Venture Capital Law in Cambodia: Engineer the Regulatory Framework to Promote the Startup Ecosystem

Abstract

As the startup ecosystem emerges, Cambodia requires a distinct set of legal frameworks to promote many regulatory aspects to boost national innovation and strengthen the connection of key players in the ecosystem. One of them is financial support for startups, ‘Venture Capital Law’. Therefore, this paper studies the current existing legal framework of Venture Capital (VC) in Cambodia, key bottlenecks that VC encountered, comparative analysis with other countries such as the United States, Japan, and China, and then propose new regulatory frameworks which solve the key bottlenecks and aim to optimise the growth of a startup ecosystem. The finding is that different stages of VC present different bottlenecks such as fundraising (funding source), startup investment (investment readiness of the startup, and deal structure), and exit (immature the capital market for startup's IPO and lack of regulations for Merger and Acquisition (M&A)). The new regulatory frameworks should endorse the use of pension funds as a source of VC funds in the future, encourage private corporations to invest in startup causes, include regulations to promote the readiness of founders, encourage the use of convertible notes, and fasten the regulation governing M&A with the balance of antitrust law.

Venture capital, which originated in the United States (US), is a form of financing that provides funds to early-stage startups, small businesses, and emerging companies with high growth potential.¹ Unlike other types of financing, the venture capitalist (VC) provides not only financial but also managerial and networking support to the startup founders. This form of financing is recognised as a powerful driving force for national innovation, job creation, and economic growth.² Curiously, Cambodia is still relatively new to the concept of venture capital despite the tech startup ecosystem emerging several years ago. Currently, there is no specific law on monitoring and promoting venture capital and startups yet. On the other hand, the US pioneered the VC and startup regulation in 1959.³ Thereafter, many nations, such as Germany,⁴ Australia,⁵ Japan,⁶ China,⁷ and Singapore,⁸ tried to replicate the system. Some replications worked well, while others unfortunately led to disasters.⁹ Therefore, with the startup wave just arriving in Cambodia, what regulatory framework can the government prepare to support the flourishing of this VC-startup trend?

This article will seek to explore the engineering of the VC community from a regulatory perspective, and propose a supportive policy and regulatory framework to promote the flourishing of this VC-startup trend. Specifically, the article seeks to answer three main questions:

1. 1. How do the current regulations in Cambodia affect VC activity?

2. 2. What are the current bottlenecks for VC in Cambodia?

3. 3. What could possible regulatory solutions be for the VC community?

First, the article focuses on the current regulatory framework that monitors investment activities in Cambodia. It starts with a short history of the nation and then explains how the nation bootstrapped its economy before discussing the need for venture capital in Cambodia. Subsequently, it scopes down to current legal frameworks that are particularly important to venture capital, namely corporate law, tax law, and other laws. This section will end with three major reasons of why the government and legislators should put effort into engineering the concrete regulatory framework for VC. Lastly, it divides VC activities into three stages: formation, investment, and exit. In each stage, the regulatory bottlenecks will be analysed with comparison to the US, China, and Japan; and finally, the author will propose the regulatory framework that best fits Cambodia's situation.

Current Investment Regulatory Regime in Cambodia

After two decades of civil war from 1970 to 1990, Cambodia fell to ‘ground zero’. The infrastructures were destroyed. Many educated people were lost. Ultimately, Cambodia signed the Paris Peace Agreement in 1991 to stop the war, and initiated the rehabilitation process. In 1992, the United Nations Transitional Authority in Cambodia (UNTAC) worked on the Constituent Assembly elections to ensure a free and fair process. As Cambodia had just woken up from a long war, globalisation and regionalisation arrived at the nation's doorstep. From ‘ground zero’, this fragile post-war nation had to restore the situation in multi-sectors including agriculture, education, tourism, manufacturing, technology, and more. Then, the country had a choice: whether to keep a closed door and start building everything from scratch on its own, or to open the door and take advantage of globalisation by allowing foreign investors to enter and develop businesses on the territory. Each choice had its costs and benefits. However, with the right policies, the nation might catch up with richer nations.¹¹

In 1993, the new Constitution was adopted to set Cambodia as a kingdom of democracy and pluralism,¹² with a market economy system.¹³ Many regulations were established in the aftermath of the civil war to attract foreign investors. The Law on Investment (LoI) was established in 1994 and then got amended in 2003.¹⁴ The amendment opened the nation to potential foreign investment by establishing an investment licensing system to regulate the approval process for foreign direct investment (FDI) and create incentive packages¹⁵ to attract potential global investors. Looking at the effects of this law on the actual economy, the annual FDI from 1994 to 2004 is seen to barely hit USD 150 million; however, after 2005, the FDI grew from USD 131 million in 2004 to USD 3.6 billion in 2019 (see Figure 1). This increase in FDI suggests that Cambodia has an open policy to foreign investors, and that the amendment of the LoI in 2003 did create a positive impact on the economy.

Figure 1. Cambodia's Foreign Direct Investment, net inflow

Source: World Bank Data¹⁰

While FDI attraction has been a great starting point to boost Cambodia's economy until recently, it is time for the nation to take further steps¹⁶ by enabling the untapped local talents to reach their potential. This simply means that new policy should strengthen and encourage local human resources to be the backbone of the economy rather than relying mainly on foreign investors who may pull out of the country when there are some adverse situations. In the last 20 years, the youth in Generation Z has had the opportunity to take proper education locally and internationally. This proper education and some professional experiences are a great reservoir for the local talent to break the norm by starting their businesses with breakthroughs and ultimately boosting the national economy from within. With a population of 17.2 million,¹⁷ the internet penetration rate abruptly jumped from 6.8% in 2013 to 78.8% in 2022.¹⁸ Since the 4G LTE network was introduced to the nation in 2014, tech businesses have begun to emerge. In 2018, more than 300 active technology startups were operating in the kingdom.¹⁹ In late 2020, Cambodia successfully trialed the first Standalone (SA) 5G site reaching a speed of 1.6 Gigabits per second (Gbps).²⁰ This will create a core infrastructure for more internet-intensive startups in the future.

Nevertheless, based on the report of ‘Cambodia's Ecosystem for Technology Startups’²¹ in June 2022, early-stage startups reported having difficulties raising funds.²² This statement emphasises that financial support is the common bottleneck for most founders around the world for startups. Due to its high-risk characteristic and lack of collateral, startups usually have difficulty getting financial support. That is where venture capital comes in and provides financial support, validates the business model, liaises with the startup to the potential network of partners, and, most importantly, assists founders in the business direction. More than just being a fund provider, VC also catalyses startup success through industry knowledge, networking, and management support.²³ However, only 1 in 10 startups in Cambodia received funding from the VC.²⁴ Given the stage of market development, Cambodia only has several VC funds available.²⁵ Those funds are invested differently based on the stage and field of the startup.²⁶

Although there is no specific law to regulate and promote VC activity yet, the existing business-related regulations generally still influence the VC market. The following section will discuss the VC regime under current regulations.

