Equity Finance 2024 Comparisons

In the Republic of Korea (“South Korea”), various types of early-stage and venture capital (VC) investments are being made, particularly in sectors such as AI, semiconductors, rechargeable batteries and pharmaceuticals/biotech. These investments often occur in multiple rounds. As early-stage and VC investments take place before the financial performance of the investee company is attained, they are mostly in the form of mezzanine investments such as redeemable convertible preference shares (RCPSs), bonds with warrants (BWs) or convertible bonds (CBs). Convertible loans are not allowed under Korean law, so CBs are often used instead.

There is a wide range of growth and private equity (PE) financing in Korea. Compared to early-stage and venture financing, growth/PE financing generally involves larger investment amounts and fewer investors. These investments are often made at a stage when the investee company has already achieved some level of financial performance, and the number of investors tends to be smaller as investors often want to be involved in the management of the investee company, such as by having the right to appoint one of its directors.

In Korea, in order for a company to go public, it must appoint a securities firm, apply for listing eligibility review by the Korea Exchange, obtain approval for listing eligibility and submit a securities statement to the Financial Supervisory Service of Korea (FSS). Upon FSS’ acceptance of the securities statement, the company is allowed to conduct a public offering process through demand forecasting and then list its shares and start trading on the Korea Exchange. In Korea, the public offering market is very important for companies in need of financing, and it serves as an important exit vehicle for private equity funds (PEFs) that have invested in start-ups or venture companies. In the Korean capital market, companies in sectors such as pharmaceuticals and biotech, rechargeable batteries, semiconductors, and K-beauty frequently pursue IPOs. IPOs are mainly driven by the company’s need to raise capital and for the purpose of providing exit opportunities to pre-IPO investors.

CBs and RCPSs, which are the main types of mezzanine investments used in the Korean capital market, are recognised as liabilities under Korean International Financial Reporting Standards (K-IFRS) and are often converted to common stock to improve the financial soundness of a company, especially in preparation for IPOs. In such investments, the largest shareholder may be asked to refrain from exiting as a means of protecting investors in case where the IPO is unsuccessful after the conversion into common stock. If the target company needs to raise additional funds in the event that the IPO is not completed or the company is valued lower than the unit price of the existing investors’ investment, it is often difficult to obtain the consent of existing investors if the unit price of new investors’ investment is lower than that of the existing investors’ investment. In this case, the existing largest shareholder may sell their shares to existing investors at a reduced price to secure additional investment.

The typical corporate governance structure of a company under the Korean Commercial Act consists of a general meeting of shareholders and a board of directors. The general meeting of shareholders, which consists of multiple shareholders, appoints directors, and such directors form the board of directors to make decisions on important matters relating to the company. Major organisational changes, such as mergers or business transfer, must be approved at the shareholders’ meeting. If there are multiple shareholders, the matters relating to the general meeting of the shareholders, and the composition and the powers of the board of directors, are often determined through a shareholders’ agreement and reflected in the company’s articles of incorporation.

In unlisted companies, certain shareholders may have additional rights, as set forth in the shareholders’ agreements, including the right to have access to company information and the requirement to obtain such shareholders’ consent on important decisions relating to the company. Although these rights are generally recognised in the case of unlisted companies, when a company goes public through an IPO, many of these rights under the shareholders’ agreement rights are often restricted from the perspective of the principle of shareholder equality and compliance with fair disclosure.

Investing in both equity and debt in the same company is not common in the Korean capital market, though it is legally permissible. However, there may be legal reasons to invest in both equity and debt simultaneously, as equity investors may suffer a greater loss in the event that the investee company becomes bankrupt. Also, in M&A transactions, acquisition financing is frequently used, in which case there is often a distinction between the investors who invest in equity and those who invest in debt. The method of investment would depend upon the investors’ investment style (aggressive vs conversative approach) and characteristics.

The Korean capital market features various types of equity finance options. Hybrid financing methods, such as CB, BW and RCPS, are also widely used. Many PE managers make investment using VC, growth equity, and PE strategies. Recently, the credit solution business, which uses a pure loan strategy permitted under the amendments to the Capital Markets Act, has also been growing. On the other hand, companies seeking investment are actively pursuing fundraising through IPOs and post-listing markets in addition to PE investment, which requires a high level of management involvement and oversight.

