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Venture business, venture capital and Kosdaq

The year 1997 saw the Korean government implement legislation to promote venture businesses. The most important statute under this legislative scheme was a law that provides the basic tools necessary for the development of venture-backed companies. Young Cheol Jeong of Yun Kang Jeong & Han, Seoul look at the success of these measures.

In addition to the SLPVB, the Korean government adopted the Law for the Assistance of Small and Medium-sized Enterprises Start-up (LASMES), the Law for the Financial Assistance to New Technology Enterprises (LFANTE), the Finance Business Specialized in Lending Law (FBSLL) and the Law on Limitation of Special Tax Treatment (LLSTT) to address various other aspects of VB.

Based on this policy drive and other socio-economic factors, the Kosdaq, which was incorporated into the regulatory framework of securities through the 1997 amendment of the Securities Transaction Law, boomed during 1998, 1999 and early 2000. For instance, while the number of initial public offerings (IPOs) at the Korea Securities Exchange (KSE) stood at just 16 in 1999, 114 companies - comprising of VB as well as non-venture businesses - went public through Kosdaq in the same year. Further fuelling Kosdaq's boom was the rather significant addition of mutual funds, under the newly enacted Mutual Funds Company Law (MFCL).

During 1999, Kosdaq-registered companies financed W6.4bn ($5.7m) through issuing new shares and selling corporate bonds over 306 times. These figures more than double the same results for 1998. From December 1999, the daily trading on Kosdaq was more than W2000bn Despite the fact the Kosdaq market experienced a downturn during the latter half of 2000, the number of newly registered companies for 2000 stands at a more than modest figure of 140.

This summarises the regulatory framework of venture businesses in general, and also looks at financing sources and investment vehicles related to venture businesses in Korea.

Definition of venture businesses

Under the SLPVB, there are four categories of VB. One overriding element is that they must fall within the definition of small and medium-sized enterprises (SMEs), according to SMEBL. The SMEBL provides specific limitations on the maximum number of permanent employees and the size of assets on a per industrial sector basis. The four categories of VB as defined in the SLPVB are as follows:

Venture capital VBs

If the amount of investment by certain qualifying venture capital accounts for 20 per cent or more of the paid-in capital of the company, or if stock subscription price is 10 per cent or more of the paid-in capital, the company is considered to be a venture capital VB. The investment can be made in stock, convertible bonds or warrants. The qualifying venture capital investments are those made through: i) SME investment company and investment funds under LASMES; ii) new technology financier and new technology investment funds under the LFANTE and FBSLL; iii) Korea Venture Investment Funds; and iv) Dasan Venture Company.

Research and development (R&D) VBs

If the amount spent on research and development accounts for 5 per cent or more of the annual gross sales revenue, the company is considered to be an R&D VB.

New technology commercialisation VBs

If the company is engaged in the business of commercialising patents, utility models, high technology licensed abroad, and qualify for the tax exemption, or other knowledge or technology supported by various statutes such as the Industry Development Law, Energy Use Rationalization Law, Telecommunications Basic Law, Technology Development Promotion Law, etc., then the VB vitalization committee, under the SPLVB, has the authority to designate the company as a new technology commercialisation VB.

Miscellaneous VBs

If the company is engaged in the business of commercialising less advanced technologies, such as design, and other less advanced knowledge or technology, the Agency for Technology and Standards, the SM Industry Promotion Corporation (SMIPC) under the Law for SME Development and Preferred Purchase Promotion, or Korea Technology Credit Guarantee Fund (KTCGF) under the LFANTE, can evaluate the relevant technology and declare it as excellent technology. Once this evaluation is rendered, the company is considered a miscellaneous VB.

