South Korea is riding the global trend of high liquidity in the startup scene. Money is pouring into the sector, and investors are looking for the next big thing to invest in.

However, concerns linger that the upcycle is being maintained by government spending, and not a real appetite for startups.  

In 2018, venture capital investment surged 43.9 percent on-year to 3.4 trillion won ($3 billion), according to latest data by the Ministry of SMEs and Startups. However, of that amount, 20 percent actually came from the government, which had cleared a 1.9 trillion won supplementary budget to spend on startups.

There are also many more accelerators, with 60 percent of the 138 accelerators in Korea launched in 2018, according to government data. But this too may be an illusion, because as soon as the government funding evaporates, they may too. 

This imbalance or potential lack of sustainability, coupled with heavy government regulations that are keeping a startup’s innovative business at bay can eventually cause a disruption in startup valuations, according to industry watchers.

“A big volume of liquidity stemming from a government-led supplementary budget will not necessarily result in more venture capital deals,” Lee Ki-dae, director at startup advocacy group Startup Alliance, told The Korea Herald. “Instead, it will just increase the ticket size of each deal.”

And when the price tags become heftier, investors may feel they need to turn elsewhere, causing an unintended exodus.

“It’s a matter of demand and supply,” one venture capitalist told The Korea Herald on condition of anonymity. “There is a lot of liquidity in the market, but it’s still not easy to find startups with a competitive edge. In fact, there is a sense that Korean startups are somewhat overvalued.”

The source said when privately held companies like startups are valued, it is normal to multiply their revenue by three times or income by 10 times. But in Korea, this figure often goes too far, even up to 50 times the revenue.

“For some, the degree of overvaluation is so big that it’s a real concern that we might find ourselves struggling to take returns and exit from these startups.”

“VCs are worried because they have to make investments ahead of the maturity of their fund’s portfolio holding,” Lee of Startup Alliance said. “This sparks unnecessarily fierce competition between VCs over a certain startup, causing the deal price to go up even further.”

Will the sandbox work?

Despite the forebodings, there are some silver linings.

A recent policy move by the government to offer exemption from regulations or relieve the burden of getting regulatory approval for startups through a so-called “regulatory sandbox” initiative shows that Korea is trying to create a healthier eco-system.

Before the initiative went into effect on Jan. 17, local startups had no choice but to tackle the paperwork and regulatory framework and frequent changes in authoritative interpretations. Also, startups, usually small in size in terms of capital and workforce, had to struggle to create a business model that would steer clear of the regulations.

The arrival of the regulatory sandbox might help not only startups, but also VCs find their investment destination, because more such firms that deserve VC investment will come into being and investors will be given a wider array of choices, industry watchers said.

“Among startups that applied for the regulatory sandbox, there were ones that failed to perform adequate due diligence and receive investment despite their technology prowess, because utilizing their technology in Korea was against the law,” according to Choi Sung-ho, managing partner at Veat Law Firm.

Koo Tae-eon, managing partner at Tek & Law, called the sign of deregulation a potential “virtuous cycle,” as the success of startups participating in the regulatory sandbox initiative would allow more competitive players to crop up. 

“More startups will benefit from the regulatory sandbox, if the success of beneficiaries leads to a revision of laws to allow them to perform,” he said.

By Son Ji-hyoung
(consnow@heraldcorp.com)