OPINION
2023 Jul/11
Causes of the Recent Decline in Venture Capital Investment and Future Challenges for Venture Capital Market Development
Jul. 11, 2023
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- Summary
- The startup funding support that has been implemented in response to a sharp decline in venture capital (VC) investment is expected to exert a positive effect on the recovery of VC investment in that it represents the policy authority’s commitment to supporting the VC market. The contraction of VC investment is a phenomenon caused by the overlapping of the policy aimed at expanding private funds during a rate hike cycle. This phenomenon seems to have resulted from a temporary delay in investment, driven by the gap between market supply and demand rather than a lack of investment funds. In this respect, creating the private VC market is still a meaningful policy direction. The future policy for the VC market should be directed towards creating an ecosystem that improves the private sector’s investment capability and creativity and scales up investment funds through market principle-based investment funds distribution. In the meantime, the rise of future strategic technology fields will require policy financing to act as a catalyst for relevant technological advancement.
Recent Decline in venture capital investment and its causes
As the benchmark rate has increased at home and abroad starting in mid-2022, the Korean venture capital (VC) market has contracted sharply since the fourth quarter of 2022, resulting in a plunge in fundraising and new investment. The amount of funds raised fell by 2.8% on a YoY basis from KRW 17.8 trillion in 2021 to KRW 17.3 trillion in 2022, while new investment slid to KRW 12.5 trillion from KRW 15.9 trillion during the same period, representing a 21.8% decrease. On a quarterly basis, the market contraction was more serious. As for VC funds registered under Korea Venture Capital Association, fundraising was curtailed by 78.6% from KRW 2.7 trillion in the first quarter of 2022 to KRW 600 billion in the first quarter of 2023, and new investment declined by 60.3% from KRW 2.2 trillion to KRW 900 billion during the same period.
The recent decline in VC investment can be attributed to a temporary delay in investment resulting from disagreements over valuation between VC firms and investors or investors’ intention to execute investment after confirming the market bottom, rather than a lack of investment funds. Although how much dry powder VC funds hold has not been disclosed, the amount held only by VC investment associations is estimated to be KRW 10.3 trillion1) at the least, suggesting that the recent funding crunch hardly stems from an absolute lack of VC investment funds. For this reason, VC investment is expected to gradually resume once changes in the market environment give rise to new investment conditions.2) The current situation can be seen as a phenomenon that emerges at the beginning of a recession period in the boom-bust cycle of the VC investment market. In the previous cases of Korea and the US, the contracted investment market staged a recovery after a certain period of time.
Evaluation of policy responses to the decrease in VC investment
With respect to shrinking VC investment, the Financial Services Commission and the Ministry of SMEs and Startups announced the “Policy Measures to Support Funding for Innovative Venture Capitalists and Startups and Strengthen their Competitiveness” to devise the improvement plan to expand policy financing and promote the private sector’s VC investment.3) More concretely, the policy measures aim to additionally provide KRW 10.5 trillion in the form of policy financing, policy funds and R&D funds to meet the funding needs of firms in each growth phase, double the VC investment limit that has been 0.5% of banks’ net capital from 0.5% to 1%, support the establishment of M&A and secondary funds, and reform the regulation of corporate venture capital (CVC) in order to facilitate the private sector’s VC investment. In addition to the increase in capital injection, the measures are also designed to expand external talents eligible for stock options, swiftly introduce the multiple voting rights scheme under discussion, and make permanent the Act on Special Measures for the Promotion of Venture Businesses scheduled to expire in 2027, with the aim of overhauling the entire venture capital system for supporting the stability of VC firms and revitalizing their business activities.
According to the policy measures, loans, investments and R&D funds will be differently allocated by growth phase and institutional improvements will be implemented to support exit strategies and expand the private sector’s investment funds, which are expected to positively affect the increase in private funds and the recovery of VC investment. Above all, the policy responses can be meaningful in that they allow market participants to affirm the policy authority’s commitment to market stability under tight market conditions. When the VC investment market becomes tight due to market adjustment, however, it is inappropriate to take a market stabilization approach that fully provides liquidity to VC firms or startups suffering from financial strains. In this case, market stabilization needs to be implemented to ensure that promising venture capitalists and startups overcome financial difficulties and achieve continuous growth through the selection of providers of funds.