Equity financing is mostly provided by PE or VC. Due to high interest rates and a sluggish IPO market, VC investments in start-ups or venture companies have decreased somewhat, making it challenging to exit through IPOs. However, PE houses are increasingly investing in large corporations to support their restructuring process. The recent amendments to the Capital Markets Act have removed the restriction that used to require PEs to invest at least 10% in the investee company, and such amendments have led to more diversified investment by PEs. While Korea generally imposes no restrictions on foreign investors, there are limitations on foreign shareholding in sectors like broadcasting and national strategic industries, which means that the acquisition of significant stakes in companies in such industries requires approval from the relevant authorities. In the financial sector, any investor, whether domestic or foreign, who wishes to become a majority shareholder of a financial institution must pass the eligibility test required by the financial supervisory authorities.

Large companies that seek capital for the purpose of corporate restructuring tend to prefer a small number of large PE firms. Typically, start-ups and venture companies tend to have multiple investors due to the associated risks, and they often want to set a long timeframe to recover the investment, preferably through a qualified IPO. While the investee companies may prefer debt to minimise interference in management, equity investors are less concerned with simple interest margin, so the investee company rarely has a choice. For this reason, mezzanine investments are often made to meet the needs of both the investors and the investee companies at the same time.

The Korean capital market has a well-established equity finance market. However, there is no organisation that provides comprehensive statistics on various equity finance deals, and most deals are led by PE firms, making it difficult to track the number and size of those deals due to confidentiality. According to the Korea Venture Business Association, the venture capital investment volume in the first half of 2024 was KRW2.6754 trillion, with 1,228 investee companies, showing a slight increase from the first half of 2023. The PE sector does not have statistics from the PE Managers’ Council, but annual figures will be compiled by the Financial Supervisory Service early next year. According to unofficial IPO-related information, a total of 59 companies raised about KRW1.9 trillion through IPOs in the first half of 2024, which represents a slight decrease in the number of IPOs and the amount raised compared to the first half of last year. In 2025, the overall equity finance market is expected to be more active than this year as central banks of influential countries, including the US Federal Reserve, are expected to gradually lower interest rates as part of their monetary policy changes.

Private allocated equity and public-raised equity are both necessary for a company’s growth process, and it is difficult to say which of the two is more important. Typically, start-ups, venture companies and new high-value spin-offs from large companies first seek funding from PE sources such as VCs and PEs. After three to five years, these investors exit through an IPO, and the company raises additional public funds to continue R&D or capital investment. However, when the IPO market shrinks, the pre-IPO market also tends to follow the same path. Recently, the Korean capital market has been experiencing some contraction in the IPO market due to high interest rates and geopolitical uncertainty, leading to a decrease in VC investments.

Start-ups and venture firms often source deals from VC funds, PEFs, accounting firms or law firms. On the other hand, large enterprises often handle deal structuring and sourcing internally through their own strategic planning or finance departments. For large corporate deals, global investment banks or PEFs with large assets under management are actively sourcing deals with full-time client management. For example, SK Group recently reorganised its entire business, and Boston Consulting Group conducted strategic consulting before sourcing specific deals.

In the Korean capital market, IPO is the most important exit strategy, and equity finance investors mostly plan for an IPO within three to five years from the time of investment. Therefore, if the IPO market shrinks or there is a decrease in the market valuation of a particular industry, and the IPO pricing is less favourable than the initial investment price, exit may be challenging. To hedge this kind of risk, investors often design many structures that include put options, allowing them to have the right to sell their stakes to the largest shareholder of the investee company in certain cases or drag-along rights if the largest shareholder does not exercise a call option. Recently, in the case of its e-commerce subsidiary, 11th Avenue, SK Group gave up exercising the call option due to the bad market conditions, leading to ongoing negotiations for the PE firm H&Q to exercise drag-along rights. However, exits under such down-side protection clause often result in investment losses and potential disputes.

In the case of start-ups and venture companies, equity finance is preferred over debt finance, which increases the debt-to-equity ratio, in order to secure financial soundness for an IPO. On the other hand, large companies often prefer debt finance over equity finance because they are uncomfortable with investors’ involvement in management and since the corporate bond market is well-developed. As for investors, aggressive PEFs prefer equity investments because they can expect upside returns and have influence over the investee company’s management, while stability-oriented pension funds are more likely to consider debt investments. Mezzanine investments, which combines both, are also commonly used.

For an unlisted company, going through the process of negotiating the initial key investment terms, conducting due diligence, drafting and negotiating contracts and closing the deal usually takes three to five months. The process may be delayed for several months if material issues are spotted during the due diligence. On the other hand, if the financing is time-bound, equity finance can sometimes be raised through a public tender offer, which can be managed on a tighter timeline and may be closed within two to three months. Critical issues during the deal process includes valuation, exit plans, downside protection, and the timing and scope of damages.

