The Venture Capital Process in Korea

Ryan Kangjoon Lee, Greg Moon & Daniel Kang, SOFTBANK Korea

Reprint Permission from Aspatore Inc., All Rights Reserved

Background/General Practices

The venture capital process in Korea is quite similar to that in other countries, though there are a few unique attributes. The most significant is that the Korean government plays a critical role in fundraising. With the exception of two or three years during the IT gold rush in 1998-2000, the government and its affiliated organizations have been the primary source of VC funds, contributing about 40 percent. The other 60 percent consists of pension funds (~30 percent), financial institutions (~15 percent), corporate investors (~10 percent) and others (~5 percent).

As for investment, prior to the IT crash, Korean venture capital firms had only been focusing on equity investment, mostly common stocks. After the IT boom burst, Korean VC firms became more sensitive in their risk management and accordingly took more prudent measures in their investments, diversifying into preferred stock, convertible bonds, bonds with warrant, etc. (The latter were first introduced by SOFTBANK Korea.)

Exit Strategies and Timing

Unlike the U.S., mergers and acquisitions have rarely been an effective exit method for Korean venture capital firms - IPOs have been the dominant strategy. This is primarily because there are very few companies both able and willing to do an M&A. Another reason for the limited M&A activity is likely the unwillingness of most entrepreneurs to relinquish management control. There is also a cultural aversion toward M&As, especially hostile ones.

Our investment horizon is determined by the life of the fund. For a fund backed by the government and/or pension funds, duration is usually five years. So the maximum time before we exit is about four years. Our exit timeline, however, may be adjusted by the following external factors:

1) The macroeconomic situation and the stock market situation can affect our exit timing decisions as each has a significant influence over EPS and applied multiples, respectively. 2) In addition, any significant change of investee company, such as a change in management control, that may affect the fundamentals of the company and, accordingly, the value of our investment, can change our exit timing schedule.

Identifying Potential Investments

VCs and entrepreneurs traditionally find each other through personal networks, community activities, referrals and tech conferences and seminars. The type of entrepreneur we are looking for depends on the industry. For hardware/device industries like handsets, semi-conductors and displays, people who are former executives of large corporations like Samsung Electronics, LG Electronics, LG Philips LCD and Hynix often succeed in receiving VC funding. Their networks and contacts with former employers greatly increase their chances of success in the Korean market. For the software, Internet and online game industries, entrepreneurs who have fresh, innovative ideas as well as execution capabilities are often successful in receiving VC funding regardless of their academic and professional backgrounds.

At this point, we only invest in Korean companies. Since its establishment, SOFTBANK has adopted and maintained a "divide & conquer" strategy. Accordingly, we have focused exclusively on the Korean market. Our sole interest in the Korean market can also be attributed to the restrictions of the fund we are currently managing.

There are three major criteria we use to make investment decisions. First is the size and growth potential of the market that the candidate company is targeting. Second are the candidate company's skills, assets, capabilities and relationships that increase the likelihood of success. Third are the quality and practicality of the management team's long-term vision and strategy, as well as the team's ability and determination to execute. In addition, the trustworthiness of the management team is an important factor in our final investment decision.

Valuing a Company

We use the same basic valuation methods that others use, such as discounted cash flow analysis and comparable analysis. Ultimately, we believe that valuing highly volatile IT startups and making an investment decision based on that is not a matter of precision but a matter of confidence. At the end of the day, the value of the company is created by the investee company and determined by the market, and investors play relatively little role in both processes. While potential investees always shop around to try to get better conditions from other investors, the main purpose of conducting our own valuation is to figure out our comfort zone with the company and to understand the key value drivers of the company's business and the implications of any assumptions used as the basis of post-investment management and contingency plan development.

Term Sheets

SOFTBANK Korea uses U.S. venture capital practice in structuring our terms and conditions, and in some cases, we have introduced American concepts to the Korean market. Investment in certain types of preferred stocks or convertible bonds is one example.

The primary factor that affects the term sheets is the level of maturity of a potential investee. If it is an early-stage company, taking management control or retaining a significant influence over critical management decisions is most important. When the exit possibility of a potential investee is uncertain, risk hedging through various protective structures such as convertible securities (bonds or preferred stocks) with liquidation preferences, put-back options, drag-alongi and/or tag-alongii rights is critical. We take these risk-hedging methods in order to at least secure some way to achieve liquidity by the maturity of the fund in case exiting through an IPO or M&A is not available. In some cases, especially in early-stage investment, investee companies cannot afford to comply with those provisions, but they can at least give us leverage to seek other alternatives, including forced sale or divestiture of investee companies. Last but certainly not least, if a potential investee's revenue and/or profit is unstable and thus there is a substantial degree of risk that the pre-money valuation turns out to be too high, agreement on a certain ratchet condition is what we most care about.

Role of the Board

The role of the board of directors is becoming increasingly important in Korea as a result of the increased focus on transparency and accountability. Requests from shareholders for a better corporate governance system are unusually high. That is true not only for IT startups but also for many other companies, including chaebols, as evidenced by the strong demand on SK group corporate governance reform by Sovereign Asset Management, Monaco-based fund seeking for corporate governance-related investment opportunities. Several forces triggered this change such as reinforced legal system, more vigilant regulatory authorities, increased influence from media, and so on.