Current Venture Capital Regulation in Cambodia

Despite the absence of a VC law in Cambodia, its relevant rules are scattered in various laws, mainly the Law on Commercial Enterprise (so-called Company Law or LCE), Trust Law, and Tax Law.

Company Law

Cambodian Company Law consists of 8 chapters.²⁹ This law mainly governs the structure of the partnership or company, its registration procedure, compliance, and some miscellaneous issues.

This law regulates how VCs establish themselves legally. Based on their Company Law, there are three main types of structure such as a sole proprietorship, partnership, and company. To be recognised as a legal company, the VC has to file a registration application with the Cambodian Ministry of Commerce (see Table 1 for registered VC companies).

Table 1. The structure status of some VCs in Cambodia²⁷

Meanwhile, it is interesting to note that the Limited Liability Partnership (LLP) structure is a popular structure to set up VC funds in the top VC nations like the United States, China, and Japan. The Small Business Investment Act of 1980 in the United States originated this business structure of ‘limited partnership’, which then significantly contribute to the boom of venture capital between the 1980s and 1990s.³⁰ This structure increases the choice of funding sources without conflict of interest with the parent institution (institutional VC), enhances the flexibility to structure adequate compensation or incentive packages for VC, provides the benefit of pass-through tax compared to corporate, and has the limited life and liability of investors.³¹ Usually, under this form, the general partners have complete control over investment decisions, while the limited partners are restricted from daily operation.³² Seeing this, Japan³³ and China³⁴ also established a similar form imitating the US limited partnership. It did not work well at first (as explained in footnote 34); however, the condition has been improved after some revisions to the regulation.³⁵

Fortunately, Cambodia has already had a similar form of LLP in place since the inception of the LCE in 2005. ‘Limited Partnership’, in chapter 2 (Part II) of the LCE, is defined as ‘a contract between one or more general partners who are the sole persons authorised to administer and bind the partnership, and one or more limited partners, who are bound to contribute to the capital of the partnership.’³⁶ The next step is to see if this form realises the spirit of the US Limited Liability Partnership or not. First, there are two key differences between the general partner and the limited partner – the degree of liability and management obligation. The limited partner must contribute money or property to the partnership, and his/her liability is only to the extent of that invested money and property.³⁷ On the other hand, general partners’ liabilities are extended to that of the partnership to the third parties jointly and severally.³⁸ This unlimited liability of the general partner might be due to its non-inference management right to the partnership fund.³⁹ In a VC's Limited Liability Partnership, the general partner is the VC who manages the fund and decides which startup company to invest in. The limited partner, in this VC case, are the fund investors. The investors have no discretion in fund management. If the investors violate this rule and join the management, their liability may extend to the obligation of the partnership resulting from the acts.⁴⁰ If the frequency of involvement indicates that the limited partner acted as a general partner, the liability will extend in the same manner as the general partner.⁴¹ These two critical differences between limited partners and general partners encapsulate the US Limited Liability Partnership's key spirit, which is limited investor liability. Unfortunately, the benefit of pass-through tax is unlikely to be applicable for Cambodia's VC Limited Partnership because of the tax on capital gain⁴² that the General Department of Taxation in Cambodia will implement from 2024 onward (see below for further explanation).

Tax Law

The most relevant taxes for the VC are tax on capital gain and tax incentives for small businesses. Tax on capital gain is significant because, during an exit, the capital gain from the investment will be the taxable subject. Tax incentive for small business also plays a significant role because startups usually go through an intense period of cash-burning, at least in the first few years. Therefore, the VC must understand how a startup should deal with the taxation aspects.

Tax on capital gain is a matter under Cambodian Law on Taxation and the Prakas ⁴³ No 346 on Capital gain tax. Capital gain, by the Prakas, is applicable when there is a sale or transfer of ownership rights.⁴⁴ In the case of a VC, this should occur when the VC sells or transfers the share in the portfolio company (the startup) and realises the gain.⁴⁵ The gain will be subjected to a fixed tax rate of 20%.⁴⁶ This rate was supposed to be put into force from 1 July 2020; however, it has since been delayed twice and will only be in force from January 2024.⁴⁷ Meanwhiles, for a VC company, this tax has already been in place in the form of income tax.⁴⁸

The tax incentive for small and medium enterprises was strongly advocated in Cambodia even before it became a reality on 2 October 2018 under Sub-decree No 24 on Tax incentives for small and medium enterprises in the prioritised sector (Sub-decree). This Sub-decree is enforced to stimulate local productivity and enhance job creation in Cambodia. This article will first seek to discuss how the Sub-decree defines Small and Medium Enterprise (SME) to see if the startup company is also subjected to this incentive, and then explain what the incentive is.

Based on Article 4 of the Sub-decree, the definition of small and medium revolves around (i) the number of employees in the company; and (ii) Annual Turnover or Asset, whichever is higher (see Tables 2, 3, and 4). However, not all SMEs receive the tax incentive; only SMEs that operate in the prioritised sector will be eligible for the incentive.

Table 2. Definition of Small & Medium Enterprise in the Agriculture Sector

Table 3. Definition of Small & Medium Enterprise in the Industry Sector

The definition of an SME was updated in January 2021,⁴⁹ with more specific terms based on different sectors such as agriculture (Table 2), industry (Table 3), and service and commerce (Table 4).

