BSI - Business Strategies International



There are some 200 venture capital funds in Japan, all looking for good places to invest. Most of them are under the umbrella of big Japanese banks and securities firms that do not take an interest in startups, and many of these consider high-tech investments too risky. But a growing number of venture capital and private equity investment firms are turning to high-tech, especially IT, as the best place to invest.
Upside Magazine, June 2020

Suddenly there are signs of life in the lifeless Japanese economy, and there are signs of change in its change-resistant society.

Japan is in the grip of excitement over the enriching prospects of information technology. Venture capitalists and investment funds are multiplying in Japan like pachinko parlors. Japanese retirees are taking money out of their savings accounts and investing in hot technology stocks. And young entrepreneurs are flocking by the thousands each month to a “Bit Style” networking get-together organized by the Bit Valley Association.

This highly contagious affliction arrived in Japan only recently. It has been identified – but not yet isolated – as Bit Valley Fever.

Will Bit Valley Fever help deliver Japan – the world’s second largest economy after the United States – from its doldrums? Is Japan on the verge of becoming the next Silicon Valley, a hotbed of technological innovation and investment? And if so, where are the opportunities – and what are the challenges?

The Money Flows

There are some 200 venture capital funds in Japan, all looking for good places to invest. Most of them are under the umbrella of big Japanese banks and securities firms that do not take an interest in startups, and many of these consider high-tech investments too risky. But a growing number of venture capital and private equity investment firms are turning to high-tech, especially IT, as the best place to invest.

Karl Moskowitz, managing director of KSA Ltd., a business development firm that operates in Japan and Korea, maintains that there are four types of venture capital and private equity investment firms in Japan these days. First, there are the “old style VCs,” like JAFCO Co., the largest venture capital firm in Japan. Firms like JAFCO take small positions in an investee and then they (or the investee) invite other Japanese VC firms to take similar positions “convoy style.” The old style VCs do not provide much in the way of incubation services; instead, they provide “legitimacy” to attract follow-on investors. Second, there are “enterprise-sponsor” VCs like Softbank Corporation and Hikari Tsushin Inc. that have their own business operations but invest directly in other companies, seeking to create value through the stock appreciation of their investments. These have tended to focus on high tech investments, often related to their own enterprise specialty. Softbank has actually gone further, creating a huge venture fund for startup investments. Third, there are large, mostly foreign, private equity investment firms like Warburg Pincus and Prudential Asset Management Asia (PAMA). These do not provide management assistance, but they provide some supervision and financial advice, more than do old style Japanese VCs like JAFCO. Some of the larger of these, once interested in leveraged buyout and merger opportunities, are turning their attention to startups. Fourth, there are “Western-style” Japanese and foreign venture capital firms, large and small, that provide management oversight. These are now active in Japan, but the question is whether their Japanese investees will want their “hands-on” incubating services or merely their capital and industry connections.

One of the largest foreign VCs in Japan is GE Capital Japan, which has grown its assets in Japan to $15 billion and is said to have $50 to $100 million ready to invest in promising Japanese Internet-related companies. And early this year Goldman Sachs Group Inc. announced plans to establish a $394 million investment fund with Kyocera Corporation, a large Japanese semiconductor and telecommunications equipment manufacturer, to invest in Japanese high-tech opportunities. Separately, Goldman Sachs and Morgan Stanley recently announced plans to invest $50 million in eAccess, a Japanese startup that plans to offer high-speed DSL (digital subscriber line) technology and infrastructure in Japan for the first time. Other large foreign-based VCs active in IT investment in Japan include J. H. Whitney, Warburg Pincus and Apax Globis Partners. Of the large Japanese VC firms, Softbank early this year announced the formation of a $500 million fund to invest in as many as 500 Japanese Internet-related startups over the next two years. In addition, 66 percent of the domestic companies in which JAFCO invested in the first half of last year were domestic IT startups. Similar investments in domestic IT startups were reported by Japan Asia Investment Co. and Nippon Investment & Finance Co.

