company Act, may be issued to employees first while being subject to transfer restriction of no more than two years. Employees will be able to freely transfer the shares after meeting the applicable requirements and upon the expiration of the restrictive period.

Employee stock options are usually vested by instalment over time with a vesting period of two to four years and/or when founders/employees meet certain other performance requirements. Upon the vesting of options, employee may determine whether to exercise the options and subscribe the shares in the company.

There is different tax treatment of employees in respect of (i) employee stock options and (ii) employee-restricted stock offered by a Taiwanese company to its employees in Taiwan or offered by a foreign company to the employees of its Taiwan branches/Taiwan subsidiaries. However, given that the relevant taxes arising from the exercise of employee stock options or the disposal of employee-restricted stock and the subsequent sale of the shares acquired are to be borne by the employees, said tax consideration would not generally affect the company’s determination of the structure of the incentive pool.

Given that an option pool would potentially dilute the investors’ investment, VC investors usuallyinvestors agree to reserve a fixed percentage of the total issued and outstanding shares of the company, either pre or post the closing of a fundraising round, for the employee option pool. Further, the adoption of any additional option plan would be included in the list of board or shareholders-reserved matters to ensure that the investors have control over, or at least will be made aware of, any proposed new option plan.

VC investors typically request the following rights in the shareholders’ agreement in relation to a trade sale or IPO of a target company or other liquidity event:

• Inclusion of sale or IPO of the target company in the list of board and/or shareholder-reserved matters so that the VC investors have control over, or will be made aware of, the proposed sale or IPO of the company/other liquidity event.
• Registration right – this provision is commonly observed when the target company adopts an “offshore holding structure” with the intention of going public in jurisdictions outside of Taiwan (if the target company is incorporated in Taiwan with the goal of going public in Taiwan, this is not necessary because all the issued and outstanding common shares of a company would be listed together).
• Drag-along right – where shareholders holding the majority or a certain number of shares may demand minority shareholders support, vote in favour of and participate in a proposed sale of the shares or assets of the company to facilitate the completion of the proposed sale.
• Liquidation preference in the event of a trade sale or other event that constitutes a deemed liquidation event.

“Exit” is typically defined as an initial public offering (IPO), dissolution, winding up or liquidation. A “deemed liquidation” event includes a merger and acquisition; the sale of all or substantially all the assets of the company; or any merger or acquisition of the subsidiary or affiliate of the company, whereby the target loses majority control of such subsidiary/affiliate after the closing.

It is not common to stipulate transfer restrictions to VC funds in a shareholders’ agreement, other than right of first refusal or drag-along right as discussed above.

According to a survey from the Small and Medium Enterprise and Start-Up Administration (part of the Ministry of Economic Affairs), out of a total of approximately 636,648 newly established companies over 2017–22, only around 2,000 have successfully raised funds from VC investors, and only 155 companies publicly listed on Taiwan’s stock market during the same period, which entails a successful rate of only 0.24% from start-ups to IPOs. Even if a few offshore listing precedents are taken into account (including Gogoro’s and Gorilla Technology’s listing on NASDAQ, Perfect Corp.’s listing on the NYSE, Appier’s listing in Japan, and 17Live’s listing in Singapore), the success rate for Taiwanese start-ups reaching an IPO in recent years is still low.

The choice of listing venue depends on the product of/market for the relevant start-up. The support of shareholders and strength of different stock exchange are all important elements to be considered. Take Appier’s listing in Japan, for example, according to the local news, the key management of Appier advised that Japan has always been a key market for Appier, and given the shareholder relationships with SoftBank and LINE, choosing to list in Japan would greatly benefit Appier’s continued expansion in Japan. They also considered the software industry in Japan, capital structure and start-up scale, the activeness of foreign capital, and the advice of investors. Appier chose to list on the suitably growth-oriented Tokyo Stock Exchange Mothers market.

On the other hand, the TWSE’s efforts to promoting domestic listing by Taiwan start-ups are noteworthy. According to the TWSE’s news release in January 2024, the overall market value of Taiwan’s Innovation Board has surpassed TWD150 billion, covering industries such as digital cloud, green energy and environmental protection, biotechnology and medical care, and electric vehicles. This continuous growth is driving the formation of new economic industry clusters, using an “innovation-driven” economic growth model to help companies expand into international markets, strengthen operational resilience, demonstrate innovative capabilities, and ultimately elevate Taiwan’s position in the global innovation economy.

Given the low success rate for start-ups reaching an IPO, VC investors in Taiwan find it challenging to achieve timely exits with reasonable returns before IPOs.

One key feature of the TIB is its ability to facilitate secondary market trading of start-ups. Currently, only qualified investors are permitted to participate in the trading of stocks listed on the TIB (see 4.3 Government Endorsement for details of what constitutes a “qualified investor”). Nevertheless, given that only qualified investors can trade shares on the TIB, the trading volume on the TIB is remains minimal.

If a venture capital transaction involves any “US elements”, such as the target group having business operations in the United States, or the potential investors being US citizens or companies, it is common to include the typical “disclaimer” of foreign securities offering under the US Securities Act. However, this is not a requirement under Taiwan law.

There are no specific offering provisions required by Taiwan law. However, in practice, some companies may request investors to acknowledge that they are accredited or sophisticated investors and understand the high risk of investing in start-ups.

In a venture capital transaction where there are multiple minority investors or a significant number of existing minority shareholders, the shareholders’ agreement would be signed by major shareholders meeting a certain threshold that is sufficient to pass necessary board and shareholder resolutions.

Foreign investors (other than PRC investors) (i) must obtain prior foreign investment approval from the DIR before investing in the equity of Taiwanese companies, and (ii) are prohibited from investing in Taiwanese companies that engage in certain businesses listed on a negative list. Some industries may have foreign shareholding limitations.

PRC investors as defined under Taiwanese laws (i) may only invest in Taiwanese companies engaged in the businesses listed on a positive list for sectors permitted to be invested in by PRC investors, and (ii) must obtain prior foreign investment approval from the DIR before investing in the equity of Taiwanese companies (that only engage in the businesses as described under (i) above). It is important to note that any company with 30% or more shareholding held directly or indirectly by PRC citizens/companies, or controlled directly or indirectly by PRC citizens/companies, would be considered “PRC investors” and be subject to PRC investment restrictions. Funding from military or political sources in the PRC is prohibited. However, in practice, any application for PRC equity investment in Taiwan would be subject to stringent scrutiny.

Apart from the reorganisation of the DIR, there have been no significant changes in the past 12 months regarding the restrictions governing foreign/PRC investments in Taiwan, particularly in terms of venture capital investment.