Table 4. Definition of Small & Medium Enterprise in Service and Commercial

The prioritised sectors include Research and Development (R&D) of information technology (IT), or the supply of IT-based service; agricultural products; food manufacturing or processing; manufacturing of a local product; waste recycling; tourism product; and enterprise located in the SME Cluster Zone.⁵¹ Therefore, whether the startup is subject to this incentive or not depends on three main factors, as explained above. If the asset, annual turnover and number of employees are within the threshold outlined in Tables 2, 3 and 4, and its operation is within the prioritised sectors, then the startup is availed to the incentive. Cambodian law does not draw a clear distinction between startup and SME; hence, until a clear position of the laws and regulations is established, its interpretation will be based on the competent authority (in this case, the ‘tax authority’). The next question is about the incentive scheme itself. Assuming that the startup is within the definition of SME and operating in the prioritised sector, what will be that incentive? Based on Article 6 of the Sub-decree, the startup can enjoy the exemption on income tax for three years for newly registered enterprises or from the date of tax registration update for the existing enterprise.⁵² The exemption period can be extended up to 5 years if the business meets one of the following criteria: (1) it utilises up to 60% local raw materials, (2) it increases the number of employees by at least 20%, or (3) it is located within the SME Cluster zone.⁵³ On top of that, there are incentives for deductible expenditure such as 200% weighted tax-deductible expense for IT-based accounting software and staff training; and 150% weighted tax-deductible expense for equipment or new technology that enhances productivity.⁵⁴

Trust Law

The concept of the ‘trust’, which generally exists in common law nations, also finds its way into this civil law nation. The Cambodian Trust Law was established and entered into force in 2018. Under this Trust Law, trust is classified into four categories: commercial trust, public trust, social trust, and personal trusts.⁵⁵ Trust activities include the transfer of the trustor's assets to the trustee for management, disposal, and maintenance for the interest of the beneficiary.⁵⁶ This trust concept is relatively new but has developed at a fast pace recently; as of the date of this article, it is still not clear whether all the VC funds shall be established and managed under this trust concept. Based on the definition above, it highly suggests that the trust law should apply to VC funds because the VC fund's investors (like a trustor) put their funds with the VC (trustee) to manage and generate profit for the beneficiary, which is the investors themselves. Therefore, this article assumes that trust law applies to VC funds, unless future laws and regulations clearly state otherwise.

The trust shall be made in writing and registered with the Cambodian Ministry of Economy and Finance (MEF).⁵⁷ The trustee who manages the trust shall undergo training with the MEF⁵⁸ and obtain the trustee license.⁵⁹ During the management of the trust, the activities of the trustee shall be made with care and prudence.⁶⁰

Miscellaneous laws and regulations

Pertaining to M&A regulation, it is vastly important for the VC because, at the end of the day, it governs the exit strategy of the VC. Presently, Cambodia has already put into force their anti-trust law, but still lacks ‘Merger Control’ law and other ministerial regulations (eg, Sub-decree and Prakas) to govern its specificity yet; most M&A governances are regulated under Company law or sectoral laws. The anti-trust law's purpose is to prohibit any acts that prevent, restrict, and distort competition.

Prior to proper registration of their business with the competent ministry (eg, the Cambodian Ministry of Commerce), startup founder(s) usually just kickstarted their venture project as individual(s) or natural person(s) by using their own moneys and/or loans from family and friends.⁶¹ In such a case, personal insolvency law can also affect the levels of venture capital finance because a ‘harsh’ bankruptcy regime may discourage the potential entrepreneurs that want to found their ventures. Further, if the entrepreneurs try but fail to prosper their venture due to unforeseen circumstances, market conditions or other reasons, the financial rehabilitation of bankrupt individuals will exclude those talented entrepreneurs from the start-up arena in future.⁶² John Armour has argued that the ‘severity’ of a personal insolvency law is based on three main factors: (1) the ability to return back to the marketplace free of obligations for a fresh start; (2) the range and restrictiveness of the disabilities imposed upon an insolvent person; (3) the level of exemptions (if any) of property from the estate.⁶³ In Cambodia, there is no specific personal insolvency law yet; however, the insolvency law which came into force in 2007 governs both businessmen and legal entities that own assets in Cambodia.⁶⁴ With respect to its severity of treatment of personal property, until further laws and regulations are put in force, the current insolvency law does not stipulate clearly regarding the ability to return back to marketplace for a fresh start, nor the restrictiveness of disabilities for the insolvent businessman.⁶⁵ Therefore, this can be subject to the actual court decision during the liquidation proceeding. However, the current law does allow some exemption to the estate of a debtor who is a natural person, such as a primary place of residence worth up to USD 5,000, and any other asset, right or claim exempted from execution against the debtor under the Cambodian Code of Civil Procedure, including a limit for salary⁶⁶ and other daily necessary items.⁶⁷

The above are just some overviews of the existing laws which regulate fund structure and taxation for VC. However, many other activities or potential growth of VC are still left unregulated or are not well-regulated yet.⁶⁸ A more strategic regulatory framework should be formulated, and some existing regulations should be revised for a VC to smoothly and optimally create a robust community to boost national innovation and economic growth.⁶⁹ A solid regulatory framework is essential to allow for the emergence and success of VC.⁷⁰ The engineering of the VC market should be prioritised on the agenda of government and legislators for three main reasons. First, the VC will then be able to meet the capital demand of startups and promote on emerging innovative causes to improve the national economy, as discussed earlier. Second, it will allow this financial tool (the VC) to achieve its optimal result for individual, institutional investors, and the VC themselves. Third, the growth of local talents will allow for a more sustainable economic approach.

Some of the activities in the VC market are still operating in a regulatory vacuum without a clear governing legal framework. This absence of regulatory oversight might lead to fraud and scandals in the startup community.⁷¹ On the other hand, with a clear strategic direction, the VC market can develop at a faster pace and reap better fruit for the startup ecosystem. To draft an effective regulatory framework, the government should first understand the activities of VC operations and discover the problems that legal tools could solve. The section below will explore the current bottlenecks for VC in Cambodia and its related regulations in greater depth.

Current Bottlenecks for Venture Capital in Cambodia

In order to engineer a successful VC market, Ronald J Gilson modelled a theory of ‘Simultaneity’ which states that a venture capital market requires (1) entrepreneurs; (2) investors with funds and taste for high-risk, high-return investments; and (3) a specialised financial intermediary.⁷² The market requires the simultaneous availability of all three factors where one may only exist with the availability of the other two.⁷³ In order to organise this section in chronological order, it classifies VC activities based on stages: the fundraising stage, startup-investment stage, and exit stage. Each stage has different challenges. The fundraising stage looks at the fund investor with a high-risk appetite (ie, requirement 2 of the Simultaneity theory). The startup-investment stage focuses on the investment readiness of the entrepreneur (ie, requirement 1 of the Simultaneity theory) and VC-startup deal structure (ie, requirement 3 of the Simultaneity theory). Lastly, the exit stage provides for the different routes for a VC to pull out, depicting the great incentive for a VC to select the great startups and assist them all the way to exit (ie, requirement 3 of the Simultaneity theory).

