Assessing Venture Capital Investment
Recently, public controversy has arisen regarding investment losses experienced by the community in venture capital, which have subsequently been classified as acts of corruption. In reality, not all investment failures in venture capital legally fall within the realm of corruption.
This article does not refer to any specific case. Instead, it aims to discuss the business model of venture capital and the characteristics of the business risks inherent in that model.
In legal construction, the venture capital business model consists of investment companies that provide funding for startups or small businesses with high growth potential. In exchange for the funds provided, investors receive equity ownership in the company. Thus, the object of venture capital investment is startups that carry significant business risks.
Startups are newly established companies in the development and research phase, seeking to find the right market. In other words, startups are fledgling companies that have not been operating for long. The term ‘startup’ is often associated with new companies in the technology and information sectors, which indicates that the risk of investing in startups is very high.
Venture capital is an investment-based company that invests in startups. In this regard, investors play a vital role in the growth of startups. Investors are needed by startups for various purposes, ranging from initial capital to expansion. Typically, startups are founded on brilliant ideas but often face capital constraints. Consequently, venture capital also serves as an incubator for startups.
Venture capital acts as an incubator aimed at assisting startup development in the early stages. These programmes usually consist of training, mentoring, and funding. By participating in an incubator, startups can learn how to manage and develop their business models, as many startups possess brilliant ideas but suffer from weak management. This guidance continues until the startup business is deemed stable and ready to expand independently.
High-Risk Investment
The principle of investment law applicable to the venture capital business model is ‘high risk, high return’. In fact, the ratio commonly found in venture capital investment is said to reach 1 to 3, meaning that out of four funded startup investment projects, one succeeds and three fail.
This is understandable because startups are unproven and newly built. Therefore, venture capital firms, through conditional investment agreements, usually demand sufficiently high returns given the very high investment risks.
If investment failure in startups is viewed as a form of corruption, it would set a worrying precedent for the management of government-owned venture capital or those in the form of State-Owned Enterprises (BUMN). It must be understood that venture capital is closely linked to losses; in the sense that many investment projects managed by venture capital experience losses.
There are three essential elements in assessing whether a condition qualifies as a risk. First, whether the condition was expected or unexpected by the parties. Second, whether the condition was anticipated by the parties at the time the agreement was made; if it was anticipated, it means the parties have included the risk factor in the agreement. Third, whether the condition was beyond the parties’ anticipation based on their best knowledge.
The terminology of risk in business losses cannot be applied broadly and must be assessed based on the specific conditions and characteristics of each business. However, risk must be recognised as an inseparable part of business and investment activities. Therefore, if it can be proven in the future that a condition or loss is a consequence of reasonable business risk, the resolution should be handled through civil mechanisms.
The Business Judgment Rule (BJR) doctrine has recently emerged frequently in various arguments within criminal proceedings. The BJR legal doctrine is actually a corporate law doctrine used to release business managers from legal liability in the event of losses.
The essence of the B/JR doctrine is simple: ‘business’ means using the best measures for the interest of the business, and ‘judgment’ means that the assessment or decision was made based on the needs or for the good of the business.
The metric in BJR is whether a decision was made based on proper considerations and actions for the business interest. This assessment is conducted based on the conditions and information available at the time the decision was made, rather than using the conditions after the loss has occurred as a basis to judge the decision.
This means that, in this context, corruption provisions can only be applied to venture capital managers if the loss was intentionally created or occurred because the managers intentionally failed to anticipate risks that should have been foreseeable. Similarly, it applies if the actions causing the loss were performed unlawfully to provide benefits to another party.
The determination of loss qualification must also be done carefully because a loss occurring at a specific time is not necessarily permanent. The value of a startup may increase in the future, or there may be investors willing to perform an acquisition at a higher value than the investment costs incurred by the venture capital. In the rulings of the Constitutional Court (MK), it is stated that losses in corruption crimes must be real and…