Creative Korea

The story of South Korea’s meteoric rise to prominence in 62 years of peacetime is largely the story of the chaebol. While the distinctive moniker, meaning ‘wealth clan’, was not coined until the 1980s, these massive, family-run conglomerates have had a grip on the national economy since the 1960s, delivering decades of export-led growth that have made the country a phenomenal Asian success.

Today, however, ‘creative economy’ is the new watchword among Korean policymakers; and there is a widespread perception that start-ups and small and medium-sized enterprises (SMEs) are the engines that will drive this innovation. President Park Geun-hye has made empowering start-ups the central plank of her economic platform and has enlisted the country’s corporate giants to help her do so.

Against this backdrop, patents have taken centre stage. A string of creative economy innovation centres opened their doors in the last year, with Park herself cutting the ribbons. At each centre, one chaebol takes the lead in providing investment, services and advice to small businesses in the region, focusing on a specific sector (Not every sponsoring entity is technically structured as a chaebol, but the term is used here to signify a large Korean company.) But few aspects of the innovation centres have attracted as much attention – some of it misleading – as the prospect of patents being ‘opened up’ to small companies.

The Korean government has been known to worry about the country’s patent position, even when it comes to the chaebols. The country ran a royalty deficit of $6.2 billion last year – much of which is probably attributable to licence payments made by some of the biggest conglomerates, including Samsung, LG and SK Group. So the latest initiative is just as much about helping these giants to become nimbler and more effective as it is about empowering their smaller competitors.

But there is no doubt that it is small, innovative Korean companies that need most support in the patent arena. At home, they are hoping to compete with – or be bought out by – technology companies that hold some of the largest active patent portfolios in the world; while China – arguably their most important overseas market – can appear something of a minefield when it comes to IP enforcement. But the government and conglomerates are far from the only players trying to assist Korea’s SMEs; a new, more IP-savvy breed of accelerator and venture capitalist is gradually increasing the number of start-ups that make intellectual property central to their business models.

Centres of attention

As part of Park’s masterplan, some 17 creative economy innovation centres have been set up – one for each of South Korea’s nine provinces and eight provincial-level cities. The industry sectors they focus on are largely tech related, with information and communications technology (ICT) and IT services featuring prominently: about 10 count either electronics or ICT within their remits. In total, seven of the centres have indicated that patents are playing a significant role in the interchange between conglomerates and local SMEs. At four of the centres, the relevant chaebol has ‘opened up’ a portion of its IP portfolio, making an explicit number of patents available in some way – although it is not always clear exactly what this ‘opening’ means in practice.

Hyundai Motor, which operates an automotive-focused innovation centre in Gwangju, has ‘opened up’ about 1,000 patents to encourage more start-ups to enter the hydrogen fuel cell business. When Japan’s Toyota made a similar announcement back in January, it explained that a total of 5,680 fuel cell-related patents would be available royalty free until 2020. On the other hand, when Ford hyped up a similar programme in March, it made clear that its intellectual property was available for a fee. Where Hyundai’s initiative falls between these two poles we do not exactly know; Hyundai did not respond to a request for comment. Another key differentiator in this case is that the offer on the table presumably extends exclusively to the targets of the innovation centre: Korean SMEs and start-ups.

Another former member of the old Hyundai chaebol – Hyundai Heavy Industries, which oversees an innovation centre devoted to shipbuilding and machinery in Ulsan – has made a similar move. The world’s biggest shipbuilder also succeeded in persuading two competitors to join the project, teaming up with industry number two Daewoo Shipbuilding & Marine Engineering and Samsung Heavy Industries to ‘open up’ a portfolio of 2,500 patents in a bid to foster the development of eco-friendly ships. The joint effort will be managed out of the Ulsan centre and so is likely aimed at smaller local companies. Again, however, little detail is available on the nuts and bolts of how the patents will be licensed.