“Japanese angel investors are also emerging,” says Alex Kurosawa, a director of the International Angelinvestors Institute. “Angels are important to startups because they often have the experience to help them get off the ground.” The IAI opened a branch in Japan early this year with a kickoff seminar that featured a keynote speech by renowned Silicon valley VC and angel, Hal Nissley.

Opportunity Knocks

“Many are sensing that IT investment in Japan is the opportunity of a lifetime,” says Paul Slawson, head of J. H. Whitney’s Tokyo office. “Venture capitalists and private equity investment firms like ourselves need to be here to be ahead of the developing IT environment.” In the past 12 months, J. H. Whitney has invested approximately $150 million in eight Japanese IT-related deals in the $20 million range and plans to put $150 million to work in Japan in each of the next few years. J. H. Whitney’s focus in Japan is the Internet, telecommunications, and tech-enabled financial services.

“The key to global IT development is wireless, and Japan will be in the forefront of this because of its leadership in G3 (third generation) broadband CDMA mobile phones,” claims Slawson. “Japan is two to three years ahead of the United States in broadband wireless. Wireless IT breakthroughs will happen first in Japan, then will spread to new applications and business models. IT is now about ten percent of the Japanese economy by market cap, compared to one-third of the U.S. economy, but we think IT will grow to 30 percent of Japan’s economy in the next five years.”

Japan’s NTT Mobile Communications Network Inc. launched its DoCoMo i-mode Internet-compatible mobile phone service early last year and now has over four million subscribers. In 2001 it will introduce its G3 broadband CDMA phones with connection speeds of 350kbps to 1mbps. According to Koji Morihiro, a partner in TechFarm Inc., a Tokyo- and Silicon Valley-based venture capital and incubator firm, “Mobile broadband access on a massive scale will trigger a huge wave of devices and services. The tsunami will first break in Japan. Companies that are here will have the first strike advantage, much like the U.S. had in catching the first monster wave of the Internet. The Japanese have an insatiable appetite for convenient appliances and services. Streaming audio, video and still images will be ubiquitous with broadband CDMA.”

Mobile info devices and services will be the latest new things in Japan, agrees Richard Chen, president and co-founder of OptoMail, Inc., an Internet startup in Japan that will deliver PC and mobile e-mail and information services to the wireless community. “People all over the world are on the move, and they will want their communications capabilities to be instantly available at any given moment,” he says.

Another startup, Fitech Laboratories, with 40 employees in Tokyo and five in San Francisco, developed “Netstock,” the online stock trading system of Matsui Securities, a leading e-brokerage with a 30 percent share of Japan’s online trading market. Netstock is the first Internet trading system in Japan that supports option and margin trading, real-time valuations and risk analysis, and automated order validation. “Wireless applications of the system, to help investors check on their investments and execute trades, will launch this year,” reports Chako Ando, Fitech’s chief financial officer.

Yoshi Hori, chairman and CEO of Apax Globis Partners, Tokyo, a joint venture of venture capital firms Patricof & Co. and Apax Partners & Co., believes that Japan has unique IT strengths in mobile communications, animation and games. “The technology is here, and the Internet is the big play. As applications emerge, Japan is in a perfect position to capitalize on the opportunities,” he claims.

Fujiyo Ishiguro, a founder of the Netyear Group, one of the top startup incubators in Japan, believes that Japan has the technology that will lead the global economy in the next five years and that Japanese startups, with the help of venture capital funding and incubators, will find the best ways to implement it. She believes that Bit Valley Fever will serve as the catalyst.

Enter the Exit Strategies

One of the drivers of Bit Valley Fever is a new stock market in Tokyo, the “Market of the High-Growth and Emerging Stocks,” called “Mothers,” which opened last December to a frenzy of investor interest. Mothers was introduced by the Tokyo Stock Exchange to provide easier funding for emerging companies with high growth potential and to offer a wider choice of investing instruments. Listing requirements are more lenient than those of the Tokyo Stock Exchange. Advantages include the ability to offer stock options to employees and to go public at an earlier stage. For venture capitalists, the potential for an early IPO presents an exit strategy not heretofore available in Japan.

