The adage “Nothing ventured, nothing gained” may just well describe in a nutshell the vicious cycle that the Japanese venture capital (VC) market seems to be entangled in.
Despite being the world’s second largest economy, Japan’s VC market can, at best, be described as fledgling when compared to that of the United States–and the year just passed, one best forgotten.
VC refers to private equity capital that institutional investors or wealthy individuals pump into promising startups, usually in the technology sector, with the aim of reaping a profit through a sale of the business, or an initial public offering (IPO).
IPOs account for 90 percent of yearly profits for Japanese VCs, but in the aftermath of the global credit crunch, Japan’s equity capital market managed a mere 20 public listings in 2009–60 percent less than the year before, and the lowest level in decades.
Despite a historically lackluster exit environment, Japanese VCs have managed to ride on a relatively robust decade of IPOs–compared to the post-dotcom bubble U.S.–which saw a total of 1,200 public listings, or an average of 120 a year.
Japan is renowned for its innovation and technology, so why is its VC market so far behind that of the U.S., which boasts the biggest VC market in the world? The Japan Venture Capital Association now counts around 100 members, compared to some 400 member firms in its American counterpart, The National Venture Capital Association.
Of Risks And Returns
One may argue that the U.S. had a head start in the industry. Whereas the American government paved the way for the birth of the industry by passing the Small Business Investment Act as early as 1958, Japan’s first private VCs date back to the early 1970s. But the answer likely lies behind some stark differences between the way VC firms operate in the U.S. versus Japan.
Take for a start, the modus operandi of Japanese venture capitalists themselves. VCs in the U.S. usually lend both financial brawn and business brains to the companies they invest in, for example by having one team member join the startup’s board of directors. Japanese VCs, on the other hand, usually adopt a hands-off approach.
However, a different legal and corporate governance framework gives Japanese VCs less control in a startup than American ones. Already risk-adverse financiers in Japan thus invest less money, resulting in lower returns. Japanese VCs average an Internal Rate of Return of 3.9 percent over 20 years of management, as opposed to 16.5 percent typically earned by American VCs.
Japanese VCs usually have less entrepreneurial experience than their American counterparts – if any at all. This may explain their lower risk appetite, tending to avoid early-stage startups in favor of companies that appear to be on the cusp of success.
In fact, a common complaint amongst Japanese entrepreneurs is that what VCs in Japan do is just essentially non-bank financing.
That said, a lot of Japanese VCs are affiliates of large securities companies and banks. For example, financial powerhouse Nomura owns a 35 percent stake in JAFCO, one of the biggest–and publicly listed–VCs in this country. In the same vein, Daiwa Securities Group has a large VC arm in Daiwa SMBC Capital. This makes for a vastly uneven playing field where a handful of big players dominate, in turn stifling growth.
And when Japan VCs do invest, they do so overseas – understandable given Japan’s relatively smaller and shrinking market. JAFCO has invested in over 3,500 startups in Japan and elsewhere since its establishment in 1973. Its U.S. subsidiary, JAFCO Ventures, currently manages a $350 million fund and has a portfolio of around 40 American companies. JAIC, a sizeable listed VC, has done 77 IPOs outside Japan so far.
Conversely, American venture capital activity in Japan is extremely limited with a few exceptions, such as DCM, a VC based out of Silicon Valley that has funded 13 Japanese startups and established an office in Tokyo last year. Another example is Globespan Capital Partners, a venture capital firm that manages over $1 billion and has offices in the U.S. and Tokyo.
Add to that the fact that deals that do take place in Japan tend to be a lot smaller. A recent cross-country study from Stanford University shows that in 2006, Japanese venture capitalists pumped $2.8 billion into 1,500 deals, while their American colleagues invested $23.5 billion into 3,080 deals.
It seems that Japan’s entrepreneurs, the people who are supposed to drive innovation and create jobs, will have to fight harder for venture capital in the future than ever before. The choices now left for most of Japan’s VCs, on the other hand, are radical transformation, merging with competitors or an unceremonious market exit.
Dr. Serkan Toto is a Tokyo-based web industry consultant and writer for American online media network TechCrunch.