Cambodia's situation is not unique. There are many other developing nations that have gone through the same, or at least similar, issues and have attempted various approaches in designing their regulations to solve those issues. In fact, Cambodia has late-mover advantages and is able to study others’ experiences, solutions, and follow their blueprints, if applicable. As aforementioned, the US is the father of VC regulations that many other nations tried to replicate, and the US has already succeeded in boosting the startup economy to reap great fruit of results. China, moreover, has shown incredible results in recent years. This nation has replicated some regulations from the US, with some of them not leading to favourable consequences; however, China does not stand still but continues to architect additional law or amend the current one to deal with the issue quickly. Hence, this indicates a great lesson for Cambodia that would like to follow suit. Third, Cambodia's legal framework is significantly influenced by Japan's legal framework, unsurprisingly, since Japan assisted Cambodia in drafting the latter's current Civil Code.⁷⁴ Thus, as one of the top economic nations, the legal blueprint from Japan could serve as the starting point for Cambodian VC's legal framework.

This article will point out some main bottlenecks in each stage before conducting a comparative analysis of other countries such as the US, China, and Japan. Finally, it will propose legal opinions from regulatory standpoint.

Fundraising Stage

Like a startup that needs funding, the VC needs to do fundraising as well. In general, common bottlenecks that occur in this stage are the lack of funding source(s), investor accreditation, the discretion of the VC in an investment decision, and the VC's management fee. Since Cambodia is still working to build its venture capital community, this article is going to discuss only one critical bottleneck: the lack of funding sources for the VC's formation.

Currently, the source of VC funds is dominated by private corporations, eg, Smart Axiata,⁷⁵ Forte, and World Bridge⁷⁶. On the bright side, the corporation can provide tremendous support to the VC to find portfolio companies and train them. Additionally, the reputation of big companies under the belt also creates an excellent impression on the fund. However, when the source of funds is concentrated in a small group of investors, the VC's discretion to invest can easily be distorted due to the need to accommodate the private corporations’ interests.⁷⁷ This issue is a key bottleneck for VC to form their fund. In Cambodia, ordinary individuals and most companies still prefer traditional investments such as real estate.⁷⁸ Before proposing solutions to this issue, it is helpful to understand how other countries like the US, China, and Japan deal with the same issue.

First, the US does not rely heavily on private corporations as a source of VC funds. In the last ten years, the combination of the public and private pension funds has become the most significant source of funds, followed by the foundation as first runner-up, and then the corporate investor and insurance companies as second runners-up (see Figure 2 below). However, this situation did not come about organically. As is well known, the pension fund, based on the theoretical view, is supposed to be a low-risk investment. This pension fund is paid monthly by employees for years so that they can be financially supported for life when they retire. However, VC investment somehow does not carry this low-risk yet fixed-return characteristic that the pension fund aims for. In fact, it used to be illegal to invest pension funds into risky portfolios like VCs. Hence, how can pension funds become the top source of funds for VCs in the US today? Dated back to 1959, the American Small Business Investment Companies (SBICs) Act was established with incentives of government loans and tax benefits.⁷⁹ In the 1970s, the surge of VC development was visible but still hindered due to recession and a weak financial market.⁸¹ To boost this growth of VC to an optimal level, the legislature eliminated the ‘prudent man’ investment requirement⁸² and lifted the restriction of pension fund's investment in venture capital.⁸³ After this amendment, pension funds were allowed to invest in VC funds and ultimately became a leading source of investments for VC funds.

Figure 2. Investors in US-Based VC Funds by Investor Type (Vintages 2010–2019)⁸⁰

In Japan, the source of funding for VCs is mostly from private placement.⁸⁴ The most active investors are financial institutions (such as banks, insurance, and securities firms) and corporate investors (listing companies).⁸⁵ The Japanese Corporation also hands into the fund for open innovation.⁸⁶ The Japanese Small & Medium Enterprises and Regional Innovation (SMRI), which is the extension of the Japanese government, also takes a portion of the pie.⁸⁷ The Japanese Pension Fund, formerly banned from VC investment, has started showing positive interest in VC.⁸⁸

In China, from 2011 to 2017, the capital for VC is raised from listed companies, public pension funds, sovereign wealth funds, and investment companies.⁸⁹ Interestingly, in China, only ‘accredited investors’ are allowed to invest in VCs under the China Securities Regulatory Commission (CSRC) rules.⁹⁰

These three nations allow us to understand that many sources of the fund can be injected into the VC fund formation.

Viability of utilising pension funds as a source of VC formation

As discussed above, private corporations are not the sole source of funds but merely one of them. Understanding this is an important step forward; however, the key question is ‘can Cambodia utilise the same sources?’. Currently, the answer is ‘no’. US and China have the pension fund ready for VCs to use while Japan has big financial institutions and already shows great interest to amend the law to allow pension funds to be used for VCs. The problem with Cambodia is that the pension fund is not well established yet. A public servant has a pension scheme (usually known as retirement salary) directly from the government, while employees of private companies and informal economies usually save money by themselves. Despite the current absence of pension funds, the future might shed a glimpse of light on this. On 4 March 2021, the Sub-decree implementing a pension scheme in Cambodia (Sub-decree 32) was issued to oblige companies to register with the Cambodian National Social Security Fund (NSSF). All employees are required to register for the pension scheme within three days from the date of employment.⁹¹ The contribution by all employees in Cambodia to the social security scheme on pension commenced on 1 October 2022.⁹² This scheme will create a big pool of money for a pension fund in the next five or ten years. At that point, the pension fund could then be one of the sources that VCs can tap into.

However, the current Cambodian Trust Law⁹³ still requires the trustee⁹⁴ to manage the trust property (the pension fund) with care and prudence.⁹⁵ This leads to another question of whether the pension fund should be invested in a VC fund. This is a very critical question. As already discussed, it is allowed in the US, China, and Japan. Cambodia is still very new to the concept of a pension fund; its citizens, especially the members who contribute to the pension scheme, require more time to gain confidence in this pension scheme. If the fund is invested in VCs and fails to recover its principal, this will surely affect the mentality and confidence of the scheme payer. This article advocates that the trustee should first maintain the ‘prudent manner’ rule to gain confidence from its citizens. In future, when the startup ecosystem is more mature and supported infrastructures are in place, the ‘prudent manner’ rule could be lifted, and the pension fund could be allowed to be invested into the VC fund to maximise the potential return and fuel the innovation engine for the economy.

Private placement

Since the pension fund is not available shortly, the next alternative is domestic private companies and wealthy individuals. Many companies have their cash reserves invested in other instruments such as real estate or, in some cases, have been left sitting in their bank accounts with no use at all. Therefore, these cash reserves can be the new driving force to fuel the VC fund and ultimately innovation in the startup industry. There is already a trend in Cambodia that private companies allocate a portion of their budget to invest in VC funds. For example, the Smart Axiata Digital Innovation Fund (SADIF)⁹⁶ is a USD 5 million VC fund co-invested by Smart Axiata, a telecommunication company, and Forte Insurance. Another example is the Ooctane fund,⁹⁷ a USD 55 million VC fund backed by Worldbridge Group, a local logistic company. These initiatives represent a great starting point, but the future could be even better. Companies and individuals from other sectors such as the banking, insurance, logistic, investment, education, and transportation industries should also allocate their funds to the VC initiatives. This begs the question of how to encourage other companies to follow the same path.

