Will BDCs Become the Relief Pitcher for VCs? "Initially to Be Operated as Secondary Funds" [Weekend Money]

There is an analysis suggesting that Business Development Companies (BDCs), expected to become active in the second half of this year, will initially be operated in the form of secondary funds.

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On April 18, NH Investment & Securities predicted that newly established BDCs will mainly focus on investments in secondary funds. Secondary funds are funds that purchase existing shares or equity of unlisted venture companies held by venture capital (VC) or private equity (PE) firms.

According to the revised Capital Markets Act, BDCs are required to invest at least 60% of their assets in existing shares and similar instruments. Excluding the mandatory allocation to safe assets, up to 90% of their portfolio can consist of existing shares of venture and unlisted companies.

Although it is possible to issue new securities, it will be difficult to build a portfolio centered on newly issued securities in the early stages of introduction. This is because the introduction of BDCs under the current circumstances is intended as a proactive measure to supply funds in anticipation of funding demand from unlisted companies.

Given the nature of investments in unlisted companies that require long-term commitments of more than 5 to 10 years, secondary equity transactions and company sales can meet the market’s liquidity needs for early recovery of investment capital. Through this, PE and VC firms can secure new investment resources, leading to a virtuous cycle of capital for further investments. Additionally, the acquisition of existing shares helps extend the investment period in venture companies, thereby increasing the growth potential of their businesses.

If the Korean venture capital market becomes more active, it is highly likely that BDCs will shift from secondary funds to acquisition finance investments such as new PE investments. The government has increased policy support for general PE funds during the BDC promotion process. At the end of last year, the Financial Services Commission, in its preliminary announcement of the Capital Markets Act amendment for the introduction of BDCs, abolished the 50% cap on equity investment of policy funds in general PE funds. Now, it is possible to raise 100% of funds from policy capital.

This measure aims to address the polarization among institution-only PEs. Over the past seven years, the share of large PEs with more than 1 trillion won in assets among institution-only PEs has been on the rise, while the share of mid-sized PEs with assets between 300 billion won and 1 trillion won has been declining.

Kang Changyeob, a researcher at NH Investment & Securities, said, "With such support, BDCs are ultimately expected to serve as a corporate finance channel specialized in investments in mid-sized and small companies by Korean PE firms."

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