In Korea, there are specific foreign investment restrictions in certain sectors. For instance, there is a limitation on foreign investment in the broadcasting and electricity industries. In the financial industry, both domestic and foreign investors must undergo an eligibility test required by the supervisory authorities if they wish to acquire more than a certain number of shares. Companies involved in industries designated as national core technologies (such as semiconductors) must be approved by the relevant authorities before equity investment can be made. Also, investments (including the establishment of joint ventures) from countries against or to which the USA has imposed sanctions or export restrictions, such as Russia, China and Iran, may be restricted. Violation of Korean laws or US sanctions would give rise to severe damages, so most companies respond by changing the counterparty rather than considering measures to overcome such violation.

In Korea, foreign investors are free to repatriate dividends from Korea to abroad as long as they comply with the statutory reserve requirements and pay all applicable taxes in Korea. In addition to dividends, foreign investors may also recoup their investment through capital reduction. Foreign financial institutions with large public functions may be criticised by the National Assembly or the media for excessive dividends, especially if they have minimal corporate social responsibility (CSR) activities. However, there are no legal prohibitions against such practices.

In Korea, the deal process has not yet been rigorously tested for anti-money laundering or know-your-customer rules in equity financing transactions. When issues arise during due diligence, they are often addressed through more detailed representations and warranties.

In deals involving foreign investors, it is common to agree on a dispute resolution clause with international arbitration. In particular, Korean deals often prefer arbitration through the Singapore International Arbitration Center (SIAC) due to its geographic proximity and lower costs compared to arbitration in New York or London. Arbitration at the Korea Commercial Arbitration Board (KCAB) is often chosen if the Korean party has a strong bargaining position. Meanwhile, Korean courts have a reputation for providing fair procedures and opportunities to foreign investors. However, unlike arbitration, it is a three-tiered system, which can be time-consuming and costly, making it a less preferred method than international arbitration for resolving disputes in international transactions.

The government of Korea and the Korean capital market are actively working to attract foreign investment, so there are no new regulations or burdens that foreign investors need to be particularly concerned about. In particular, the current government’s pro-business stance makes it easier for foreign investors to invest in Korea. However, as mentioned previously, the level of regulation may increase in countries or areas that are subject to US sanctions or export controls.

Disclaimer

The contents set forth in the following are simply based on Korean law. If there is a tax treaty between Korea and the country of residence of the foreign investor in question, the contents that follow may need to be revised accordingly.

Tax on Dividend Income

Under the Korean Tax Act, dividend income from domestic sources for non-residents refers to the following:

• dividends or distributions of profits or surplus received from a domestic corporation;
• dividends or distributions from entities that are considered a legal person; and
• deemed dividends.

Under Korean tax laws (Corporate Income Tax Act and Income Tax Act), the rate of withholding tax for dividend income received by foreign corporations and non-residents is 20%, excluding local income tax. If a domestic company in Korea pays a dividend income to a shareholder who is a non-resident or foreign corporation, the amount of withholding tax on the dividend income must be declared and paid by the 10th day of the month following the payment date.

Tax on Capital Gains on Share Transfer

Tax on capital gains on share transfer

When a foreign corporation or non-resident shareholder of a domestic company in Korea transfers shares in that domestic company, the capital gains generated from the transfer of shares are taxable under the Korea tax laws (the Corporate Income Tax Act and Income Tax Act). However, the capital gain from the transfer of shares of a listed corporation is not taxable if the transferor continues to hold less than 25% of the shares during the year in which the transfer date falls and the five-year period immediately preceding the transfer date.

The person responsible for withholding the withholding tax (ie, the person who pays the capital gains on the share transfer, or the securities company if the transfer is made through a securities company) withholds and pays the lesser of (i) 10% of the share transfer price and (ii) 20% of the margin on the share transfer (transfer price minus acquisition price and transfer costs) on the taxable capital gains on share transfer.

Securities transaction tax

Securities transaction tax needs to be paid by the transferor of shares; however, if the transferor is a non-resident of Korea or a foreign corporation without a place of business in Korea, the securities transaction tax needs to be paid by the transferee. In the case of listed stocks, the securities transaction tax is paid by the securities firm.

The tax rates vary depending on whether the stock is listed or unlisted. For unlisted stocks, the securities transaction tax is 0.35%. For listed stocks, the tax rates differ by market, as follows:

• for Korea Composite Stock Price Index (KOSPI)-listed stocks, the tax rate is 0.05% plus an additional 0.15% Special Tax for Rural and Fishing Villages, bringing the total to 0.20%;
• for Korean Securities Dealers Automated Quotations (KOSDAQ)-listed stocks, the total tax rate is 0.20%; and
• for Korea New Exchange (KONEX)-listed stocks, the total tax rate is 0.10%.

