[Inside Chodong] 'Productive Finance' in Name Only Undermines Entrepreneurial Spirit

Toxic Clauses in Investment Contracts Still Unfavorable to Ventures
Financial Services Commission Should Also Prepare Standard Contracts Like the Ministry of SMEs and Startups
Major Financial Institutions Must Lead a "Fair Contract" Campaign

Ultimately, the core issue lies in the details.

The Lee Jaemyung administration has proclaimed a "productive financial transformation," and it is expected that a large amount of capital will flow into the venture investment market starting next year. However, various unreasonable practices still persist, making it difficult for entrepreneurs to enter the market and preventing startup and venture CEOs from focusing on their businesses. One of the most representative examples is the presence of contract clauses that are unilaterally disadvantageous to startups and ventures.

'Joint Guarantee Ban' in Venture Contracts: A Half-Measure Reform

In reality, startups and ventures inevitably find themselves in a subordinate position when seeking investment. Even if unfavorable contract clauses are included, they often have no choice but to sign in order to secure funding. In the past, it was common for contracts to require founders to provide joint guarantees. Fortunately, investment institutions under the Ministry of SMEs and Startups have introduced standard contracts without joint guarantee clauses for several years now. Recently, the National Assembly also passed an amendment to the Venture Investment Promotion Act, elevating the prohibition of founder joint liability from a "notification" to a "law."

However, the ban on founder joint liability still does not apply to new technology business finance companies, new technology business investment associations, and private equity management firms under the jurisdiction of the Financial Services Commission. With the introduction of BDCs (Business Development Companies) next year, public asset management companies will also be able to invest in unlisted ventures, making it necessary for the government to implement a comprehensive overhaul. There is a need to establish standard contract guidelines.

'Individual Investor Veto Rights' That Hinder Founders Must Also Change

As the venture investment market has cooled over the past three years, the issue of pre-approval rights granted to investment institutions has come to the fore. It is common for investment institutions to require approval for major management decisions such as changes to the articles of incorporation, paid-in capital increases, mergers and acquisitions (M&A), and initial public offerings (IPO). The problem is that if every investment institution is given an individual veto right, the opposition of even one institution can make it impossible to move forward with any business initiative.

For key matters such as paid-in capital increases, startups and ventures must persuade every institution individually, which is fatal in a sector where "speed" is crucial. As Kim Sunghoon, President of the Korea Venture Investment Law Association, has argued, there is growing support for replacing individual veto rights with collective consent rights (where approval is granted if two-thirds or a majority of investment institutions agree).

Major Financial Institutions with Influence over VCs Must Lead the Change

There are clear limitations to legally mandating the exclusion of clauses unfavorable to startups and ventures. Even if certain clauses are legally prohibited, investment institutions will soon devise new terms that are advantageous to themselves. In fact, after joint guarantees were banned, there has been an increase in cases where similar effects are achieved through put options (stock purchase rights) with various conditions attached.

Investment institutions argue that they must also diligently protect their own limited partners (LPs). In that case, the fastest solution is for the limited partners who influence investment institutions to directly demand improvements to contracts that are unfavorable to ventures. In fact, there has been a case where Korea Venture Investment induced its fund-of-funds investment institutions to adopt standard contracts.

This year, major financial holding companies, including the top five, have been actively responding to the government's productive finance policy. Given that finance is a highly regulated industry, major financial institutions have voluntarily participated in government policies throughout past administrations. During the Moon Jae-in administration, there were cases where financial holding companies established startup incubation programs under their umbrella and made direct investments.

Financial holding companies and their affiliates are the main limited partners of domestic venture investment institutions, and capital and asset management companies under financial holding companies are directly investing in ventures. Therefore, if major financial institutions such as financial holding companies take the lead in establishing standard contract guidelines and launching a "fair contract" campaign, benchmarking the Korea Venture Investment case, it is expected to have a positive ripple effect throughout the industry.

Jo Siyoung, Deputy Editor, Securities and Capital Markets Department