For Japan, funding is largely from private placements such as banks, securities firms, and listed companies.⁹⁸ Compared to the US and China – which is usually funded mostly by pension funds and foundations – Japan shows a distinct characteristic. As a fast-growing nation of technological innovations, Japanese corporations with eyes on open innovation are increasing their interest in investing in VCs.⁹⁹ Also, the Japanese government introduced the ‘angel tax system’¹⁰⁰ to encourage investment in startups for wealthy individuals (see Table 5). The plan allows corporations to deduct 25% of the investment money on startup from their taxable income.¹⁰¹ This tax deduction is predicted to increase the investment fund for startups by at least JPY 100 million.

Table 5. Angel Tax Incentive¹⁰²

Despite bypassing the VC fund, this tax incentive lays a great blueprint for Cambodia to see how foreign nation motivates investment in innovation. While the investment in either startups or VCs is risky, a portion of the downside might be offset by these tax incentives as well. This article supports a similar tax incentive scheme to promote investment engagement from large corporations and wealthy individuals to VCs or startups in Cambodia. The other lesson that Cambodia can learn here is regarding open innovation. As mentioned, most corporations are engaging with startups due to knowledge or technology transfer. Therefore, the Cambodian government should establish a regulatory framework and policy to promote the industry-startup relationship and create a platform for them to connect. Once there is traction, corporations will ultimately see the potential value that startups can contribute to their corporations. This will further build trust and confidence for the big corporations to invest their money with VCs, and in turn invest in the startup.¹⁰⁶

Foreign funds

Lastly, the next alternative is cross-border investments. As a developing country, Cambodia utilises an open policy to create a friendly environment for foreign investors. Since the amendment to its Law on Investment in 2004, the regulatory tool has significantly driven FDI since 2005 (see Figure 1). This abrupt growth is a testament that the regulatory framework strongly influences the investment landscape in Cambodia. Under this law, foreign investors are allowed to have 100% ownership of the business. Moreover, it also allows the free flow of remittance.¹⁰⁷ This simply means that foreign investors can transfer the money to invest in Cambodia and do outward transfers of their gained capital and proceed from liquidation.¹⁰⁸ To smoothen the investment process, the process should be designed to reduce the red tape for compliance.¹⁰⁹

In this case, the regulatory framework is not the main attraction, but the growth potential of the local startups and innovation themselves is.¹¹⁰ The role of the regulatory framework should focus intensely on creating an ‘enabling ecosystem’ with a strong connection between key players including entrepreneurs, universities, industrial corporations, VCs, and incubators.¹¹¹ In late 2020, the Cambodian government partnered with 500 startups to create ‘Angkor 500’ to promote the startup ecosystem in Cambodia.¹¹² Cooperation with such a world-class VC firm also enables knowledge transfer and raises the global profile of Cambodia's startups. Until now, Angkor 500 has already trained batches of the startup acceleration programme.¹¹³

Startup-investment stage

After securing funding, the next step is to wisely choose which startup the money should be invested in. This section deals with two bottlenecks: the investment readiness of the startup and the deal structure. Simply put, it is about which team to invest in and how to invest in them.

Investment readiness of the startup

According to the report ‘Startup Kingdom: Cambodia's Vibrant Tech Startup Ecosystem in 2018’, challenges in the country's nascent startup ecosystem revolve around ‘investment readiness’ issues.¹¹⁵ This issue is critical; in fact, it is even more important than the VC's lack of funding sources. Although the number of VC funds has increased, real innovation's impact can still be hindered if the startup is not ready enough to receive investment. This issue could be seen as the Ooctane fund was scouting for ‘late-stage investment opportunities due to lack of quality deals in the early stages’.¹¹⁶ At the end of the day, all these VC funds can only impact the actual innovation growth if the startup is ready enough to claim the investment.

What does ‘investment readiness’ mean? Despite being repeatedly uttered by the VC and startup community, there is no agreed definition of the term yet in the Cambodian context.¹¹⁷ According to the Organisation for Economic, Co-operation and Development (OECD), this term can be explained based on three dimensions: equity aversion, investability, and presentational failures.¹¹⁸ First, equity aversion happens when entrepreneurs have a negative attitude towards equity finance,¹¹⁹ and when the entrepreneurs lack information about the financing source's characteristics and availability.¹²⁰ Second, it is the investability of the businesses that seeks financing. Investors usually evaluate the startup based on four main criteria: (1) the investor's investment parameter, (2) founding team, (3) market-related factors, and (4) finance (see Table 6 for details).¹²¹ Lastly, the third dimension is presentational failing. Sometimes the business model and market are promising; however, the ability of founders to pitch their business to an investor is not convincing at all. The common issues are the inability of a founder to demonstrate a strategy to attract sufficient paid customers to recoup the costs of business and a unique selling point. This poor presentation skill is interpreted by investors as a warning sign to invest: ‘if he cannot sell to investors, how can he sell to the customer?’; this rhetorical question is usually raised in this circumstance.¹²²

Table 6. Four main criteria to determine investability of the business¹¹⁴

Having defined ‘investment readiness’, it seems that all those bottlenecks are business issues rather than legal issues. Hence, how can government and legislators directly or indirectly catalyse the building of a startup ecosystem and innovation for VC investment? Table 7 utilises the three main criteria (founding team, market-related factor, and financial factor)¹²³ to propose the regulatory tools to promote a startup's investment readiness.

Table 7. Summary of a proposed regulatory framework to enhance the investability of the startup

To improve the presentation skill of the team, NGOs, universities, and incubators can play essential roles. Currently, in Cambodia, many business competitions aim to encourage university students to develop new innovative ideas and undergo an Entrepreneur Bootcamp.¹²⁷ The candidates get to learn what the investors want to see and practise their presentation skills as well. Currently, the conversion rate of a startup from ideation to investable business in the long term is not yet satisfactory.

