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A vibrant venture capital market requires well-functioning exit routes, especially IPO and M&A, the two main routes. There is a growing demand for an alternative exit channel because IPOs require more time and the M&A market in Korea is not mature yet. Private secondary market platforms in the venture capital cycle not only provide alternative exit routes, but they also have a positive spillover effect on the overall venture ecosystem. They alleviate the lack of information and information asymmetry and provide liquidity to angel investors, current and former startup employees, and entrepreneurs, and ultimately create a positive externality for the IPO market.
The secondary market in Korea is less regulated, compared to that in the US, from the perspective of securities distribution as there are no requirements on the holding period and information disclosure. However, OTC secondary market transactions in Korea are subdued due to a narrow interpretation of the definitions of and transactions in the exchange in the Financial Investment Services and Capital Markets Act (FSCMA).
SecondMarket and SharesPost are two representative private secondary market platforms in the US. As registered broker-dealers, they have IT systems for private securities transactions within the US securities regulations.
SecondMarket and SharesPost have effective customized liquidity programs that alleviate information asymmetry through encryption technology and non-disclosure agreements with program participants, which provides an important example for addressing information asymmetry, a major hindrance in the Korean OTC secondary market. In addition, the primary capital raising programs of SecondMarket and SharePost are important developments since a private company can raise capital without an IPO while remaining private. Such programs are supported by the JOBS Act's deregulation of private companies in the number of registered shareholders and allowance of general solicitation.
Because of the FSCMA, there is no private secondary market platform within the regulatory system in Korea. The securities regulations keep securities companies away from OTC securities intermediation, and several private companies provide bulletin boards for securities transaction information. These private bulletin boards are regarded as an illegal trading facility and securities intermediation.
The main hurdles for the OTC secondary market for private companies’ stocks in Korea are summarized as: (1) restrictions on OTC transaction methods, (2) restrictions on public offering, (3) prohibition of illegal market opening, and (4) prohibition of internalization. Presently, K-OTC is the only legal organized OTC market, and deregulation is essential for diverse and vibrant private secondary market platforms such as those in the US.
This report suggests the following regulatory changes. First, regulations of OTC secondary markets need to be separated into those for non-listed public companies and those for non-listed private companies. Second, private secondary market platforms should be diversified and allow securities companies to run the platforms. Third, internalization should be permitted so that securities companies can provide the intermediary function. Fourth, measures for investor protection should be strengthened, including ex ante measures such as risk notices and disclosure requirement, and ex post measures to prevent current illegal transactions in the OTC market. Finally, the mechanical 50 person criteria for dividing public offering and private placement, as well as the requirement to be individual professional investors, need be relaxed so that individual investors can be more easily classified as professional investors.