The real headlines have been made by electronics giants Samsung and LG. Through its electronics-focused centre in Daegu, the former has made a total of 38,000 patents available, specifying that 3,400 of these will be royalty free. Samsung also publicised the fact that it is dispatching its own patent experts to consult SMEs on their own portfolios and provide a ‘matching service’ to help them figure out which Samsung-owned assets could help them to grow their business. In a unique move, it has also indicated that it will reinvest some portion of the income it gains from licensing patents through the innovation centre into the local SME environment.

Not to be outdone, LG is ‘opening up’ 52,000 patents through the innovation centre in Chungbuk, which covers cosmetics, biotechnology and energy solutions. Some 47,000 come from LG companies, while the remaining 5,000 are from government-funded laboratories. About 10% of the portfolio – 5,200 assets – is available gratis. JuSeong Ryu, senior manager in the IP centre at LG Electronics, explained that more than 10 LG affiliates contributed patents to the effort, although the majority are owned by its electronics division. Display, chemicals, beauty, bio and energy are also reflected in the portfolio, which includes Korean and US patents, as well as a range of European assets and some covering other jurisdictions.

When it comes to those eye-popping headline figures, however, it cannot really be said that the patents have been ‘opened up’ so much as publicised and brought to the attention of SMEs. Ryu says of the fee-bearing assets (which make up the vast majority), “We are willing to negotiate licences to these patents.” The terms of any licences offered to Korean start-ups, though, will not necessarily be any different from those offered to other companies. Ryu explains that these particular assets were selected because they cover subject matter that may be relevant to companies using the innovation centre; he also stresses that the patents are not being offered up because LG no longer has any use for them. “These patents are still valuable to LG, but in our opinion they can help venture companies as well,” he states. “Some may be less valuable than before, but can still be beneficial to SMEs.”

LG sees the move not as a giveaway, but rather one that should also return value to its own shareholders. “We think about it in terms of CSV: creating shared value,” continues Ryu. “If Korean SMEs and venture companies can get the support they need, they can co-work with other companies like LG by coming up with some new component, method or process. We can also cooperate with them to achieve cost savings or expand Korean companies’ business with them together.” It is obviously still very early days, but Ryu hints that the company could be publicising some success stories early next year. In the meantime, full-time staff from LG are still counselling SMEs that come to use the centre on how they can get the most out of the available IP assets.

Driving deals

When a government really puts its weight behind an economic initiative, plenty of media attention and buy-in from the corporate sector are usually guaranteed. But in Korea, beyond the vaunted creative economy innovation centres and their chaebol partners, a private-sector ecosystem aimed at helping start-ups to strengthen their patent portfolios is also slowly but surely developing. While they cannot promise to secure free licences from the conglomerates, these intermediaries are assisting Korea’s SMEs in developing their own intellectual property with a view to brokering relationships with bigger players down the road.

Although there is much talk about easing South Korea’s reliance on the chaebols, the reality is that they are not going away any time soon. It is thus a fact of life for start-up founders that their best possible endgame may well be an acquisition. If a start-up gains access to patents through an innovation centre and then does something new and interesting with them, that is a good signal that it might be worth investing in and partnering with. But if a start-up generates its own intellectual property, this presents even more opportunities.

Ryu confirms that for Korean companies these days, patents are one of the most important considerations in any M&A transaction: “Most of the big companies always think about three key points – marketing, technology and patents.” This is most apparent in transactions involving other major enterprises, such as when LG Electronics acquired assets relating to the webOS operating system from HP two years ago; obtaining licences to patents originally owned by Palm was reportedly a crucial aim of the deal. But Ryu says this also holds true when LG Electronics considers investing in a new company with a much smaller IP portfolio.