Deal structure

In Cambodia, the startup fundraising process is still relatively new for most entrepreneurs.¹²⁸ To remedy the situation, investors play a role in educating entrepreneurs on various types of deal structures (eg, convertible note, equity, etc).¹²⁹ Basically, there is no one right structure for all types of deals because it depends on the parties' circumstances. In the VC-startup deal, the top two popular structures are equity investments and convertible notes. Equity investment is where the VC invests an amount of money in return for a percentage of stock (either common stock or preferred stock). The common stock exposes the investor to higher risk while the preferred stock is excessively time-consuming and involves costly negotiations.¹³⁰ Also, the startup that sells common stocks in seed rounds has a constraint to issue the stock option that limits its ability to incentivise key employees.¹³¹ Additionally, when using this equity structure, the key negotiation revolves around the valuation of the company where the startup founders ask for a high valuation and the investors try to lower the valuation down. In some unfortunate cases, this valuation negotiation might as well become a deal-breaker for both parties. On the other hand, convertible notes largely solve these problems.¹³² In essence, this structure is a corporate promissory note that converts into Series A¹³³ preferred stock when the startup reaches Series A financing.¹³⁴ This form allows the VC and founder to leave the valuation negotiation to Series A to avoid the increases in the appraised value of the company's common stock and allow the VC to get favourable terms given to Series A's investors.¹³⁵

In the US, the investment is usually divided based on stages or rounds to reduce uncertainties.¹³⁶ The preferred form of deal for seed-stage investments is not the common stock but convertible securities. In 2013, the startup accelerator Y Combinator introduced the new ‘Simple Agreement for Future Equity’ (SAFE), which offers a simpler and faster approach for the startup.¹³⁷ The usage of this agreement has been spread to many nations outside of Y Combinator.¹³⁸

Interestingly, Japanese VCs still prefer common stock rather than convertible notes, and they usually invest in seed-stage companies.¹³⁹ Preferred stock has gradually picked up the pace to surpass common stock in the past few years.¹⁴⁰ Despite not being mainstream yet, the convertible note has become an increasingly popular structure¹⁴¹ during seed financing in Japan, while the typical structure is corporate promissory notes paired with stock warrants.¹⁴²

In China, convertible preferred shares were not legalised at first.¹⁴³ To replicate convertible share characteristics, special contract terms such as a liquidation preference,¹⁴⁴ redemption rights, and anti-dilution protection came in.¹⁴⁵ At first, China's Company Law and Securities Law only recognised equity instruments like ordinary shares. The laws were silent regarding the preference share or convertible share and even stock option.¹⁴⁶ Then, the interim measure for the Startup Investment Enterprises¹⁴⁷ was added to set a clear ground that a ‘Venture Capital Fund may make investments in the unlisted enterprise by way of its stock rights, preferred stocks, convertible preferred stocks, and quasi stock rights.’¹⁴⁸ China amended the Company Law in 2005 by adding a new provision that allowed companies to repurchase their share under circumstances where the ‘company wants to reward employees by way of granting shares’ to pave the way for employee's stock options.¹⁴⁹

Currently, in Cambodia, there is no legal restriction on using this convertible note. The author advocates the use of this form in Cambodia's VC startup investment. Given that Cambodian startups are still small in investment size, the investment process should be fast, simple, and easy for both parties. The key benefits are to bypass the negotiation on valuation, to give more protection to investors, and to let the investors have more preferential terms when startups reach Series A financing. As mentioned at the beginning of this section, most founders are still very new to fundraising. To ensure fairness for both parties, the government can follow the footstep of the Y-combinator by creating a Cambodian version of SAFE¹⁵⁰ that balances the interests and obligations of both parties. This allows startups to have more faith in signing the deal as well. However, the VC also brings in non-monetary support such as management support, network, and business advisory. To realise the full potential of the VC investment, both parties can add the contractual rights regarding management rights into the convertible note's contract or SAFE based on their good-faith negotiation. As a more flexible alternative to the Cambodian version of SAFE, the competent authority may issue a Prakas to stipulate the minimum clause of the investment agreement for the VC-startup deal and, in the same Prakas, may impose some other conditions to ensure the fairness for both parties.¹⁵¹ In this way, the investment contract can contain a more standard clause while maintaining flexibility for the parties to negotiate.

Exit Stage

Unlike a limited corporation with infinite life, a VC fund is usually established within its limited time, approximately seven to ten years.¹⁵² At the end of its lifecycle, the general partner (who is a VC) will close the fund, and then the gain will be divided between the VC and the investors based on the terms and conditions outlined in the investment contract. The VC usually treats startups as an investment vehicle where they invest some money and provide some management support to drive up the venture value and then try to achieve a lucrative exit, hopefully with a good reputation. The performance of VC funds is measured by the valuation and the speed of portfolio companies’ growth.

Generally, there are four ways for VC to exit their portfolio companies: through an Initial Public Offering (IPO), trade sale, contractual buyback, or write-off. Among these four, an IPO and trade sale are the most popular exits for VCs in many countries.

Initial Public Offering (IPO)

Many studies worldwide have advocated the strong connection between the venture capital market and the capital market.¹⁵³ The IPO is the most profitable exit for both the VC and the startup (the ‘portfolio company’).¹⁵⁴ Moreover, this route also helps the founders regain control of the firm.¹⁵⁵ Despite these motivations for startups, not many startups successfully reach the stage of IPO.¹⁵⁶

Since its inception in 2012, Cambodia's stock market is still considered very young. There are only seven companies listed in the market.¹⁵⁷ All of them could be viewed as blue-chip stocks given their size and performance certainty. However, the stock price does not correlate to any news or activities of the business, which depicts the market's inefficiency. Moreover, the trading volume in the market is still small.¹⁵⁸ More time is needed to educate people and get people to invest in this capital market. Given this situation, is IPO still a viable exit for the VC in Cambodia? To better understand its viability, below is a further analysis of listing requirements and some other mechanisms in Cambodia's stock market.

The Cambodia Securities Exchange (CSX) classifies the listing applicants into two boards: the mainboard and the growth board. Looking from the perspective of listing requirements, the main board¹⁵⁹ might be a high barrier for startups due to low shareholders’ equity and profit uncertainty, not to mention the small number of shareholders. Although the growth board¹⁶⁰ sets a lower requirement standard, it might not necessarily be the right one for a startup yet. The good news is that this situation is not unusual compared to startups that want to go public around the world. This stringent requirement, especially the financial standard, is necessary to enhance investor protection and prevent underqualified companies from pursuing this route. Back in 2004, when China first launched its SME board, its stringent listing requirement¹⁶¹ had priced out most of the VC-backed startups due to the nature of its small portfolio startup companies.¹⁶² It was only in 2009 when the ‘ChiNext’ board¹⁶³ was launched on the Shenzhen Stock Exchange, with specific aims to attract firms in the high-growth and high-tech sectors as well as match the demand of startups with difficulties in securing financing. This board placed more relaxed requirements in terms of share capital and profit threshold.¹⁶⁴ As a result, within five years, the board facilitated 519 VC-exits.¹⁶⁵ Despite this inspiring record, this requirement still imposed difficulty for the startup that has yet to be profitable. Since the startup, especially in the high-tech industry, undergoes negative profit for a significant period, this board is believed to have attracted more traditional companies instead.¹⁶⁶

