Where Has All the Money Gone?

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Angel investors do not actually look like this, but they should

Korea is primed to make a startling growth in one sector, the small and medium enterprise (SME) sector. Korean SMEs account for 99.9 percent of all enterprises, 87.5 percent of all employees, and 49.4 percent of production. However, right now, SMEs are not generally growing at a rate that can positively impact the economy. They are missing a few essential ingredients, the differences between being a center of innovation and new ways to make profits, and being a second-string economy based around copying good ideas from outside sources.

There are several factors affecting the growth of SMEs in Korea. The first factor is that most Korean SMEs have only one customer with which they do business. Usually it is Samsung, or LG, or some other Korean conglomerate (chaebol). Most Korean SMEs are locked into a relationship with their chaebol, who almost acts as a patron. It's a good gig if you can get it, as you always have a dependable buyer for goods. However, this limited customer base cripples the SME in the areas of marketing and sales. When the company wants to expand its customer base, it has no idea how to go about doing that.  And if your chaebol client discovers one of your inevitable competitors, they will drop you in an instant for the faster, cheaper alternative. Then you're down to zero customers.

A second missing piece of the puzzle is a fertile ground for innovation. Korea has several areas set up to match the archetype of innovation - Silicon Valley. These areas, such as Daedeok Innopolis in Daejeon and Guro Digital Complex in Seoul, do have collections of small and medium businesses put together in parks. They also have many of the best graduates in Korea working for those small companies. They have government programs set up to aid deserving companies, and those programs do help some small amount of companies per year. However, they are missing one important ingredient of the whole recipe - venture capital. There are very few or no angel investors to give these companies the cash injection that they need to create the next Facebook or Google in Korea.

The path of technological success in Silicon Valley follows a predictable pattern. Small companies start out with a good idea, or skilled people. Two or three gifted guys work in a garage or a basement, working on their idea. Because of their location, they eventually run into the right people, who give them the venture capital that they need to hire more staff and develop their idea further. There are several rounds of investment, each time upgrading the office space and personnel of the company. Eventually, the company either burns out or begins turning a profit, and all the investors of the previous rounds breathe a little easier. The burn out vs turning a profit rate is actually very low, something like 10 or 15 percent, and yet the 85-90 percent of companies who are not successful still get some investment capital that they need to develop their idea.

Where do these angel investors come from? Most of them are from the previous generation of Silicon Valley success. The area has been the center of technological innovation for approximately 100 years, from radio tech to silicon transistors - from which the valley gets its name - to Ethernet, to the dot-com bubble, to the Web 2.0 era. Many of the successful businessmen who made it big in the dot-com era, for example, have the capital around to serve as angel investors for the Web 2.0 era. This self-perpetuating ecosystem of innovation has been changing the way we live for the past 100 years, and may continue to do so for the next 100 as well. Korea has nothing like that yet.

Some might think of foreign investment to get the sector off the ground. In fact, Silicon Valley itself could come to Daejeon and transform the place. However, Korea has some serious problems with foreign investment, despite the amount of ink used to talk about it in any Korean IT magazine or newspaper, including this one. Foreign investment can become a small part of the Korean SME scene, but cultural and political factors will most likely prevent it from becoming more than a small part.

So while the Korean government does inject some cash into the system, it can never inject enough to create a self-sustaining SME ecosystem. And while chaebol such as LG and Samsung also serve as an excellent first customer for growing companies, they will not help a company to move past the one-customer barrier. Foreign investment can work for some companies, but not enough. Only by creating a self-sustaining domestic venture capital market can Korea create the next Silicon Valley. When it happens, I recommend it be called Silicon Han.