VCs get IP smart

However, while many start-up founders recognise that intellectual property can further their cause, a lot of them just do not have the necessary means to develop it. So says Sungjae Hwang, co-founder and chief creative officer of FuturePlay, a start-up building company in Seoul that combines the roles of incubator, accelerator and venture capital firm. “Early-stage start-ups do not have any resources for filing patents,” he adds, “but we can help them to build a strong IP structure.” FuturePlay’s ‘Lean IP’ model allows start-ups to obtain relatively low-cost patents on viable concepts and then, through many rounds of evaluation and prototyping, to turn them into strong, transferable technology. The firm also assists its 18 portfolio companies with patent mapping, a crucial step in Korea. Given the sprawling IP portfolios owned by Korean conglomerates, it is no small task to identify a technology area in which a new company has enough freedom to operate and innovate.

And filing for patents is just the first step; even if start-ups succeed in creating intellectual property, they may not have the nous to realise its full value. “Start-ups usually don’t know how patents apply beyond their own business model,” says Hwang. By that same token, chaebols do not always have a comprehensive understanding of what viable technologies are out there in the start-up ecosystem and available for potential acquisition. Hwang believes that if conglomerates and entrepreneurs are going to collaborate to their mutual benefit, they need an intermediary who knows both types of business very well, noting: “The government doesn’t necessarily understand what the best way to help start-ups is”.

Interest in these services from the chaebol side is growing. Traditionally, such companies have focused on developing intellectual property in-house, and patent transactions have been difficult and infrequent. “But now outsourcing of IP is increasing because the tech cycle is speeding up and it is harder for big companies to catch up to new technology,” says Dongsuk Bae, executive director of Intellectual Discovery (ID), the firm that manages Korea’s first sovereign patent fund. Hwang has also observed a shift: “Companies like LG and Samsung are taking some creative and experimental approaches; they are interested in our effort and want to know what start-ups are working on and whether they can be viable.”

Failure is a constant in the entrepreneurial world. But something else that many Korean company founders may not realise is that, even if their business turns out not to be viable, the intellectual property it has generated may still be useful. Hwang – who has sold his own patents to companies including LG, Samsung, Apple and various non-practising entities (NPEs) – told IAM that a company in which FuturePlay had invested recently went out of business. However, the firm was able to recoup some of its capital by selling the patent portfolio to a large Korean player.

FuturePlay’s model of a start-up building company focused on IP sales is as yet unproven; but even mainstream venture capital firms in Korea are paying more attention to patents. “Five or 10 years ago, it would have sounded strange for a VC firm to hire a patent attorney,” says Bae; “but today they are hiring more and more IP experts to evaluate the assets of tech-driven companies.”

New options in start-up finance, new model for IP funds

Most start-up founders would probably agree that while IP assets are a nice thing to have, what keeps them up at night is ultimately venture funding. ID is trying to show that there can be a strong link between the two in the Korean context.

Like FuturePlay, ID is trying to pioneer the model for a Korean venture capital firm that makes patents central to both its investment decisions and the services it provides to start-ups. Subsidiary Idea Bridge Asset Management has also introduced a financial product for IP-based funding of start-ups that is new to the Korean marketplace. Known as ‘sale and license back’ (SLB), it is essentially a method of collateralising a start-up’s patents (see Figure 1). The IP assets will be transacted to Idea Bridge for a lump-sum payment. The usual term is three to five years; during that time, the start-up will pay an annual licensing fee to ID Ventures for use of the technology, which in practice acts as a kind of interest rate. In the meantime, Idea Bridge can also collect licensing fees from third-party companies, provided that the borrower does not want an exclusive licence. After a pre-determined time, the borrower can exercise an option to repurchase its patents. If not, they are added to ID’s trove of IP assets.

Figure 1. Sale and license-back

http://ibridgefund.com/page/en3_01.php

Source: Idea Bridge

At present, most of the financial support for this scheme comes from the Korea Development Bank, but 20% to 30% is provided by commercial banks. “We hope we can enlarge the portion of investment coming from the private sector,” says Bae. This, of course, will require evidence that this patent-backed finance does not just help SMEs, but also makes money for lenders: “We have to prove that our business model not only meets political purposes, but can also be commercially profitable.”