In 2013, China launched the National Equities Exchange and Quotation (NEEQ), known as the New Third Board (xinsanban). NEEQ is a national over-the-counter (OTC) market that targets ‘innovation-oriented, entrepreneur, and growing medium, small, and micro-sized business’ instead of mature companies.¹⁶⁷ This board requires the company to have valid existence for only two years.¹⁶⁸ Especially, there are no requirements on cash flow, net assets, or total share capital.¹⁶⁹ To ensure the protection of investors, this board only accepts eligible investors, and the market maker is there to coordinate the trading process. This board does not stand without any problems. There are many concerns raised such as the unintended attraction of many low-quality companies,¹⁷⁰ overvaluation of companies, manipulated supervision of market makers and extremely high volatility of price movement.¹⁷¹

In Japan, a Mothers board targets startups with high growth potential that aim to be reassigned to the Main Board in the near future.¹⁷² There is no profit requirement in this board that is best fit for high-tech startups; however, it still requires at least 150 shareholders and JPY 500 million of market capitalisation.¹⁷³ On top of that, there is a clause that obliges the founder to make a reasonable effort to go public within a certain period in some shareholder's agreement.¹⁷⁴

This comparison shows that listing requirements have installed a barrier to many startups from going IPO and reduced profitable VC exits. As seen, China solved this bottleneck with more relaxed requirements. For example, ChiNext with lower requirements and OTC markets like NEEQ established the no-profit requirement for eligible investors. This article, to some extent, does not advocate that the CSX follows this type of no-profit-requirement board at this point because of investors’ lack of financial knowledge and the risk tolerance in Cambodia to place their trust in these new startups. Unlike foreign investors in the US, Japan, or China, Cambodian investors are still learning about investing in the capital market. More importantly, they do not possess much money to absorb the loss like other nations’ investors yet. Therefore, Cambodia should take careful steps by building a solid capital market first, for at least five more years, before employing high-volatility instruments. At this stage, CSX must build investor sophistication and gain the trust of domestic and international traders to drive up the trade volume in this market first. Making the wrong move in the financial market will destroy the economy in just a blink of an eye. Cambodia's economy, despite having stable growth, is still very small; hence, the collapse or shake of its financial market will drastically affect its economy.¹⁷⁵ Last but not least, despite being the lucrative route for VCs, the IPO is not the only route for exit.¹⁷⁶ In any case, if the startup goes public with no attractive profits in its financial statements or user traction, the stock price will be hampered, making it no longer a lucrative route for the VC to exit.

Merger and Acquisition (M&A)

There is always a debate between scholars on the better exit for VC: an IPO or a M&A. As already discussed, an IPO is typically the most profitable exit for VCs and startups. However, its listing requirements and many other legal mechanisms (such as locked up agreement, duration of the listing process, and financial disclosures) are demotivating factors. A trade sale, on the other hand, is more straightforward, has less legal requirements, and is fast for the VC to realise their gains. A joint study by Harvard Business School and Dan Wang of Columbia University on more than 42,000 new ventures launched between 1982 and 2014 found that a startup funded by a VC who works with the same group of partners is more likely to seek faster exit by trade sale than a startup funded by a syndicated VC with less familiar co-investors; the latter is more likely to seek high-profile exit by IPO.¹⁷⁷ The choice of choosing between an IPO and a M&A is heavily based on more macro-factors including the legal framework surrounding the market, the developmental stage of the capital market, and the solidity of the capital market. In the US, more than 80% of exits are done through M&A¹⁷⁸ (see Figure 3). However, in China, more than 50%, except in 2013, are done through IPO instead¹⁷⁹ (see Figure 4). Most Japanese startups went for IPOs, while the remaining took the M&A approach in 2016. However, this trend has flipped since 2018.¹⁸⁰ Some large corporations have acquired startups as part of their expansion strategy or technological synergy.

Figure 3. US's VC Exits via IPO and M&A

Data Source: National Venture Capital Association¹⁸¹

Figure 4. China's VC Exits via IPO & M&A

Data Source: Zero2IPO & China Venture¹⁸²

Seeing this contradictory trend, which route would more likely be the future of VC exit in Cambodia? In the report ‘Startup Kingdom: Cambodia's Vibrant Tech Startup Ecosystem in 2018’, the survey showed that most investors believe exit opportunity is just a minor issue.¹⁸³ Even though the capital market is not robust yet, the trade sale to strategic acquirers and later-stage funds is considered a more direct path for exits.¹⁸⁴ Despite this, there is currently no major development in Cambodia regarding startup exits through M&A, and the current situation gives rise to legal ambiguity for such transactions. To date, there is no law specifically governing M&As.¹⁸⁵ Therefore, what should be the right approach to engineer the related legislation to promote M&A exit for VC-backed startups in Cambodia? The discussion below will address such M&A-related regulations based on three legal frameworks: antitrust law, company law, and tax law.

In a study conducted by Gordon Phillips and Alexei Zhdanov, the authors utilised the dataset from 66,213 firms across 48 countries including the US, Japan, and China to understand the relationship between VC investment and M&A.¹⁸⁶ They found a strong positive relation between VC investments and M&A activity because an active M&A market creates a viable exit opportunity for VC companies.¹⁸⁷ On top of this, the authors also found that VC activities intensify in nations with pro-takeover legislation, while it decreases in nations with stringent anti-trust legislation.¹⁸⁸ This finding is also aligned with recent concern on the antitrust issue that the US will rewrite the antitrust law to limit the M&A activities focused on the acquisition of smaller companies by larger technology companies with the purpose to stifle competition.¹⁸⁹ This change in legislation is expected to hamper innovation and entrepreneurship, according to concerned experts.¹⁹⁰

Back in Cambodia, the Law on Competition was just recently enacted on 5 October 2021. In Article 3 of the Law on Competition, the business combination is defined as acquiring the right of control, voting rights, shares, or assets on other entities that were previously independent of each other.¹⁹¹ This term is Cambodian law's definition for a trade sale. Since the trade sale involves the selling of VC shares to a third party, it will fall into the definition of business combination as stated earlier; therefore, its implementation will be subject to the law on competition. A potential bottleneck in the trade sale (or M&A) is obtaining antitrust approval from the Cambodia Competition Committee (CCC). However, with the current legal framework, this whole examination process is still undefined. The specification of this approval process will be legislated via a Sub-decree. Hence, since the relevant laws are not officially and widely implemented yet, the author believes that the CCC should take into account the balance between avoiding anti-competition and promoting a friendly M&A environment. Moreover, the approval process should be as short as possible. In the US and Japan, the merger approval is 30 days from the date of application receipt.¹⁹²