Significance of the private-centered venture capital market
It is hard to deny that policy financing has played a significant role in the remarkable growth of Korea’s venture capital market since the mid-2000s. Given the recent decrease in the fund of funds’ investment budget, however, it is worth considering boosting the capabilities of private VC to make financial position and public resources more sustainable and achieve a mature VC market. This necessitates the gradual establishment of a private-centered VC ecosystem. For instance, it has been pointed out that Korea’s VC market has hardly scaled up despite the increase in VC investment. This is evident in the average size of VC funds and the share of follow-on investments. The average size of VC funds established between 2015 and 2021 amounts to KRW 190 billion in the US and KRW 110 billion in China, while Korea’s VC funds only reached KRW 27.9 billion during the same period. Although having climbed considerably compared to the past, the share of follow-on investments made by Korea’s VC associations as of 2021 still stands at 71.2%, lower than 92.6% in the US. In this regard, Korea lacks a large size of funds necessary for large-scale equity investments in the late stage of startups and rarely has a wide investor base in the capital market.4)
To overcome the limitations of its VC market, Korea should set a policy direction to enhance investment capabilities by promoting investment creativity and autonomy in the private sector and to scale up investment funds through market principle-based investment funds distribution. In other words, it needs to create a private-centered VC market to enable sustainable scale-up and nurture unicorn firms.
As the recent VC market tightness has resulted from the policy direction for private capital expansion during the period when the VC market voluntarily takes a breather, the policy for creating the private-centered VC market environment is obviously indispensable. Notably, it is necessary to adjust the policy scope and intensity flexibly, depending on VC market conditions.
Future roles of policy financing
As the Korean VC market has grown quantitatively over the past decade, the policy focus should be gradually geared toward facilitating both quantitative and qualitative growth going forward. In this respect, the present government’s policy stance of putting a priority on private VC aligns with a necessary shift in the mid- to long-term policy. In line with this policy shift, the role of policy financing, which has been used as a pump primer for creating the VC market ecosystem, needs to be reestablished.
In terms of VC, policy financing plays a role in responding to or remedying market failures, such as high investment risk in a specific field and the resultant underinvestment. As new investment fields, which may be characterized as market failure, continue to emerge, policy financing is expected to keep playing a crucial role in VC. A prime example is the investment in future strategic technology. As it is difficult for private investors to undertake such investments individually, the government must use its capabilities and policy financing tools to promote investing in strategic technology. For instance, future technologies called super-gap technology, deep tech and national strategic technology, which are currently being developed across the government, have a high possibility of failing in the market due to high risk and initial infrastructure costs.5) Despite this, the super-gap technology and deep tech field can determine a country’s technological prowess in the future and thus, countries are engaging in fierce competition for developing such technologies.
While investing in startups is characterized by market uncertainty, the super-gap and deep tech field is affected by both technological uncertainty and market uncertainty. For this reason, the field requires a long time from technology development to commercialization and sales generation and a huge amount of funds for large-scale tests and facility investment in the pre-prototype production phase. The uncertainty and long gestation period in the super-gap and deep tech field necessitate a more intense diversification and longer-term investment strategy, compared to investing in startups. Furthermore, as the investment in the field leads to continuous demand for funds before sales are generated, it is hard to attract the appropriate level of private investment by applying a general VC investment strategy that usually makes investment decisions based on sales generation.6) Considering this, intellectual capital and patient capital, rather than typical VC, play a critical role in investing in such new technologies and policy financing should act as a catalyst in the field until private investment is expanded.
To promote efficient policy financing in the future technology field, a government-wide support system should be built as the field falls under the jurisdiction of various government departments. It is necessary to select and prioritize future strategic technology fields by examining prospects for future industries and technologies. What is also needed is the systematic management of information needed to discover promising companies in an effort to prevent or adjust portfolio overlap. To this end, a desirable approach is to use private experts in relevant fields and establish a consumer-oriented discovery system to locate strategic fields and execute policy financing in a private or market-friendly manner. On top of that, the effect of policy financing support should be evaluated on a regular basis and the evaluation result should be reflected in policy financing to enhance efficiency in policy financing distribution.
1) This article assumes that venture capital associations have an average maturity of 7.8 years and an investment period of 3 years.
2) In the wake of the global financial crisis, fundraising and investment in the US fell by 62.2% and 24.8% in 2009, respectively, which climbed to 67.2% and 16.1% in 2010, partially reversing the downward trend of investment. In Korea, fundraising and investment decreased by 66.1% and 2.2% in 2012, respectively, due to economic uncertainty at home and abroad, which immediately increased by 99.0% and 12.3% in 2013.
3) Ministry of SMEs and Startups & Financial Services Commission, April 20, 2023, Policy Measures to Support Innovative Venture Capitalists and Startups and Strengthen their Competitiveness, press release.
4) The absence of an investor base that can supply funds in large volume in the late state of startups is generally recognized as a limitation not only in Korea but also in the EU (Quas, A., Mason, C., Compañó, R., Testa, G., Gavigan, J.P., 2022, The scale-up finance gap in the EU: Causes, consequences, and policy solutions, European Management Journal 40, 645-652).
