It has been revealed that the government-created mother funds, intended to support the growth of small and medium-sized enterprises (SMEs) and venture companies, are actually holding them back. Unfair investment contracts, such as inserting billions of won in damages clauses in contracts for failure to achieve an IPO or demanding the withdrawal of investment funds if performance falls short, are becoming commonplace. Experts point out that mother funds managers are obsessed with performance, focusing on safer startup investments and neglecting riskier ones.
According to data released by the office of Democratic Party of Korea lawmaker Lee Jae-kwan, the number of violations of investment contract provisions by mother fund managers detected by Korea Venture Investment Corporation (KVIC) from 2021 to 2023 reached 184. This represents a nearly threefold increase, from 39 cases in 2021 to 107 cases in 2023. Under current standards, mother fund managers are prohibited from demanding early withdrawals in the event of underperformance, stock price discounts in the event of a failed IPO, or return of investment if specific sales targets are not met. However, these practices continue to persist.
Mother funds are policy funds where the government indirectly provides funding to startups by investing in venture capital (VC) firms. Korea Venture Investment is the management entity. However, the case in which HB Investment signed an investment contract with the craft beer company Korea Craft Beer (KCB) under the condition that it would pay the principal plus 20% annual compound interest if the company failed to go public by 2022, and subsequently filed a lawsuit, reveals that mother funds are effectively transferring risk to startups.
Government policy funds are mismanaged despite a surge in contracts with poison pill clauses.
The court ruled that the contractual clause in question violated the investment principles of the Capital Market Act. In March, the Seoul Central District Court dismissed HB Investment's claim, stating, "The 20% annual compound interest compensation clause guarantees principal and a fixed return, and thus runs counter to the spirit of the Capital Market Act." This ruling is interpreted as emphasizing that the essence of venture investment involves accepting performance uncertainty.
There's also considerable discontent on the ground. One startup CEO lamented, "When raising investments exceeding 1 billion won, most VCs include a clause allowing the company to reclaim equity, like a bond, in the event of a failed IPO or poor performance. This structure is entrenching the risk of investment failure on the founder." Some investment firms are also known to engage in unfair practices, such as demanding excessive equity or entertainment.
The problem is that the legal basis for regulating this is inadequate. The Venture Investment Promotion Act doesn't even clearly define "unfair practices," so even when unfair practices by mother fund managers are uncovered, there are often no fact-finding investigations or sanctions. Korea Venture Investment Corporation (KVIC) also simply compiles a simple count of cases, without providing statistics on specific types of violations or tracking subsequent improvements.
Rep. Lee Jae-kwan pointed out that “while the mother fund is a system intended to promote the growth of startups, it has actually degenerated into a structure that hinders them through poison pill provisions,” and declared, “We will improve unfair investment practices through legal and institutional supplements and promote the sound growth of the venture ecosystem.”
The government's mother fund, established to preserve the original intent of "venture capital," is facing growing criticism for fostering a distorted investment culture through excessive profit guarantees and mandatory listings. Concerns are also being raised that if contracts based solely on profit recovery continue without considering the uncertainties faced by startups in their early stages, policy funds could become even more dangerous "unregulated power brokers" than private capital. Startup ecosystem stakeholders are calling for institutional and policy measures, such as expanding secondary funds, to foster a more startup-friendly environment, with mother funds responsible for early-stage investment and incubation, and accelerators.
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