Special assistance and exceptions to VBs

Direct and indirect supply of public funds and guarantee

Most of the public funds can invest up to 10 per cent of their funds directly to VBs, or indirectly through SME investment funds, new technology investment funds or Korea venture investment funds. Korea venture investment funds are those set up by the SMIPC. In addition to these funds, the Korean government incorporated Dasan Venture Company to further aid investments in VBs. In order to provide a sufficient guarantee, the KTDGF, guarantees SMEs financing from other financial institutions, is required to guarantee the debts of VBs before guaranteeing those from non-venture businesses.

Special treatment of foreign investment

Under the Foreign Investment Promotion Law (FIPL), foreign equity investment for a “continuous economic relationship” with a Korean entity, unlike foreign portfolio investments, may satisfy notification requirements by simply filing a notification to a foreign exchange bank. An investment in SME investment funds, or Korea venture investment funds, is deemed to qualify as foreign investment for a continuous economic relationship as set out under the FIPL and, therefore, a simple notification is sufficient to meet the notification requirements. Investment in a listed VB is exempt from the restrictions on acquisition of securities listed on the KSE under Article 203 of the Securities Transaction Law (STL). So, a foreigner can invest in a listed VB without being subject to any caps.

Variation from basic corporate law

The minimum paid-in capital of a VB is W20 million. As the minimum paid-in capital of a joint stock company is W50 million, it is easier to incorporate a VB with less financial resources. The SMPVB provides for stock options, which used to be possible only for listed companies. However, as the revised Korean Commercial Code (CC) allows any joint stock company to adopt the stock option plan, this is no longer a special favour. Nonetheless, the stock option for VBs is slightly different from that of a joint stock company in general. While joint stock companies may grant stock options only to its officers and employees, VBs may also grant stock option plans to outside researchers, legal counsel and even accountants. The cap on this is 50 per cent of the outstanding shares. It should also be noted that any stock option plan must be reported to the Korea Securities Dealers Association and the SME Administration. The methodology of the plans, the procedure, the method of deciding the option price and the market value, are the same as stock option plans in general.

Tax benefits

The LLSTT provides for a number of tax benefits, such as exemption of acquisition tax, registration tax or stamp duty, special deductibility of certain reserves, and investment tax credits relating to SMEs and R&D in general. These benefits have been expanded further for VBs. For certain VBs, the corporate income tax is reduced 50 per cent for the five years. They are also free from acquisition tax and registration tax for two years after incorporation, and 50 per cent of property tax and composite land tax are waived for the first five years.

Pre-IPO financing

Angel investors

The SLPVB allows for special tax benefits on an individual's direct investment in a VB, or indirect investment made through other venture capitalist funds, angel investment partnerships, etc. Under the LLSTT, investment, if made by the end of 2000 to a VB of seven years' old or less, is credited up to 30 per cent of its taxable income for the taxable year in which the investment is made, or for one of two following taxable years. If, however, the investment is recovered through stock transferal or redemption within five years, the tax credit is recouped. Angel investment partnerships must be reported to the SME Administration for tax benefits. Any capital gains from the transfer of stock are not taxable if the investment was made to a VB of three years' old or less.

Venture capitalists

The LASMES gives special support to SME investment companies. These are venture capital companies recognized by the SME Administration. They must be a joint stock company with paid-in capital of W10 billion, with the business aim of investment in SMEs of seven years' old or less. Once an SME investment company is duly registered with the SME Administration, it can borrow public funds, and issue bonds up to 10 times the paid-in capital and retained earnings. It cannot make an investment in another SME investment company, or own more than 50 per cent of the shares of another SME. They cannot invest in big conglomerates or financial institutions, under the Anti-Monopoly and Fair Trade Law. Each year, SME investment companies' financial statements must be reported to the SME Administration.

An SME investment company can organize an SME investment fund in a partnership with other investors. Under these agreements, an SME investment fund must have a general partner who bears unlimited liability, and limited partners. SME investment companies must be the general partner, while other investors are the limited partners. Investment through an SME investment fund qualifies for certain tax benefits.