5) To be specific, it includes system semiconductors, the bio-health sector, mobility, eco-friendliness and energy, robots, big data, AI, cyber security, aerospace, next-generation nuclear power plants, and quantum technology.
6) IFC, 2021, Financing Deep Tech,
BCG, 2021, The Deep Tech Investment Paradox: a call to redesign the investor model.
As the benchmark rate has increased at home and abroad starting in mid-2022, the Korean venture capital (VC) market has contracted sharply since the fourth quarter of 2022, resulting in a plunge in fundraising and new investment. The amount of funds raised fell by 2.8% on a YoY basis from KRW 17.8 trillion in 2021 to KRW 17.3 trillion in 2022, while new investment slid to KRW 12.5 trillion from KRW 15.9 trillion during the same period, representing a 21.8% decrease. On a quarterly basis, the market contraction was more serious. As for VC funds registered under Korea Venture Capital Association, fundraising was curtailed by 78.6% from KRW 2.7 trillion in the first quarter of 2022 to KRW 600 billion in the first quarter of 2023, and new investment declined by 60.3% from KRW 2.2 trillion to KRW 900 billion during the same period.
The recent decline in VC investment can be attributed to a temporary delay in investment resulting from disagreements over valuation between VC firms and investors or investors’ intention to execute investment after confirming the market bottom, rather than a lack of investment funds. Although how much dry powder VC funds hold has not been disclosed, the amount held only by VC investment associations is estimated to be KRW 10.3 trillion1) at the least, suggesting that the recent funding crunch hardly stems from an absolute lack of VC investment funds. For this reason, VC investment is expected to gradually resume once changes in the market environment give rise to new investment conditions.2) The current situation can be seen as a phenomenon that emerges at the beginning of a recession period in the boom-bust cycle of the VC investment market. In the previous cases of Korea and the US, the contracted investment market staged a recovery after a certain period of time.
Evaluation of policy responses to the decrease in VC investment
With respect to shrinking VC investment, the Financial Services Commission and the Ministry of SMEs and Startups announced the “Policy Measures to Support Funding for Innovative Venture Capitalists and Startups and Strengthen their Competitiveness” to devise the improvement plan to expand policy financing and promote the private sector’s VC investment.3) More concretely, the policy measures aim to additionally provide KRW 10.5 trillion in the form of policy financing, policy funds and R&D funds to meet the funding needs of firms in each growth phase, double the VC investment limit that has been 0.5% of banks’ net capital from 0.5% to 1%, support the establishment of M&A and secondary funds, and reform the regulation of corporate venture capital (CVC) in order to facilitate the private sector’s VC investment. In addition to the increase in capital injection, the measures are also designed to expand external talents eligible for stock options, swiftly introduce the multiple voting rights scheme under discussion, and make permanent the Act on Special Measures for the Promotion of Venture Businesses scheduled to expire in 2027, with the aim of overhauling the entire venture capital system for supporting the stability of VC firms and revitalizing their business activities.
According to the policy measures, loans, investments and R&D funds will be differently allocated by growth phase and institutional improvements will be implemented to support exit strategies and expand the private sector’s investment funds, which are expected to positively affect the increase in private funds and the recovery of VC investment. Above all, the policy responses can be meaningful in that they allow market participants to affirm the policy authority’s commitment to market stability under tight market conditions. When the VC investment market becomes tight due to market adjustment, however, it is inappropriate to take a market stabilization approach that fully provides liquidity to VC firms or startups suffering from financial strains. In this case, market stabilization needs to be implemented to ensure that promising venture capitalists and startups overcome financial difficulties and achieve continuous growth through the selection of providers of funds.
Significance of the private-centered venture capital market
It is hard to deny that policy financing has played a significant role in the remarkable growth of Korea’s venture capital market since the mid-2000s. Given the recent decrease in the fund of funds’ investment budget, however, it is worth considering boosting the capabilities of private VC to make financial position and public resources more sustainable and achieve a mature VC market. This necessitates the gradual establishment of a private-centered VC ecosystem. For instance, it has been pointed out that Korea’s VC market has hardly scaled up despite the increase in VC investment. This is evident in the average size of VC funds and the share of follow-on investments. The average size of VC funds established between 2015 and 2021 amounts to KRW 190 billion in the US and KRW 110 billion in China, while Korea’s VC funds only reached KRW 27.9 billion during the same period. Although having climbed considerably compared to the past, the share of follow-on investments made by Korea’s VC associations as of 2021 still stands at 71.2%, lower than 92.6% in the US. In this regard, Korea lacks a large size of funds necessary for large-scale equity investments in the late stage of startups and rarely has a wide investor base in the capital market.4)
To overcome the limitations of its VC market, Korea should set a policy direction to enhance investment capabilities by promoting investment creativity and autonomy in the private sector and to scale up investment funds through market principle-based investment funds distribution. In other words, it needs to create a private-centered VC market to enable sustainable scale-up and nurture unicorn firms.
