[Inside Chodong] Problems That the "40 Trillion Won Venture Investment" Will Bring

Growth of Deep Tech Startups Stalled During the Past Three-Year Downturn
Investment Surge Next Year May Inflate Valuations Without Substance
Need to Consider How to Strengthen Venture Capital Capabilities

The Lee Jaemyung administration has finalized next year's budget plan. The budget for startups and venture businesses will increase significantly to 4.4 trillion won, up 23% from this year. The first key pledge, the institutionalization of Business Development Companies (BDC), has been realized, and a blueprint for the National Growth Fund has also been unveiled. The government is rapidly moving toward its goal of achieving 40 trillion won in venture investment within five years.

Startups and venture businesses drive innovation in the economy and contribute to expanding job opportunities for young people. Expanding investment is a desirable move. In the past, 12 trillion won in public funds was injected to save just one company, Daewoo Shipbuilding & Marine Engineering. With that amount, it would have been possible to invest 1 billion won in each of 12,000 startups. The job creation effect is far greater than that of large corporations. As large corporations relocate to the United States, it is inevitable for the government to rely on startups and venture businesses to fill the gap.

However, a closer look at the reality of the startup and venture industry over the past few years reveals many concerns. There are worries about the aftermath of the Yoon Sukyeol administration's cuts to the venture and research & development (R&D) budgets, as well as the sharp increases in these two areas under the Lee Jaemyung administration. In particular, the 'roller-coaster' of venture and R&D budgets is likely to have repercussions that will last for years.

Deep tech startups, such as those in artificial intelligence (AI) and biotechnology, devote themselves to R&D even before founding their companies. Participating in government R&D projects is almost essential, as it serves as a signal to investors such as accelerators (ACs) and venture capitalists (VCs) that the company possesses strong technological capabilities. Government R&D projects are also a key quantitative indicator in the technology evaluation process, which is the first hurdle for a KOSDAQ technology-special listing.

Over the past three years, passing government R&D projects has become a narrow gateway. Existing deep tech startups that failed to secure these projects could not attract follow-up investment and thus struggled to grow. Those who were preparing to launch new startups postponed their dreams in the face of grim realities. This is why there is increasing talk among ACs and VCs these days that "deal sourcing in the deep tech sector is difficult."

Starting next year, there will be a surge of capital in the venture investment market. While there are few promising deep tech startups, there will be an abundance of money available for investment. A similar situation was witnessed just five to seven years ago. During the Moon Jaein administration, the rapid increase in venture investment capital played a positive role in nurturing today's deep tech unicorns (unlisted startups valued at over 1 trillion won). However, there has also been criticism that valuations of unlisted companies became excessively inflated and that ACs and VCs failed to improve their capabilities.

Because deep tech is inherently highly technical, outsiders find it difficult to accurately assess the technological capabilities of startups. For investment managers who review dozens of investment proposals each year, it is difficult to study and make informed judgments. Moreover, it is virtually impossible to read global market trends in the early-stage deep tech sector, which is just beginning to take shape.

For this reason, during times when venture investment capital was abundant, there was a surge in club deals, where investors would flock to startups rumored to have great potential. From the perspective of ACs and VCs, they might invest only 2 to 3 billion won, but if the company later goes public on KOSDAQ with great success, they could recover 10 to 20 times their investment. Even if the company fails, the investment managers can easily deflect responsibility by saying, "Even that famous investor put money in."

Club deals are an example of 'herding behavior' in economics. While this is a rational choice, rational choices often lead to side effects. Many companies that easily succeeded in listing on KOSDAQ at high valuations based on famous VC club deals now have market capitalizations of less than 100 billion won. These were either 'deep tech in name only' or failed to anticipate changes in the global market.

Furthermore, during the past three years when the venture investment market was frozen, ACs and VCs focused their investments on companies generating immediate revenue rather than on deep tech. Naturally, they had little time to develop in-depth expertise in deep tech. From next year, as they rush to deploy massive amounts of capital, we can expect to see more cases where valuations are inflated beyond fundamentals and proper due diligence is lacking.

The government appears to be trying to mitigate these risks by expanding investment capital and diversifying investment entities. Through competition and division of roles among investors vying for the Korea Fund of Funds, the intention seems to be to identify truly capable players. The plan is to invest hundreds of billions to trillions of won in areas such as AI through the National Growth Fund, to activate Series B to C investments via BDCs, and to increase seed to Series A investments by expanding the Korea Fund of Funds. However, long-standing behaviors such as herding among general partners (GPs) managing these funds are likely to persist. There is also the problem that it takes too long to identify truly capable players.

Now, there is plenty of money in circulation. It is time to seriously consider how to solve the longstanding challenges facing the startup and venture market.