A meeting between a venture investor and a startup. [Korea Venture Capital Association]
A meeting between a venture investor and a startup. [Korea Venture Capital Association]

Startup founder in rehabilitation faces 1.2 billion won personal debt from 500 million won investment

Korea SME Institute: investment losses belong to investors; distinction from loans must be clear

Stock purchase rights, penalty clauses create blind spots even where joint liability is restricted

In 2017, the founder of a startup — identified only as CEO A — received 500 million won ($332,000) from a financial institution. The funding was not a loan but an equity investment through the issuance of redeemable convertible preferred shares. When the company entered rehabilitation proceedings due to financial difficulties, however, the investment came back to haunt the founder personally. A contract clause gave the investor the right to sell the shares back to CEO A at a price equal to the original principal plus 15 percent compound interest. The amount CEO A owed came to 1.2 billion won. The Supreme Court issued a final ruling in April ordering CEO A to pay the investor 1.2 billion won.

In a separate case, startup B raised funds by issuing redeemable convertible preferred shares to 13 investors. The contract stipulated that if the company entered rehabilitation proceedings without investor consent, both the company and its CEO would pay a penalty equal to the original principal. The Supreme Court found that a company's guarantee of a specific investor's principal could be void as a violation of the equal-treatment-of-shareholders principle — but ruled that the CEO's personal liability remained. The implication: even an agreement void as a company obligation can survive as a personal debt if the CEO individually promised to make the payment.

In both cases, the funding was structured as investment rather than a loan, yet once the companies ran into trouble, the losses fell entirely on the founders personally. Equity investment is a financial arrangement in which investors share in the upside when a company grows and absorb losses when it fails — but when a contract includes a CEO's obligation to buy back shares or a penalty clause, the investment effectively becomes the founder's personal debt. Legal circles at the time flagged the issue as a potential deterrent to entrepreneurship.

The liability that slips through the gap between investment and loans

The Korea Institute for Small and Medium Enterprises and Startups (Korea SME Institute) said in a report on overseas venture finance liability structures, published Monday, that the attribution of responsibility between investment and lending must be clearly distinguished. According to the report, because investment supplies capital by acquiring equity in a company, the investor bears both the gains and losses tied to the company's performance. Investors carry limited liability up to the amount of capital contributed, and the principle is that they lose their investment if the company fails.

Lending, by contrast, supplies capital on the premise of principal and interest repayment. Regardless of the company's performance, the borrower bears the contractual obligation to repay, and collateral and a personal guarantee from the CEO may be attached to secure debt recovery. Han Seong-yeon, an associate research fellow at the Korea SME Institute, said: "In investment, losses are attributed to the investor, whereas in lending, the borrower bears the repayment obligation. The distinction between the two is a standard that enhances clarity in liability attribution and predictability in financial transactions."

Efforts to reduce founder liability in South Korea have continued steadily. In 2018, the government revised the Fund of Funds standard articles to restrict the practice of making founders jointly liable for a portfolio company's obligations in the absence of willful misconduct or gross negligence. In 2022, the Venture Investment Act was amended to establish a legal basis for limiting third-party joint liability, allowing exceptions only when the investee company committed gross negligence — such as misappropriating funds.

The problem lies in the gap between the rules and reality. In actual investment contracts, clauses that impose separate obligations on founders — without using the term "joint guarantee" — have been widely used. Common examples include stock purchase rights triggered by a company's rehabilitation or bankruptcy, put options borne directly by the CEO, penalty clauses tied to the original investment principal, and independent debt obligations assumed separately from the company.

In the case of CEO A, whose Supreme Court ruling was finalized this year, the investor never demanded a joint guarantee on the company's debt. Instead, the financial institution argued that a separate contractual stock purchase obligation had arisen for CEO A personally. Even when joint liability restrictions are in force, if a contractually equivalent clause is recognized as an independent debt, the founder's personal liability survives. The Supreme Court agreed, leaving CEO A with a debt more than double the original 500 million won investment.

Han Seon-yeong, an associate research fellow at the Korea SME Institute, said that while contracts requiring founders to assume all of a company's obligations have become less common recently, agreements signed before the restrictions took effect remain active and are materializing during rehabilitation and bankruptcy proceedings. The contract at the center of this year's Supreme Court ruling was signed in 2017, before restrictions on joint liability in venture investment were fully established.

[Korea Institute for Small and Medium Enterprises and Startups]
[Korea Institute for Small and Medium Enterprises and Startups]

UK bans home collateral; Japan offers startup loans without guarantees

Major economies have designed specific rules governing the scope and adjustment of personal guarantees even when they are attached to loans. According to the Korea SME Institute, venture investment contracts in the United States and the United Kingdom place investor protections in contractual rights and governance structures — voting rights, board composition, priority rights and equity arrangements — rather than in a founder's personal obligation to repay principal. The National Venture Capital Association in the US and the British Private Equity and Venture Capital Association both use standard-form contracts to define investment terms and investor participation rights in management.

The UK's Coronavirus Business Interruption Loan Scheme prohibited lenders from requiring personal guarantees on loans of 250,000 pounds or less. For larger loans, the amount recoverable through a personal guarantee was capped at 20 percent of the outstanding loan balance. Lenders were also barred from taking a CEO's primary residence as collateral.

Japan introduced its "Management Guarantee Guidelines" in 2014, requiring financial institutions to explain the necessity and appropriateness of any personal guarantee demanded from a CEO, and establishing that guarantees should not be required from companies where the assets and accounts of the legal entity and its representative are clearly separated. A management guarantee reform program introduced in 2022 included a credit guarantee scheme exempting companies within five years of founding from CEO guarantee requirements. The program also provides a procedure for negotiating guarantee debt adjustments with financial institutions — rather than going through court bankruptcy — after a company fails, allowing the CEO to retain a certain level of personal living assets.

In the United States, Small Business Administration guaranteed loans generally require a personal guarantee from any owner holding a 20 percent or greater stake. The guarantee obligation is limited to those meeting the equity threshold, and after a company fails, debt burdens are adjusted through bankruptcy and restructuring procedures.

The Korea SME Institute said that while the design of these systems varies by country, the principle of limited liability is maintained in the investment sphere, and a common structure emerges in which approaches to managing personal liability differ in the lending sphere. The institute said this suggests that the design of liability structures plays an important role in the stability and predictability of financial transactions.


hong@heraldcorp.com