The Amendments to the Financial Investment Services and Capital Markets Act (the Capital Markets Act) passed the South Korean Parliament in July 2015 and went into effect on January 25th, 2016, laying the framework for investment crowdfunding in South Korea. The adoption of investment crowdfunding opened up a new way for South Korean startups to raise funds online while providing retail investors the opportunity to invest in early stage companies.
According to the amended Capital Markets Act, Korean firms that have been in business for less than seven years or firms that have acquired “Venture Firm License” (given by South Korea’s Small and Medium Business Administration) may raise funds via investment crowdfunding. Eligible companies can raise up to 700 million KRW (roughly 610,000 USD) annually, in the form of equity or debt. Companies raising above 500 million KRW must receive a financial audit.
Companies must commit to a semi “All-or-Nothing” campaign, where they must terminate the fund-raise if they fail to raise 80% of the target amount within the preannounced campaign period. After a successful campaign, all newly issued securities of the crowdfunded companies must be deposited at the Korean Securities Depository. The issued securities are subject to a one-year lock-up and may be freely transferred after one year since issuance.
Investment limits are also in place. In order to prevent unsophisticated investors from investing and, possibly, losing excessive amounts, “common investors” may only invest 2 million KRW (roughly 1,700 USD) per company and 5 million KRW (roughly 4,300 USD) in total, per annum. The regulation, however, allows sophisticated investors to invest larger amounts if they submit proofs of qualifications. Sophisticated investors are either “income-accredited investors” whose annual taxable income exceeds 100 million KRW, or “professional investors” who possess a government-issued professional license, such as accountants, licensed angel investors, lawyers, etc.
Investment crowdfunding portals must adhere to strict guidelines. To register, investment crowdfunding portals must submit documented proofs of qualifications to the Financial Supervisory Commission. After registration, portals must submit monthly, quarterly, and annual governance reports to the Financial Supervisory Services, and receive annual audits. The portals may not give financial or managerial advice to fund-raising companies, and cannot acquire securities that are being offered through their services. Portals may not provide investment curation for investors as well.
As of November 14th, 2016, 14 portals are registered with the Financial Supervisory Commission. Of the 14 portals, six are operated by investment banks or financial broker-dealers. The other eight portals operate full-time crowdfunding portals. Of the 166 total crowdfunding campaigns, 88 have successfully raised a total of 13.9 billion KRW from 4,463 investors. The most popular sectors were healthcare, energy, IT, and films.
The success of investment crowdfunding in films is a phenomenon unique to South Korea. Because using investment vehicles is permitted, filmmakers and distributors can raise funds for specific films through crowdfunding. ‘Participating bonds’ of the vehicles are offered to the investors. Investors of these bonds share the profit or loss that derives from the primary and secondary sales of the films. Because of the short maturity of the bonds and the public appeal of films, investment crowdfunding in films is becoming increasingly popular. The 314 investors who invested 580 million KRW in the recently released film Operation Chromite, will soon realize a 25.6% pre-tax return on investment.
But there is much room for improvement.
Despite the early traction, there is a consensus among crowdfunding portals that the conservative regulations must be revised for the crowdfunding industry to flourish. Investment limits and restriction on general solicitation are two of the most repeatedly mentioned obstacles.
From the investor’s perspective, annual investment limits and lack of tax benefits deter active participation and investment. Given the 2 million KRW investment cap placed on common investors, it is hard to imagine an average person going through the hassle of analyzing and evaluating a startup company, only to invest a minor sum of money. Furthermore, there is no tax return or exemption benefits given to crowdfunding investors. Considering that the EIS/SEIS tax relief was the most important driver for UK investors’ participation in crowdfunding, a comparable tax relief scheme should be adopted to encourage crowdfunding investments.From the fund-raising firm’s perspective, the annual funding cap and the prohibition of general solicitation discourage firms from choosing crowdfunding as a reliable financing solution. While 700 million KRW per annum is not small money, a rapidly expanding growth company certainly require more. If crowdfunding cannot satisfy such needs, firms will obviously choose alternative solutions. Even worse is that firms are not permitted to publicly advertise their fundraising. A clear majority of the “crowd” does not know about crowdfunding or the companies that are crowdfunding. Because of the ban on crowdfunding advertisement, it is nearly impossible for firms to find and convince enough investors to reach their target amount.
From the fund-raising firm’s perspective, the annual funding cap and the prohibition of general solicitation discourage firms from choosing crowdfunding as a reliable financing solution. While 700 million KRW per annum is not small money, a rapidly expanding growth company certainly require more. If crowdfunding cannot satisfy such needs, firms will obviously choose alternative solutions. Even worse is that firms are not permitted to publicly advertise their fundraising. A clear majority of the “crowd” does not know about crowdfunding or the companies that are crowdfunding. Because of the ban on crowdfunding advertisement, it is nearly impossible for firms to find and convince enough investors to reach their target amount.
Investment crowdfunding is a revolutionary method for young businesses to raise capital online. However, for the nascent industry to grow, much needs to be done to make crowdfunding known to the public, and to improve crowdfunding’s attractive for both companies and investors.
The regulators are not blind to such needs. According to the announcement made by the Financial Supervisory Commission on 6th November, the ban on investment advertisements is expected to be soon lifted.
Now, any firm that is crowdfunding may advertise their campaign via a social network, media, and other online methods. Furthermore, crowdfunded companies that satisfy a certain requirement (more than 300 million KRW from over 50 investors) may be considered for fast-track listing on the KONEX (Korea New Exchange). The KONEX is a market established in 2013 for small and medium-sized enterprises exclusively in order to form the basis of creative economy by reinforcing support through the capital market for SMEs at the early stage.
Additional good news for the Korean investment crowdfunding industry is the establishment of the KSM (Korea Startup Market), which is scheduled to open on 14th November. The KSM is a private securities exchange, on which all successfully crowdfunded companies may register. All outstanding shares, regardless of security type, may be exchanged at the KSM. Hoon Ko, the CEO of the South Korean investment crowdfunding portal YINC, commented that
“Because the establishment of a secondary market provides liquidity and early exit opportunities for investors, it will definitely have a boosting effect on the primary market, which is investment crowdfunding.”
Jihoon Yeon is a contributor to Crowdfund Insider. He is the director of research at YINC (https://yinc.kr/), one of the leading investment crowdfunding portals in South Korea. He publishes a Korean crowdfunding blog, YINC Insight (http://insight.yinc.kr/), that covers daily media reports, investment trends, and related regulations, etc.