[Resetting Venture Capital]①"More Money, Less Risk"... The Paradox Created by Reliance on Policy Finance

Share of Early-Stage Investment Halved in Three Years
"Patient Capital" Role Fades Amid Focus on Short-Term Performance
High Policy Finance Share in Korea Makes Bold Investment Difficult

Editor's Note"There is more money, but less risk-taking." This is the paradox of the 'Fund of Funds,' which has fueled the growth of South Korea's startup and venture industry for the past 20 years. Many point out that, after years of a funding winter, policy-driven venture capital has become overly focused on short-term performance management and loan-type operations. The Asia Business Daily examines the role and future direction of venture capital, and over three parts, explores the conditions for a 'venture nurturing ecosystem' where startups, venture capital firms, and limited partners can grow together.

"Compared to overseas cases, the proportion of policy finance in South Korea's venture investment structure is quite high, while the share of long-term institutional investors such as pension funds is low." (Kim Hyunyeol, Research Fellow at the Korea Institute of Finance)

As the market stagnates, the role of the 'Fund of Funds,' which proactively assumes risk to foster startup and venture growth, has come back into the spotlight. However, industry voices are increasingly raising concerns that the Fund of Funds is not fully performing its original function as long-term patient capital. The larger the scale of policy finance, the more the management structure tends to focus on risk aversion and short-term results, creating a contradiction.

"Looking for companies that won't fail first"... Shrinking early-stage investment

The Fund of Funds is an indirect investment fund that invests in funds managed by venture capital firms, rather than investing directly in individual companies. In South Korea, it functions primarily as a top-level fund supplying policy capital aimed at fostering specific industries and small and medium-sized ventures. This is because deep tech (innovative technology) fields are highly uncertain until commercialization, require massive initial investment, and need a long time for technology validation and market formation.

The problem is the growing conservatism in the domestic venture investment industry. Many venture capital firms are flocking to established companies that can deliver faster results. According to the Korea Venture Capital Association, the total committed capital of the 257 new venture investment funds established through November last year reached 6.1 trillion won, a 17.2% increase from the same period the previous year. However, only 14.1% of new investments went to early-stage companies. The share of early-stage investments, which was 29.6% in 2022, has been cut in half in just two years. In contrast, the share of mid- and late-stage investments soared to 41.5% and 44.4%, respectively.

Industry insiders say that because venture capital funds are managed with limited partners' money, the pressure for short-term results increases as the investment environment worsens. The need for short-term performance to form the next fund puts survival pressure on general partners, while policy finance limited partners, especially public institutions, are focused on avoiding losses. These factors combine to create a conservative environment.

The CEO of a mid-sized venture capital firm said, "Once many venture capital firms obtain general partner status, they only formally meet the minimum allocation for the primary investment purpose and focus the rest of the capital on Series C or later rounds, which can reach an IPO in three to four years." He added, "If you make proper early-stage investments, it takes eight to ten years to exit. To maintain trust with limited partners, you inevitably have to look for companies that already show revenue and profit on their financial statements."

"Privately-led growth in the U.S.... Korea has been government-led from the start"

Some experts are emphasizing the need to diversify the sources of venture capital. They argue that excessive reliance on policy finance has weakened the function of venture capital.

In fact, in the United States, government-affiliated venture investors are involved in less than 3% of all venture investment deals. Government-backed venture capital programs are relatively small in scale and are operated in ways that encourage private investment. Unlike the U.S., where the market developed under private leadership, South Korea's venture capital market has been government-led from the beginning. This explains the relatively high share of policy finance.

Kim, the research fellow, analyzed, "If dependence on government funding is excessively high, it becomes difficult to make bold investments in certain promising sectors, as budget allocation inevitably requires consideration of fairness." He continued, "Despite the large size of the domestic venture capital market, the average investment per deal (about 1.4 billion won as of 2024) and per company (about 2.5 billion won) remain small."

He added, "The more diverse the composition of venture capital investors, the more varied the purposes and characteristics of the invested capital can become. For example, pension funds and university endowments may focus on long-term returns, while foundations may prefer investing in companies that pursue specific social values."

Diversifying Venture Ecosystem Investors Needed... "Establishing the Identity of Venture Capital Must Go Hand in Hand"

This year, the Ministry of SMEs and Startups' Fund of Funds investment budget is 820 billion won, an increase of about 320 billion won from last year. Initially, the government presented a blueprint to expand the Fund of Funds to 1.1 trillion won, aiming to foster a 40 trillion won annual venture investment market and trigger a "third venture boom." However, the actual budget was reduced during the National Assembly's budget review process. The total cross-ministerial Fund of Funds budget, including the Ministry of Culture, Sports and Tourism and the Ministry of Science and ICT, was expanded to 1.57 trillion won (about a 60% increase from the previous year), but this too was cut by about 430 billion won from the government's original plan.

The government is working to improve the system to channel funds into productive areas such as venture capital and to encourage more diverse participants in the venture capital market. This year's initiatives include the introduction of the National Growth Fund, Business Development Company (BDC), Integrated Investment Account (IMA), and tax incentives for venture investments.

However, some argue that as both public and private capital flows in, the fundamental role of venture capital must be reestablished. They stress the need to provide patient capital to high-risk technology sectors that cannot easily access traditional bank loans, and to restore the identity of venture capital as a partner that shares risk and growth outcomes with companies and fund managers.

An executive at a major domestic venture capital firm said, "Even if programs like BDCs (which allow participation by general investors) are introduced, it will be difficult to truly revitalize early-stage investment. Financial authorities prioritize investor protection. Under the current atmosphere, even if a variety of participants, including individuals, invest, a significant portion will go into safe assets, and only a small amount will flow into early-stage investments."