To similar effect, Nasdaq-Japan will open at the Osaka Stock Exchange in June. Nasdaq-Japan is a joint venture of the National Association of Securities Dealers and Softbank Corp., with the Osaka Stock Exchange having a profit position. And the NASD recently announced a joint venture, IndigoMarkets, with SSI Technologies of India to develop Internet-based trading and market for Nasdaq global markets, including Nasdaq-Europe and Nasdaq-Japan.

“It will now be possible for a startup to go public in one to two years,” says Hori of Globis Apax Partners.

Challenges to Overcome

With great IT, abundant funding, an accommodating stock market and Bit Valley Fever, is there nothing but blue sky in this picture? Actually, there is a problem with the startups.

First, there is the problem of finding a good one. “I have had a dozen meetings in the past month alone with VCs and fund managers wanting ideas for where to park their money,” says James Higa, president of RealNetworks Japan. “It’s very hard to find a startup with a great idea and the ability to implement it. The biggest obstacle is that the talent pool is too thin. You cannot form a team of veteran entrepreneurs who have been through three or more startups, as you can in Silicon Valley.  Here, there are either salarymen from big companies parachuting out into Internet space, or young and restless Bit Valley rookies who have passion but no practical experience.”

“The lack of managers who have had team-building and P&L responsibility with international exposure is a very serious problem for startups in Japan,” agrees Koji Morihiro of TechFarm.

Second, there is a lack of startup infrastructure resources. While some VC firms like TechFarm and Netyear offer incubation and development services, there are few lawyers, accountants, public relations experts and other resource people who specialize in advising startups. Many startup entrepreneurs receive little guidance for implementation, P&L management and organization.

In the view of Jim Kelly, the former head of Robertson Stephens & Company’s Tokyo Representative office and now a venture consultant in Japan, a lot of money is being managed in Japan by venture funds that have limited experience with startups and do not fully understand the “value-added” function of venture capital as practiced in the U.S. The recent success of the U.S. venture capital industry is currently a source of inspiration to Japanese investors, but it did not happen overnight, he adds. It is the result of a mentality and culture, combined with an infrastructure and legal framework, which developed over 50 years. Japan cannot create a Japanese Silicon Valley by throwing money at entrepreneurs; it must create the proper environment for startup companies to flourish. “The risk is that poor investment results could set back the VC industry in Japan by years,” he says. “There is historical precedence of this. In the late 1980s and early 1990s, Japanese institutions dabbled in venture capital investments. When the results were poor, many of these institutions concluded that venture capital investments were too risky, and they have not returned to this market.”

But these problems of shortages in startup experience and infrastructure resources would seem to be evolutionary. With Bit Valley Fever blazing the trail, they will develop in time. So the question is: how quickly will they develop?

“In Japan, starting in a new direction is like getting a supertanker underway,” says Gordon Campbell, a partner of TechFarm Inc. “It takes time to gather speed, but when it does the momentum can become unstoppable.” Campbell notes that 15 years ago the primary goal of a talented young Japanese was to become an employee of the biggest and best Japanese corporation, and then to settle into a career of lifetime employment. Today, following years of recession and the failures of huge organizations like Yamauchi Securities Corp. and Japan’s Long Term Credit Bank, Japanese of all ages are beginning to question that career model.

The adjustment process can be slow. Koji Morihiro says that his mother was shocked when he told her that after 13 years he was leaving a fast-track career in Fujitsu Ltd.’s business development group to become head of TechFarm’s Tokyo office. His move was a source of considerable embarrassment to his mother, who could not explain the tragic development to relatives and friends, until one day she saw his picture on the front page of the Nikkei Financial Daily (Japan’s equivalent of the Wall Street Journal) with a story highlighting how TechFarm helped Japanese entrepreneurs launch NuCore Technology Inc. Her pride in her son is now fully restored.

Chen of Japanese startup OptoMail believes that it will take a long time for Japan’s startup supertanker to build up speed. “In a homogeneous society like Japan’s, there is great comfort in accepted behavior, like being part of a large company. People don’t like to stand out from the crowd. There is a strong fear of failure and of losing face.” There is also a reluctance to be the one to take the first step. Ken Darrow, president of California Gold Catalog Co., a Japanese language e-commerce Web site, says: “First movers are not applauded in Japan.”