Moreover, some existing laws (such as the company law and contract law under Cambodia's Civil Code) are also the main legal frameworks monitoring M&A activities. At this present stage, the target startups or companies to be acquired or merged are still private companies. Hence, the framework is not required to be too cumbersome to regulate this activity. Nevertheless, it is even better for VCs if the regulation can cover some specific issues such as the protection of minority shareholders. VCs typically own the minority share of the portfolio companies.¹⁹³ This minority ownership subjects the VC to many risks such as price dilution, squeeze-out mechanism, and lack of board participation. That is why the VC should be provided the minority protection rights such as supermajority voting, dual-class voting right,¹⁹⁴ consent right, information rights, board participation, right of first refusal, pre-emptive rights, tag-along rights, drag-along rights,¹⁹⁵ anti-dilution, and put rights.¹⁹⁶ All of these rights are currently provided based on a contractual agreement between the parties, not by law.¹⁹⁷ Sometimes the VC has a lower bargaining power and fails to procure these essential clauses. Codifying these rights will create a more friendly M&A environment for VCs. In the future, when more startups become public companies, the M&A process may become more complicated. This increase in complication requires the legal framework to evolve to cover more areas such as tender offers, hostile takeovers, and public disclosure. In Japan, the Japanese Financial Instrument and Exchange Act (FIEA) regulates these issues. This can be a good blueprint for Cambodia to draft a law to cover similar matters.

The third aspect is taxation on the M&A activity. Based on the existing law, the transfer of any or all parts of the company's share is subject to stamp duty at a rate of 0.1% of the value of the shares.¹⁹⁸ Currently, there is no public concern raised on this matter yet; hence, it is hard to know whether this rate is appropriate or not.

Interestingly, Singapore formulated a tax incentive scheme to promote M&A activities, especially for Small and Medium Enterprises (SMEs) to internationalise and grow.¹⁹⁹ As a fast-growing nation in Southeast Asia, Singapore grants an M&A allowance, a stamp duty relief, and a Double Taxation Deduction (DTD) on transaction costs.²⁰⁰ The M&A allowance is up to 25% of the acquisition value at a cap of SGD 40 million. The stamp duty relief comes with a cap of SGD 80,000 for each financial year. The DTD is applicable for legal, valuation, and other professional fees related to the M&A transaction. The deduction is capped at SGD 100,000. In M&A transactions, taxation is one of the key consideration points for both parties. In the worst case, this might be a deal-breaker if the rate is too high relative to the synergy value of the transaction. Hence, from this perspective, the incentive scheme that Singapore sets out might produce an effect in promoting M&A activity in the nation. Nevertheless, taxation is a core revenue for many nations, including Cambodia. The taxation incentive is great, but the government still needs to function, so the tax relief may not be sustainable.²⁰¹ With the limited information on this matter, the author advocates reducing the rate of stamp duty, but not providing a complete relief. This duty is fuel for Cambodian ministries to function; cutting out the fuel is not a great idea. However, if some reduction in the rate can increase the number of M&A transactions, this will become a more sustainable approach. Moreover, taxation is just one factor. Another critical factor is the synergy factor between the companies, which is far more important than tax relief.

Contractual buyback

Contractual buyback happens when the startup has the contractual obligation to buy back its share from VC at a future date. This is not a popular option for VC-exit; however, incidences are inevitable. For instance, Japanese VC usually includes the ‘buyback’ mechanism in the contract.²⁰² As a result, in 2016, roughly 28% of VCs took that route as an exit;²⁰³ the mechanism devastated the startups.

In Cambodia, the contractual relationship between VC and startups is always kept confidential between the parties. Hence, there is no public information to indicate whether such a method has been utilised or not. VCs do not like this mechanism because it is not profitable. Also, the buyback puts pressure on the startup's cash liquidity. The VC usually considers this an exit reserve if the investment becomes a ‘living dead’ or ‘lifestyle’ company that only satisfies the entrepreneur's desire but has virtually no home-run potential.²⁰⁴ The author does not advocate for using this mechanism because, as discussed above, it drops the cash burden on the startup that already has a hard time surviving, and increases the founder's risk to pursue the startup. This is discouraging for future founders with potential ideas to initiate their ventures.

As a result of the current ecosystem still developing, the startups in Cambodia are very small compared to other nations. Hence, the investment size is not that big for the VC with millions of dollars in funds. Also, VC investment is usually made in stage-financing with concrete milestones for founders to achieve. Therefore, the investment size is somehow even smaller; the VC is left with two options – to put in more money in the next round or not. At this stage, all parties should trust and collaborate at their best for the overall good of the startups rather than securing a backup plan to pull out in case things do not work out. If the parties still want to incorporate this clause into the contract, there should be a condition that this clause can only be triggered if the startup has an amount of excess surplus with no potential plan of usage. With this condition, the startup does not bear the cash-flow pressure and gains back control, while the VC can successfully exit without finding a third party to buy out their share.

Conclusion

Venture capital in Cambodia is still in its early stage. Currently, there is no specific law to regulate the activities of VC, but there are existing laws that govern some activities including company law, tax law, and trust law. This article argues that the government should allocate their resources to create a concrete regulatory framework for the VC community in Cambodia to promote their presence and reduce the key bottlenecks that VCs encounter. The regulatory framework can be classified into three main stages: fundraising, startup investment, and exit. During the formation stage, the lack of funding sources should be solved by creating tax incentives for domestic corporations and wealthy investors to invest in the VC, building more international cooperation agreements with potential partners abroad, and allowing the pension fund (when the size is large enough and the startup ecosystem is more robust) to be invested in the VC. In the startup-investment stage, the regulatory framework should focus on promoting the investment readiness of the startup to get the fund from investors, promote the use of convertible notes during the seed stage, and issue a Prakas regulating the minimum term of the investment agreement. Lastly, the current capital market in Cambodia still needs some time. Hence, more efforts should be allocated to create a regulation related to M&A; legislators need to balance between being anti-competition and the promotion of an M&A-friendly environment.

All in all, when it comes to business-related matters, real growth comes from the community itself. The regulator can only indirectly assist by creating an enabling environment to enhance a strong connection of key players such as entrepreneurs, VC, local and foreign talents, government, accelerator, and the university. There is still much effort needed from those key players to achieve the business vision, be open to potential partnerships with one another, and do business in good faith, creatively and diligently for the greater good of the whole nation.