[What Is Venture Investment BDC]③Removing Barriers to Venture Investment Is Key to BDC Growth

Allowing BDCs to Borrow... Addressing 'Investor Risk' Concerns with Parallel Regulation
Introduction of Fund-of-Funds BDCs... Easier Capital Raising and Risk Diversification
Revitalizing the Venture Investment Ecosystem to Maximize BDC Impact
Lowering Bank Venture Investment RWA, Strengthening Growth PE and Mezzanine PD

Editor's Note'Business Development Company (BDC)' is one of President Lee Jaemyung's top campaign pledges. It was proposed as part of a policy to foster venture businesses. The legislative bill to introduce BDCs, which are a type of listed venture investment fund, is rapidly progressing in the National Assembly. Over three installments, we will analyze the precise concept and background of BDCs, their impact on investors, the venture industry, and the capital market, as well as directions for the positive development of BDCs.

Although the legislative bill for introducing Business Development Companies (BDC) has passed a National Assembly subcommittee and expectations are rising in the venture investment market, critics point out that institutional obstacles still remain, hindering innovative growth. Some argue that, to vitalize BDCs, it is necessary to both expand operational flexibility for BDCs and diversify exit channels through structural solutions.

Even When Companies Need Additional Growth Capital, They Cannot Borrow More

One concern surrounding the current bill is that BDCs are not allowed to borrow money. BDCs are 'closed-end' public offering funds, which means it is difficult to inject additional capital after their creation. Even if companies need more funds for growth later on, it is hard to raise additional capital. The Financial Services Commission proposed allowing BDCs to borrow up to 100% of their total assets from financial institutions, but the National Assembly did not approve this, citing potential risks to investors. From the perspective of asset management firms, this inevitably weakens their incentive to actively participate in BDCs.

In relation to this, Kang Kyunghoon, a professor at Dongguk University's Department of Business Administration, stated, "In order for BDCs to function as investment vehicles that support not only the establishment and early stages of companies but also their growth stages, it is necessary to allow BDCs to borrow. Concerns about moral hazard or insolvency can be addressed by imposing regulations on borrowing purposes, limits, and disclosure."

The introduction of fund-of-funds type BDCs is also being discussed as a way to enhance BDCs' capital-raising and operational flexibility. A fund-of-funds BDC refers to a 'parent fund' that diversifies its investments across multiple individual BDCs. If the parent fund gathers more capital from investors and allocates it to various BDCs, each BDC can receive stable capital, and the total amount available for investment in venture companies can be greatly expanded. The risk diversification effect is another advantage of the fund-of-funds structure, as it allows investors to invest with greater confidence.

There are also opinions that BDCs should be granted tax benefits because they are long-term investment products. This would encourage investors to invest more actively in BDCs, enabling BDCs to continuously support venture companies with this capital. Professor Kang explained, "It can take up to 20 years from the establishment and listing of a BDC fund to its final liquidation. It is necessary to consider granting tax benefits at a level similar to those provided to other investment vehicles that support small and venture businesses."

Exit Methods Beyond IPO and Secondary Are Needed

The market believes that, for the introduction of BDCs to have a real effect, the entire venture investment ecosystem must ultimately be revitalized. If the investment market is stagnant or capital circulation is blocked, the effects of BDC investment and operation will inevitably be limited. Conversely, if the ecosystem is activated, more investment capital will flow in, exit channels will diversify, and both investors and innovative companies will benefit.

One solution is to lower the risk-weighted assets (RWA) for venture investments in the banking sector. RWA is a figure that reflects the risk of various assets held by banks; the higher the RWA, the more capital banks must set aside, making them reluctant to invest. Currently, the RWA for venture investments at domestic commercial banks is set at 400%, which is higher than that for general stocks (250%). The Korea Chamber of Commerce and Industry recently emphasized in its report, "Current Status and Policy Tasks of the Venture Investment Market," that "although this is in accordance with the Basel regulations, which are international standards for strengthening bank soundness, the Basel regulations are only recommendations. Therefore, lowering the current venture investment RWA to at or below the level for general stocks can expand financial institutions' capacity for venture investment."

There is also strong demand for the activation of the growth PE (Private Equity) and mezzanine PD (Private Debt) markets. The domestic venture investment market relies heavily on IPOs for exits, making it vulnerable to stock market volatility and creating significant uncertainty in investment recovery. Sales to general companies or private equity funds (PEFs) have not been sufficiently activated either. As a result, the proportion of secondary exits?where venture companies are traded as secondary assets in the venture capital (VC) market?has averaged 27% over the past 10 years. This reduces the turnover rate of venture capital and undermines the dynamism of the venture investment market. Growth PE and mezzanine PD are important tools that allow venture companies to recover investment capital through various means, even if they do not go public.

Growth PE refers to 'growth capital' that invests in venture companies that have reached a certain level of maturity, helping them scale up further. When the invested venture company later goes public or is acquired by a larger company through M&A, the growth PE sells its stake at a higher price to realize profits. It serves as a bridge for exits, enabling VCs that invested in earlier stages to recover their capital more quickly. Mezzanine PD involves lending money to companies through instruments such as convertible bonds or subordinated bonds, and upon the company's growth, converting these into shares for sale or recovering the principal and interest as an exit. This allows venture companies to raise capital without the burden of equity dilution.

Kang Changyeop, a researcher at NH Investment & Securities, explained, "These alternative investment methods can help resolve funding shortages that may arise between early Series A investments and B and C investment rounds, and can also help stabilize company valuations as each investment round progresses."