Legal instruments

Common stock, preferred stock and convertible bonds, classified as such under the Korean CC, are used as legal instruments for investment in VBs. Owing to a dearth of legal authorities overseeing the relationship between common and preferred shareholders or convertible bondholders, however, a clear picture has yet to emerge on the precise classification of the various instruments that may be used. Nonetheless, the various features of convertible preferred stock or bonds, such as preference in dividend payment, liquidation preference, adjustment of conversion price and redemption have been adopted. Although one cannot be totally free of doubt, it appears that a separate agreement on lock-up, drag-along, tag-along, or right of first refusal can also be made.

Kosdaq registration

Requirements

The requirements for registering with Kosdaq are generally no less stringent than those for the KSE. With respect to VBs, however, several significant financial and historical requirements are waived. These are: i) a three-year operating history; ii) minimum paid-in capital of W500 million and debt-to-equity ratio of less than 1.5 times that of the average ratio of the applicable industrial sector; and iii) existence of ordinary income and positive net equity for the immediately preceding fiscal year. Other requirements are equally applicable to VBs. These include requirements pertaining to distribution to the public; restrictions on capital change by means of stock bonus and issuance of new shares during a one-year pre-application period; independent auditor's opinion; designation of a transfer agent; standard stock certificates; finalized financial statements for the previous fiscal year; no litigation; no restriction on transfer of shares; and no change to the shareholding ratio of the largest shareholder during six months pre-application period.

The distribution requirement has recently been changed and, under the revised rules, the total number of shares offered to the public from the date of the preliminary review for registration, to the date of its application, must be either at least 30 per cent of the total issued, and outstanding shares, or at least 10 per cent of the total issued and outstanding shares, and at least one million to five million shares, depending on the amount of equity. Additionally, there must be 500 or more minor shareholders. (The Employee Stock Ownership Association is deemed to be one shareholder.) If a venture capitalist has made a capital injection one year before the preliminary review application, the 10 per cent distribution requirements are deemed to have been met.

As a procedural matter, a VB first must register as a securities issuer with the Financial Supervisory Commission (FSC). Then, it can file a preliminary review for an IPO with the KSDA. After the KSDA reviews the preliminary application positively, the VB can issue new shares to the public to meet the distribution requirement, upon filing a registration statement with the FSC. Once the distribution requirement is met, the VB is duly registered.

Regulations for a Kosdaq-registered VB

Once a VB is registered with the KSDA, the largest shareholder cannot sell its shares for one year after the IPO. In the second year, it can sell up to 5 per cent a month of its initial shares. After two years, no restrictions are imposed. As for venture capitalists, if the capital injection was made one year before the IPO, a three-month lock-up is applicable. If the venture capitalists invested less than one year before the IPO, a six month lock-up applies.

A lot of regulations and exceptions available to KSE-listed companies are generally available VBs too. These are:

i) VBs can acquire treasury stock through the market up to the amount of distributable retained earnings, despite the prohibition under the CC;
ii) VBs can issue new shares to the public, according to the resolution of the Board of Directors, despite the preemptive rights under the CC;
iii) VBs can issue non-voting shares of up to one-half of the total number of outstanding shares, despite the CC's one-quarter rule;
iv) VBs can make stock dividends up to the amount of distributable retained earnings, despite the one-half cap under the CC;
v) VBs can issue participating bonds or exchange bonds in addition to convertible bonds and bonds with warrants allowed under the CC;
vi) the amount of bonds that VBs can issue is unlimited, unlike the restrictions of four times the net asset value under CC regulations; and vii) as regards minor shareholders, the two-week prior notice requirement for a shareholders' meeting under the CC, can be replaced by two public notices in a daily newspaper.

Copyright © 2002 IFLR

Originally appeared in the IFLR Yearbook, To subscribe to IFLR, or for further information, please contact Simon Oliver, Associate Publisher on 44 (0) 207 779 8496 or fax 44 (0) 207 779 8665 or email soliver@iflr.com
 
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