Thus, the overall tax rate is 0.35% for unlisted stocks, 0.20% for KOSPI-listed stocks, 0.20% for KOSDAQ-listed stocks and 0.10% for KONEX-listed stocks.

Korean tax law provides for a variety of tax credits – and reduction and exemption systems – for various tax policy reasons. The key measures are as follows.

• Corporate tax reduction and exemption for small and medium-sized enterprises (SMEs): reduction of 50% to 100% of the corporate tax payable each year, for five years, from the year of income generation after establishment for SMEs founded before 31 December 2024.
• Special tax reduction for SMEs: reduction of 5% to 30% of corporate tax for SMEs operating in tax-exempt industries, such as manufacturing, until 31 December 2025.
• Integrated investment tax credit: when an SME or a middle-standing enterprise invests in tangible assets for business, such as machinery and equipment, a certain amount of the investment amount is tax-deductible from corporate tax.

• R&D tax credit: R&D expenses are tax-deductible from corporate tax for the relevant tax year. The deduction rates vary depending on the type of technology. For new growth and source technology, the deduction ranges from 20% to 40%, while for national strategic technology, it ranges from 30% to 50%. For general R&D, the tax credit is the higher of either 25% to 50% of the amount exceeding the R&D expenses of the previous year or 0% to 50% of the R&D expenses for the current year.

• Tax credit for companies that increased labour income: for SMEs and middle-standing enterprises that satisfy the following conditions, 20% (10% for middle-standing enterprises) of the excess wage growth over the average of the three preceding tax years is tax-deductible from corporate income tax.
1. The average wage growth rate of full-time workers exceeds the average of the average wage growth rates for the three preceding tax years.
2. The number of full-time workers exceeds the number of full-time workers in the preceding tax year.

Korea has double tax treaties with almost all countries, and these treaties prevent double taxation of capital gains in Korea. However, tax avoidance tactics such as disguising real estate investments as equity investments, and conducting business activities such as having a de facto permanent place of business without having a corporation or branch office in Korea, are subject to taxation, including corporate tax.

When a company commences insolvency proceedings, its investors’ equity shares are usually reduced through a capital reduction process, the shareholders’ meeting becomes largely procedural and the representative director appointed by the rehabilitation court manages the company under the supervision of the court. In addition, creditors’ decisions are more important than the shareholders in approving a rehabilitation plan. Therefore, the commencement of insolvency proceedings has the effect of shifting the centre of the company’s management to the court and creditors, whereas the shareholders play a passive role.

In the event of insolvency, the company first distributes to tax creditors, secured creditors and general creditors, and then to shareholders if there are any remaining assets. In Korea, the concept of uncalled capital commitment is not generally recognised for general corporations. Although uncalled capital commitment may exist under a shareholders’ agreement, it is not enforceable against the company as it is not a contract with the company. Even if such a contract is entered into with the company, it is unlikely that the insolvency court will enforce the uncalled capital commitment.

In Korea, there are two types of insolvency proceedings: (i) rehabilitation proceedings to revive a company and (ii) bankruptcy proceedings to dissolve the over-indebted company. Rehabilitation proceedings typically take about a year to get the plan approved, and the procedure concluded, depending on the composition of the target company’s shareholders and creditors, and the nature of the industry. Bankruptcy proceedings, which involve repayment to creditors and dissolution, often take several years due to the potential lawsuits.

In Korea, the primary method of rescuing a company is through a rehabilitation process. Such process is usually initiated by the existing management of the company, which will retain control of the company and prepare a rehabilitation plan with the approval of the rehabilitation court. The plan is prepared based on the decisions of the creditors and finally approved by the court, and the approved plan is implemented over several years and subject to court oversight. In some cases, a company may be granted Autonomous Restructuring Support (ARS), which allows the company and its creditors to negotiate a voluntary restructuring before formal rehabilitation. On the other hand, if the creditors are predominantly financial institutions, they often utilise a workout process, which is a more flexible restructuring process than the court-based rehabilitation process. In this case, creditors, which are often financial institutions, rather than shareholders take the lead in the overall process.

Korea is a country with a well-established limited liability system in which the shareholders of a company are generally only liable for the amount of their investments. Therefore, even if the investee company enters rehabilitation or bankruptcy proceedings, investors are not typically subject to additional liabilities beyond their invested amount. However, it is possible in theory that the directors of a company may be liable for damages if their actions contravened reasonable business judgment rules and contributed to business failure. In addition, if the company has overdue taxes, investors may have secondary tax liabilities if their shareholding ratio exceeds 50%.