Changes in South Korea’s economic policies and challenges faced by business owners in passing control from one generation to another are creating a steady stream of private equity opportunities in the small and medium sized enterprises (SMEs) space, according to leading market experts.
That opportunity could appeal to local institutional investors, which have been aggressively looking into private equity opportunities in order to improve their annual returns.
“Many SMEs in Korea are faced with increasing costs, so the operating environment has become more challenging,” Jenhao Han, chief executive of growth equity investment firm KCA Capital Partners, told AsianInvestor sister title to FinanceAsia.
One of those costs is labour: In July 2017, the administration of new Korean president Moon Jae-in said it would raise the minimum wage by 16.4% in 2018—the largest increase since 2000, according to Korea’s Minimum Wage Commission.
Moon’s left-learning government has initiated policies favouring labour unions and worker rights over business owners since attaining power in May 2017, according to Yong Hak Huh, chief executive of alternative investment advisor First Bridge Strategy. One example is a reversal of labour guidelines that the previous administration had introduced to make it easier to layoff employees.
Yong was speaking at panel at the Hong Kong Venture Capital and Private Equity Association (HKVCA) Asia Private Equity Forum 2018, in Hong Kong on January 16.
These labour challenges are leading some small business owners to throw in the towel, which is offering private equity some opportunities, say experts.
“Business owners are becoming more receptive about the idea of swapping equity for cash—it’s what we have seen from the second half of last year,” said Michael Chung, head of Korea at Morgan Stanley Private Equity Management, on the same panel discussion.
Cultural shift
At the same time, a cultural shift in the attitudes towards business succession among aging business owners could also offer PE funds some options, say some experts.
“The theme of generational shift and transfer of business will be a key theme in Korea,” said Gordon Cho, head of Korea at asset management firm The Rohatyn Group.
Historically, the idea of giving up control of a business in Korea was frowned upon. “For mid-sized company owners, their business is their pride and joy, and selling out the business is seen as a betrayal,” said KCA Capital Partners’ Han.
But many family-run small and medium-sized enterprises (SMEs) face the prospect of the next generation not being interested or equipped to take over the business. And hiring an expensive professional manager to run the business can also be tricky for a mid-sized company, Cho said.
“Even if this one CEO or major shareholder is so forward-looking they [the company owner] gives them that money [to hire them], you can imagine that they're going to be sticking out like a sore thumb,” he explained. "It's hard to effect real change," he added.
That’s left more owners with little choice but to sell the business to peers or professional investors. And sentiment towards such buyout transactions has changed from hostility to understanding the compulsion of such an action.
This has been helped by the ability of some private equity firms to buy such companies and make them larger and more successful. This has helped change the attitudes of SME owners, who now see a buyout as a viable exit, and represent the best area of opportunity, Cho added.
Cho did not respond to requests by AsianInvestor to offer an example by presstime. However rival VIG Partners, which specialises in mid-sized PE investments, impressed in February 2016 when it sold out of Burger King's South Korea franchise for W210 billion ($170 million), after originally investing into it in 2013 for W110 billion.
Experts at the event said typical annual internal rates of return in Korea for PE funds were in the range of 20% to 30%.