SOFTBANK Korea has also steadily enhanced the level of involvement or participation in the management of our portfolios. As a condition for investment in our portfolio companies, we require that managerial information, including financial performance, be shared among investors on a monthly basis, and that most critical management decisions be made by the board of directors. For example, in our recent investment in Tri-D communications, an interactive 3D online avatar game/community provider, we made an agreement that all critical management decisions regarding business development, marketing, major capital expenditure and M&A should be endorsed by the board.

Changes & Trends

As the economy picks up, I think we are going to see an acceleration in the introduction of new technologies and an increase in the flow of money to the venture capital industry. That, in turn, will encourage entrepreneurship to flourish. However, the uplifted entrepreneurship will rapidly intensify fragmentation, competition in IT industry, and ultimately result in industry consolidation by the final survivors.

The industries that are based on a fundamental understanding of customers' needs will be the most successful in attracting investors. The question we're constantly asking ourselves when we look at new services and technologies is: "Will people be willing to pay for this?" Some areas I think will be successful are digital convergence (home networking, telematics, post-PC, next-generation handsets), ubiquitous technologies and network convergence (fixed-line and mobile) and digital contents and services consolidation.

Golden Rules

The three "golden rules" to successful venture capital deals in Korea are to first evaluate the potential of the target market, then look at the likelihood of the potential investee's success and its sustainability and third to consider the quality of the people involved. The third one is especially important in Korea. Our CEO frequently emphasizes the people issue with the following three principles: Find good people, support good people and encourage and motivate good people.

Best Advice

I tell entrepreneurs to make it their first priority to pay close attention to the market needs and trends. At the end of the day, innovation of technology, product and service should be well adopted by the market and be translated into the revenue and profit of the company.

About the Authors

Ryan Kangjoon Lee, Senior Associate

Ryan is a senior associate of SOFTBANK KOREA specializing in corporate finance and strategy. Since joining Softbank, his duties include conducting valuation, strategic due diligence and developing exit strategy for existing portfolio companies as well as leading investment screening process for its private equity arm. Prior to joining Softbank, he worked for McKinsey & Company where he primarily worked on corporate finance and strategy issues in various industries. Ryan has also served as an investment committee member of Stanford SEIT-Fund I, and has been serving as a board member of Korea-Stanford Venture Forum Venture Clinic since 1999 as a part of extracurricular activities.

Ryan received his B.S. in Computer Engineering from Seoul National University. He also completed the executive education program named "Strategy and Entrepreneurship in the Information Technology Industry" from the Graduate School of Business at Stanford University.

Greg Moon, President & CEO

Greg Moon, president & CEO, SOFTBANK Korea & SOFTBANK Ventures Korea, oversees SOFTBANK's venture investment in Korea. His major career accomplishments include CEO, SOFTBANK Media, TriGem Computer's investment team as well as business development at Narae Mobile Telecom. He has also worked at SOFTBANK Venture Capital USA (Mobius) in their technology investments team. In 1999, he was the host of a SBS nationwide T.V. economic journal program "Money Sense." He is currently on the board of directors at Yahoo! Korea, iMas, CST, SOFTBANK Media, HeyAnita, JoyinBox, and Prism. Greg received his MBA from Drexel University, and received his BA from Korea University.

Daniel Kang, Partner and Executive Director

Daniel is a partner and executive director of SOFTBANK Ventures Korea. He is responsible for investing in local based IT companies and finding value-up opportunities for portfolio companies. His investment focus is internet, display and telco industries. Prior to joining SOFTBANK, he served as a core staff member in the CEO office of Daum Corp, the leading internet portal in Korea, and has worked for Media2.0, a new media company, as a CFO. He is currently serving as a board member of Cyberdigm, imedia.

Daniel received his BA and MBA from Seoul National University.

About SOFTBANK Korea

SOFTBANK Korea is the local subsidiary of SOFTBANK Corporation (headquartered in Japan; CEO & President: Masayoshi Son). It is also the holding company of SOFTBANK Ventures Korea, founded in February 2000 as an independent venture capital arm.

Founded in 1991, and with approximately US$100 million in funds under management, our mission is to help promising Korean IT startups to succeed globally, and to maximize the return of our limited partners and investors. We are able to achieve our mission given our ability to leverage SOFTBANK's global network and expertise to enhance the performance of our portfolio companies. This is one of the key attributes which distinguishes SOFTBANK Ventures Korea from other venture capital firms in the Korean market.

Our specific areas of investment interest include: infrastructure/equipment, devices and services related to the Internet, digital convergence, next generation networks and ubiquitous computing. We typically consider early-stage through mezzanine-level investments in the range of US$1 million to US$3 million.

Our current portfolio companies include: Yahoo! Korea, Bellwave, and Tomato LSI.

i [1] "Drag-along " right enables us to force management to sell their stock in any sale of stock by the investors

ii [2] "Tag-along" right enables us to include our stock in any sale of stock by management