[VC Reset] ① "More Money, Less Risk-Taking"... 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 served as a growth catalyst for the Korean startup and venture industry for the past 20 years. Many point out that, after enduring years of a funding winter, policy-driven venture capital has become overly focused on short-term performance management and loan-like operations. The Asia Business Daily diagnoses the role and direction for improvement of venture capital, and over three parts, examines the conditions for a 'venture nurturing ecosystem' where startups, venture capitalists (VCs), and limited partners (LPs) grow together.

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

The role of the 'Fund of Funds,' which proactively assumes risk to foster startup and venture growth during market downturns, is once again in the spotlight. However, industry insiders continue to raise concerns that the Fund of Funds is not fully performing its original function as a source of long-term patient capital. They point out that as the scale of policy finance grows, the management structure paradoxically becomes more focused on risk aversion and short-term performance.

"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 capitalists (VCs), rather than investing directly in individual companies. In Korea, it primarily functions as a top-tier fund supplying policy capital with the goal of nurturing specific industries and small and venture businesses. In deep tech (innovative technology) sectors, the uncertainty before commercialization is high, initial investment costs are substantial, and it takes a long time for technology validation and market formation.

The problem is the increasingly conservative trend in the domestic venture investment industry. Many VCs are flocking to proven companies that can guarantee faster returns. According to the Korea Venture Capital Association, the total committed capital of 257 new venture investment funds formed as of November last year reached 6.1 trillion won, a 17.2% increase from the same period the previous year. However, when looking at the share of new investments by company age, only 14.1% went to early-stage startups. The proportion of early-stage investments, which was 29.6% in 2022, has halved in just two years. Meanwhile, the share of mid-stage and late-stage investments soared to 41.5% and 44.4%, respectively.

The VC industry argues that, since funds are managed using capital from limited partners, the pressure for short-term results intensifies as the investment environment deteriorates. The urgent need for short-term performance by venture fund managers (GPs) to form subsequent funds, combined with the conservative nature of policy finance LPs, who are focused on loss prevention typical of public institutions, all intertwine to create this situation.

A representative of a mid-sized VC said, "When many VCs qualify as GPs, they only formally meet the required allocation for the primary investment objective, and then focus all remaining funds on post-Series C investments that can go public within three to four years." He added, "If you make proper early-stage investments, it takes eight to ten years to exit, so to maintain trust with LPs, you inevitably have to look for companies that already show revenue and profit on their financial statements."

"Privately driven development in the US... Government-led from the start in Korea"

There are also calls for diversifying the base of venture capital investors. Some diagnose that excessive reliance on policy finance has weakened the function of venture capital.

In fact, in the United States, government-backed venture investors are involved in less than 3% of all venture investment deals. Government-backed VC programs are relatively small in scale and are executed to encourage private investment. Unlike the US, where the market developed under private leadership, Korea's VC market has been government-led from the outset. This explains the relatively high proportion of policy finance.

Kim, the research fellow, analyzed, "When dependence on government funds is excessively high, it becomes relatively difficult to make bold investments in certain promising sectors. This is because considerations of fairness are inevitable in the budget allocation process." He continued, "Despite the large scale of the domestic VC 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 LPs in venture investment, the more varied the purposes and nature of the capital can become. For example, pension funds and university endowments may focus on long-term returns, while foundations may prefer to invest in companies that pursue specific social values."

Diversifying LPs in the venture ecosystem is necessary... "Establishing the identity of venture capital must go hand in hand"

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

Going forward, the government is working to improve the system to channel funds into productive sectors such as venture capital and to encourage the participation of more diverse players. This year, the introduction of the National Growth Fund, Business Development Company (BDC), Individual Management Account (IMA), and tax incentives for venture investment are representative examples.

However, there are also calls to first reestablish the original role of venture capital, alongside the inflow of public and private funds. The argument is that patient capital should be supplied to high-risk technology sectors that have difficulty securing traditional bank loans, and that companies and fund managers should share risks and the fruits of growth, thus restoring the true identity of venture capital.

A representative of a major domestic VC commented, "Even if vehicles like BDCs, which allow general investors to participate, are introduced, it will be difficult to truly revitalize early-stage investment. Financial authorities are organizations that prioritize investor protection. In the current climate, even if various players, including individuals, invest money, a significant portion will go into safe assets, and only a small amount will flow into early-stage investments."