Equity Linked Note - Download Now DOC

							VENTURE

Introduction


The purpose of this section is to




      1. present a general overview of Korea's venture capital ("VC") industry and practices

           employed therein;

      2. outline the current structural strengths as well as outline structural problems in

           Korea's venture capital; and,

      3. present potential suggestions for improving Korea's venture capital environment.



General Overview and Practices of Korean Venture Capital



       Explosive Growth in VCs and Assets Deployed to VC Investing



             (in                                                                   2000
                                    1997            1998           1999
             US$ million)                                                          Oct

             Number of

             Venture
                                    56              68             94              147
             Capital

             Firms

             Assets

             Under
                                    1,430           1,592          2,053           2,708
             M anagement

             (1)


    Note: (1) Assets Under Management defined as equity capital of VCs and their

    fund partnerships under management.

    Source: Korea Venture Capital Association

 Creation and Classification of VC firms as Non-Bank Financial Institutions with

    Loose Definition of Investment Scope



    Korean VC firms are licensed entities with the primary licensing criteria of Won 10

    billion in paid-in-capital. As of October, 2000, there were 147 licensed VC firms

    in Korea. The companies are considered and classified legally as a Non-Bank

    Financial Institutions and are allowed to perform various financial activities aside

    from equity (or equity -linked) investments in start-up enterprises. Korean VCs are

    allowed to make loans to their portfolio companies, allowed to make investments

    in other asset classes aside from private equity investments in start-ups (such as

    listed company investments) and are solely viewed as providers of capital, not

    partners who get heavily involved in assisting entrepreneurs build their businesses.



 Korean VC Firms are Structured as Corporations



    Given the paid-in-capital requirement, Korean VC firms are registered as

    corporations with their own balance sheet and shareholders. Some are even listed

    entities. The VC firms themselves are allowed to borrow against their capital base

    and operate with considerable operating leverage. While debt levels vary, many VC

    firms are highly leveraged, with debt/equity levels of on average 150%. Thus,

    Korean VCs have two forms of capital to invest: (i) their own leveraged capital

    base and (ii) funds raised via limited partnerships. As of M ay 2000, of 111 VCs in

    Korea, only 54 were managing funds. The remaining were investing via their own
        leveraged capital base. Of the approximately Won 1.8 trillion (US$ 1.5 billion)

        invested by Korean VCs as of M ay 2000, over two -thirds of such funds were

        sourced from VC's own leveraged capital base.



     Funding Assistance from Government



        The Korean Government, in an effort to promote the VC industry as well as

        promote new business creations and an entrepreneurial culture in Korea, provides

        significant financial assistance by investing as a limited partner in partnerships

        raised by Korean VCs. The VCs are to contribute their own capital to a fund and

        the Korean Government will also contribute to the fund a fter considering their

        track records and credibility. The amount that the Korean Government contributes

        can vary significantly. The remaining funds are raised by the VCs from both high

        net-worth individuals and institutional investors. The funds operate via an annual

        management fee and "investment profit-sharing" through "carried interest" - as in

        the US. The average life of a fund is typically three to five years (some with an

        option to extend to seven years) and funds have an immediate draw -down feature

        (all of the capital raised is collected at the launch of the fund). Capital not used in

        VC investing is put in a money -market account. There is also regulation governing

        the proportion of funds which must be invested in Korean technology companies

        over the life of the fund. For example, approximately 30% of the funds should be

        invested in a Korean venture company by the second anniversary of the fu nd, etc.



Recommendations:



     Limit Corporate Charters of VCs - in Particular their Ability to Borrow
    Allowing VCs, as corporations, to borrow against their capital, and in turn, invest

    in what are inherently high risk investments, creates a structure that is highly

    vulnerable. Venture capital, by definition, is risky business. The success rates in

    the companies VCs invest in is low and very binary. In other words, investments

    that pay off can be big, but those that do not are often completely written off. T o

    be able to leverage the capital used to make such investments can leave investors

    highly vulnerable particularly in an investment downcycle which inevitably exists in

    VC investing. In the United States, where funds raised under limited partnerships

    by VCs are the only source of capital used to make investments, the limited

    partners, given the riskiness of this investment asset class, often prohibit the use

    of leverage in making investments. A similar level of prudence and discipline

    should be applied to Korean VCs in limiting their ability to borrow against their

    capital. Korean VCs should be restricted to earning their money by investing in the

    right companies only, not by enhancing returns through financial leveraging.



 Limit VC Investing Activity to VC Investing Korean VCs should be restricted from

    making investments in forms other than equity and equity -linked into promising

    venture companies. While it sounds obvious, a VC should be restricted to doing

    only VC investing. VCs should not be allowed to make investments in listed

    companies and should not serve as a "bank", leasing or loaning to other

    enterprises. A VC is not a Non-Bank Financial Institution.



    However, venture capital is more than simply providing money to start-up

    enterprises. A start-up enterprise, given its inherent small size and lack of

    resources, needs assistance and guidance on a number of non -financial matters.

    A VC is a partner in the enterprise and needs to provide its portfolio venture

    companies ("venture companies" being loosely defined as small, unlisted, hi-tech
           companies) with a host of strategic services for the portfolio company to grow

           and build its business. A VC needs to get active and needs to provide its portfolio

           companies with strategic advice, help the management team implement its

           business plan, help build the management team with recruiting assistance,

           connect them with global strategic partners, and the like. A VC's efforts should be

           narrowly focused on this area - not on non-venture -related investment activities.



        Continue Government Assistance to VC's Fundraising Activities



The current structure of demanding that the VC contribute its own capital to a fund that it raises and

providing government assistance is positive in the development of Korea's VC industry and Korea's

entrepreneurial start-up culture. VC's own capital contribution properly aligns incentives of the VCs

with those of the limited partners in the fund. Government assistance helps promote private and

institutional investors to contribute to the fund partnership. Such incentives are particularly important

in Korea as the VC industry, while it traces its origins back to 1974, is essentially a new industry that

became significant and recognized only two to three years ago. M oreover, there is a strong need -

economically, politically and socially - for Korea to rely less on a large, interlinked chaebol business

model, and more on a more independent, entrepreneurial small and medium sized business model.



Channeling government sponsorship via investments in limited partnerships is beneficial. While

venture capital and start-ups are receiving a great deal of a ttention in Korea, it is important to note

that a total of only Won 1.8 trillion (US $1.5 billion) has been invested or lent to Korea's start -up

enterprises as of M ay 2000. This amount is relatively insignificant when compared to Korea's GDP

and its level of industrial activity, or when compared to the amount of funds supported by the

Korean government in distressed assets and banking institutions, or when y ou compare it to the

amount of capital the chaebol are able to access. Continued public support is necessary to promote

this industry in Korea.