There is also a Catch 22 big-company mindset. Kumiko Kajiyama, when floating startup ideas to acquaintances before settling on a Web site idea, approached a friend who works at a large Japanese PC manufacturer that has a stated commitment to IT projects. The friend liked the idea and encouraged her to bring her idea to the company, but then on second thought he added, “Of course, my company would do a thorough check of your company and probably wouldn’t be interested in a startup with only a few employees and insignificant capital.” Kajiyama, a 1989 Stanford MBA graduate, believes that U.S. and European venture capital firms are the best bets for Japanese startup funding. “They’re here and they know what to look for,” she says.

Startup Slowdown

But if Japanese startups rely solely on U.S. and European venture capitalists, they might find themselves with backers branded as carpetbaggers. At the moment, Japan is impressed with the success of Silicon Valley and is eager to catch the IT wave. “Japan especially wants access to U.S. technology and capabilities,” says Chen of OptoMail, “but this is a society of relationships – Japanese relationships. Outsiders should never forget that.”

“It’s also a country of government regulation,” adds Kajiyama. “When a government agency takes an interest in an industry, it feels a need to regulate it. There’s also a possibility that the government will encourage some large Japanese companies to get together to form some kind of high tech venture capital fund, and Japan will end up with a bunch of oligopolistic VCs who will invest in large, safe ventures conjured up by one of their corporate relations. If this happens, it will kill real entrepreneurs.”

A lot of large Japanese companies and financial institutions are already caught up in Bit Valley Fever. “But the old guard will find it hard to grow the new business models,” claims Higa of RealNetworks Japan, “and there will be a lot of blood spilled as a ton of money gets put into bad ideas.”

Looking down the road, other things could go wrong, according to Hori of Apax Globis Partners. “If IT startups go public in Japan and then find a disappointing aftermarket, it would be a very wet blanket,” he says. “Also, if there is a collapse of Nasdaq tech stock values in the U.S., a lot of interest in Japanese IT startups could dry up.”

Bit Valley Fever Rising

On the other hand, Slawson of J. H. Whitney, Tokyo, believes that there will be rapid development of startup opportunities and of entrepreneurial talent. “Young Japanese are not tied to the old system. They do not have years invested in one company and a single set of relationships. To the contrary, they see the failure of the old ways, and they want more compensation and more excitement in their lives.” He adds that some 75 percent of the Japanese workforce is employed by small companies with fewer than 50 employees, so it’s not as if everyone works for a big corporation or government ministry. Slawson sees the Japanese as highly creative people who need the right environment to succeed. “They are fierce competitors and great implementers,” he says.

“The Japanese are great students, relentless in their execution of programs and plans,” adds Jeff Samberg, entrepreneur-in-residence at Greylock Management Corporation. Samberg, who spent much of the last decade in Japan at Fuji Xerox Co. Ltd., SynOptics Communications and PeopleSoft, Inc., says that the Japanese have a unique ability to imitate, adopt and perfect technologies and successful business models wherever they find them.

To support a positive startup environment, J. H. Whitney invested $20 million in Japanese incubator Neoteny, providing facilities and funding for its startups. Neoteny currently has eight startups under its wing and expects to have 80 more within three years. Netyear is also supporting a startup environment with a $30 million fund and its incubating services. It plans to invest in 40 to 50 Japanese startups this year, with investments ranging from $500,000 to $1 million.

“There are also more and more Japanese business schools opening up to train young entrepreneurs,” notes Hori, who in addition to heading Apax Globis Partners runs the Globis Management School . In addition, many experienced high-tech Japanese business people who have left their jobs for one reason or another, like Roger Kuniyoshi, the former CEO of Transtech Inc., are providing consulting services to startups.

Despite the lingering impediments of Japan’s culture and outdated business environment, some see an advantage for startups. Venture consultant Kelly believes that the inefficiencies and risk-aversions of Japan’s old ways create some of the best opportunities for startups. “The opportunities for quick-moving startups are truly enormous,” he says.

Bit Valley Fever is just the beginning, says James Higa. “It will take a decade to play out, but the times they are a-changing.”

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