Idea Bridge also participates in more traditional equity investments, leveraging its resources as a patent fund to improve a company’s IP portfolio. “Usually, SMEs do not have enough IP expertise inside the company; so once ID Ventures invests in a company, the IP experts from the parent company will help them add value through analysing their portfolio and generating additional IP,” explains Bae. He points to a company which manufactures key components for smartphones as a success story in this mould. About a year and half ago, Idea Bridge invested a few million dollars in the business, which specialises in wearable computing technology. Having beefed up its IP portfolio, the venture has managed to secure high-quality clients, including a global smartphone manufacturer, which last year named the company its ‘vendor of the year’. Thus far, the company’s valuation is making the deal look like a financial win for ID and its subsidiaries.

Of course, while IP-focused investment models begin to emerge in Korea, they have fallen on uncertain times in the United States. Writing on the weakened US IP system in the last issue of IAM, David Kline observed: “Most venture capitalists will still want to see that a start-up has patents before investing in it. However, given today’s new IP realities, they will probably discount the value of that IP protection and the value of the start-up itself.” Bae points to a range of publicly traded IP companies and other NPEs based in the United States that are struggling to adapt to the new patent environment there: “The IP business as a whole is not doing so good. We may need to consider revising or restructuring our business model in the future. But the fact that we have two very functional subsidiaries that are able to make a profit in the VC sector is a promising sign.”

Figure 2. Centres for creative economy and innovation nationwide

Source: Korea JoongAng Daily

Government initiatives a start, but not enough

It is still too early to judge the merits of the creative economy initiative, as the first centre to be established is barely a year old. The final centre was opened in July 2015; at the time, the government announced that 250 start-ups and 175 other SMEs had already benefited from either investments or tech transfers through the centres. Its aim is to support 5,000 companies by the end of 2017 with the ₩1.8 trillion ($1.6 billion) in funding that has been pledged so far. But there are many reasons for cautious expectations. This is not the first time that the Korean government has attempted to boost SMEs and start-ups; previous initiatives aimed to promote innovation, start-ups and ‘next-generation growth drivers’, but none of these survived the administration that proposed it.

Others have suggested that splitting the various centres among the provinces and conglomerates will prevent the creation of a true cluster effect and make more open approaches impossible. Indeed, a July 2015 report in the Korea JoongAng Daily found that while urban innovation centres were humming, some of those in the provinces were ghost towns. Equally worrying, an unnamed chaebol executive told the paper that his particular company was participating in the initiative mainly due to “visible and invisible” pressure from the government, and regarded its participation as a sort of “donation”. The executive also hinted that in some circles the centres are expected to be around for only a few years.

Other concerns highlighted by Korean media include overlap with other programmes designed to spur growth. For instance, the Ministry of Trade, Industry and Energy has kicked off a technology-sharing project with some of the same companies, including Samsung Electronics and Hyundai Motors. There are also government-backed ‘techno parks’ all over the country – in fact, several of the new creative economy innovation centres are housed in existing techno park campuses. A local government official in Jeju said: “Jeju Techno Park is already struggling with a shortage of human resources and financial support, and when the government injects funds into the creative economy centre, the situation with the techno park will get even worse.”

Ultimately, however, Korea’s start-up economy will stand or fall on its own merits, not on the strength or weakness of government initiatives. In the mobile space, which accounts for 11% of the economy, SMEs are already growing and adding jobs faster than the conglomerates, according to a recent report from Boston Consulting Group. The same study pointed at Qualcomm’s co-development efforts with Korean partners as a model for successful collaboration, suggesting that the chaebols may have some catching up to do in this area. The latest big foreign company to get in on the action is Google, which recently opened a start-up community ‘campus’ in Seoul, the only Asian location for this initiative so far. It is a potent reminder that there are lots of potentially valuable start-up ideas in Korea’s tech community; and if the local government and chaebols cannot adapt to take advantage of this, foreign companies and venture capitalists will reap the benefits.