As the recent VC market tightness has resulted from the policy direction for private capital expansion during the period when the VC market voluntarily takes a breather, the policy for creating the private-centered VC market environment is obviously indispensable. Notably, it is necessary to adjust the policy scope and intensity flexibly, depending on VC market conditions.
Future roles of policy financing
As the Korean VC market has grown quantitatively over the past decade, the policy focus should be gradually geared toward facilitating both quantitative and qualitative growth going forward. In this respect, the present government’s policy stance of putting a priority on private VC aligns with a necessary shift in the mid- to long-term policy. In line with this policy shift, the role of policy financing, which has been used as a pump primer for creating the VC market ecosystem, needs to be reestablished.
In terms of VC, policy financing plays a role in responding to or remedying market failures, such as high investment risk in a specific field and the resultant underinvestment. As new investment fields, which may be characterized as market failure, continue to emerge, policy financing is expected to keep playing a crucial role in VC. A prime example is the investment in future strategic technology. As it is difficult for private investors to undertake such investments individually, the government must use its capabilities and policy financing tools to promote investing in strategic technology. For instance, future technologies called super-gap technology, deep tech and national strategic technology, which are currently being developed across the government, have a high possibility of failing in the market due to high risk and initial infrastructure costs.5) Despite this, the super-gap technology and deep tech field can determine a country’s technological prowess in the future and thus, countries are engaging in fierce competition for developing such technologies.
While investing in startups is characterized by market uncertainty, the super-gap and deep tech field is affected by both technological uncertainty and market uncertainty. For this reason, the field requires a long time from technology development to commercialization and sales generation and a huge amount of funds for large-scale tests and facility investment in the pre-prototype production phase. The uncertainty and long gestation period in the super-gap and deep tech field necessitate a more intense diversification and longer-term investment strategy, compared to investing in startups. Furthermore, as the investment in the field leads to continuous demand for funds before sales are generated, it is hard to attract the appropriate level of private investment by applying a general VC investment strategy that usually makes investment decisions based on sales generation.6) Considering this, intellectual capital and patient capital, rather than typical VC, play a critical role in investing in such new technologies and policy financing should act as a catalyst in the field until private investment is expanded.
To promote efficient policy financing in the future technology field, a government-wide support system should be built as the field falls under the jurisdiction of various government departments. It is necessary to select and prioritize future strategic technology fields by examining prospects for future industries and technologies. What is also needed is the systematic management of information needed to discover promising companies in an effort to prevent or adjust portfolio overlap. To this end, a desirable approach is to use private experts in relevant fields and establish a consumer-oriented discovery system to locate strategic fields and execute policy financing in a private or market-friendly manner. On top of that, the effect of policy financing support should be evaluated on a regular basis and the evaluation result should be reflected in policy financing to enhance efficiency in policy financing distribution.
1) This article assumes that venture capital associations have an average maturity of 7.8 years and an investment period of 3 years.
2) In the wake of the global financial crisis, fundraising and investment in the US fell by 62.2% and 24.8% in 2009, respectively, which climbed to 67.2% and 16.1% in 2010, partially reversing the downward trend of investment. In Korea, fundraising and investment decreased by 66.1% and 2.2% in 2012, respectively, due to economic uncertainty at home and abroad, which immediately increased by 99.0% and 12.3% in 2013.
3) Ministry of SMEs and Startups & Financial Services Commission, April 20, 2023, Policy Measures to Support Innovative Venture Capitalists and Startups and Strengthen their Competitiveness, press release.
4) The absence of an investor base that can supply funds in large volume in the late state of startups is generally recognized as a limitation not only in Korea but also in the EU (Quas, A., Mason, C., Compañó, R., Testa, G., Gavigan, J.P., 2022, The scale-up finance gap in the EU: Causes, consequences, and policy solutions, European Management Journal 40, 645-652).
5) To be specific, it includes system semiconductors, the bio-health sector, mobility, eco-friendliness and energy, robots, big data, AI, cyber security, aerospace, next-generation nuclear power plants, and quantum technology.
6) IFC, 2021, Financing Deep Tech,
BCG, 2021, The Deep Tech Investment Paradox: a call to redesign the investor model.