Report No.5
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Japan Entrepreneur Report No. 5 March 2003
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- Exit strategies East and West (II)
- Allen Miner: Inside the Japan Venture Capital Association
- Nelson Fung solves another annoying problem
- Cell phone trumps PC as default e-mail terminal
- Bits and bytes
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Exit strategies East and West (II)
In the second issue of JER, we talked about exit strategies and how there are only two ways to
sell a company. One is in a private equity transaction, whereby another company or a group
of employees or managers buys the company. The other is to sell the company in small
pieces to anyone who wants to buy a share (an initial public offering, or IPO); in other words,
"going public" (see <http://www.japanentrepreneur.com/200301.html#2>). The previous
discussion focused on IPOs; this month we look at private equity transactions, which
generally represent a much more practical exit for both entrepreneurs and investors.
The problem is that the market for private equity transactions in Japan is small. In other
words, companies here simply don't acquire each other as frequently or readily as they do in
the United States, for example. To understand the reasons why, we consulted with Mr.
Private Equity himself: Michael Korver. Born and raised in Tokyo, Michael is a venture
capitalist, attorney and the author of a Japanese language book called - you guessed it -
Private Equity
(http://www.amazon.co.jp/exec/obidos/ASIN/4492711279/qid%3D1045013447/250-3277033-3105869).
Here's what he had to say:
- Most observers agree the market for small, private equity corporate acquisitions here in
Japan is extremely limited. In your view what are the key structural and cultural reasons for
this?
Your question actually has two components. One has to do with the "supply" side, meaning
the number of companies that become available for sale in private equity transactions. From
a private equity investor's standpoint, this "supply" is referred to as "deal flow." The other
side of your question has to do with the "demand" side, which refers to the number of
investors and amount of money available for purchasing companies. The "demand" or
investor side of things is the primary standpoint from which I view the market, but I can
comment briefly about the "supply" side.
While it's true the market for private acquisitions here in Japan is small, that's primarily
because the supply side is limited. You need to look at the issue in the context of deal sources.
One source is aging owner/managers whose children are unable or uninterested in taking
over the company. That happens, but perhaps not as often as you might think, since owners
in Japan try very hard to have sons and get them to take over the business. Usually that's a
better option for the son than working as a salaryman.
Another factor is that Japan's inheritance tax scheme is quite favorable in terms of the
valuation of privately held companies. In the United States, for example, if you can't pay the
estate tax, you have to sell the business. But in Japan, if you do things like not distributing
too many dividends and keeping profits down, you can end up with a very low valuation that
results in relatively reasonable inheritance taxes. There are a number of inheritance
tax-related schemes that make it easier to keep the company in the family. Finally, there is
certainly cultural reluctance to selling a company.
Another source of deal flow is subsidiaries, departments or divisions of large, publicly listed
companies. But most Japanese companies have not yet aggressively restructured, and
moreover, these subsidiaries and other units are often repositories for "surplus" employees
who are not stellar performers. And many companies here have simply not been faced with
the market discipline that would force them to sell off such units.
Some players have attempted to acquire publicly held Japanese corporations and take them
private, but what self-respecting Board of Directors would recommend the sale of the
company? It has never happened and it never will. Board members are not outside directors,
they're all insiders. Why would they ever recommend that the company be sold? Try doing a
hostile takeover in Japan and see how far that gets you. It doesn't happen.
These factors are all on the "sell" side of things, and for the structural and cultural reasons
mentioned, there's not a whole lot of deal flow.
- What about the "buy" side?
There is very strong pent-up demand for those few good companies that do go up for sale. In
Japan, the biggest problem with private acquisitions is transaction cost. With a venture
capital injection, the key issue is valuation. Is it a good company? If so, can the investor
afford the valuation given the risk level? If you are an entrepreneur looking for money, the
deal is going to go through, because you need that money. The only issue is valuation. But
there is essentially no danger that the founder of the company will change his mind and
decide not to do the deal once the valuation is agreed upon.
In contrast, in the buyout or mergers and acquisitions (M&A) business, you have very high
transaction costs because sellers tend to change their minds for reasons other than valuation.
In other words, the sellers are not always committed to doing the deal. You may end up
negotiating for a long time, spending a substantial amount on due diligence, and so forth, and
ultimately the deal doesn't happen. The seller changes his mind, or some other force - either
business or non-business - comes into play.
Another factor that increases transaction cost is the auction situation that results because of
the very small number of good deals available, and the substantial amount of money in Japan
looking for good buyout deals. The result is a lot of people go after the same deals. It
becomes a bidding process. That raises the transaction cost, because the chances of you
getting the deal fall in proportion to the number of other players bidding. And even if you are
successful in winning the bid, that may indicate that the price you paid is too high.
- What other factors have kept the private M&A market small here in Japan?
In the U.S., why does a company go public? It's a way of financing growth. Companies can
go public because they have some sort of growth strategy and real growth prospects. For
example, the company may have some market opportunity that requires investment in capital
equipment in order to expand. But in a fairly mature market like the United States today,
where there aren't a lot of rapid growth sectors, aggressive buying of other companies
(M&A) is one growth strategy. One "currency" for conducting that M&A is publicly
tradable stock.
In Japan, on the other hand, for some reason the stock market is not considered to be a market
for financing. Rather, it's a market for "prestige," so to speak. Reasons for going public
include enhancing the ability to hire good employees, for example. The market is not utilized
as aggressively for financing growth. That's why stock prices are languishing now.
Companies go public not necessarily because they want to pursue a growth strategy, but
because they've "made it." That's the time to sell a company, not to list!
Some of the structural impediments to M&A have been removed recently. For example,
stock swap transactions are now allowed, where they previously weren't. You can now do an
M&A transaction by exchanging shares. That's a tax-advantaged deal, so that's a positive
development for Japan. But historically you couldn't do that. You had to pay cash. So M&A
simply was never a growth strategy in Japan. That's why the M&A market - the market for
buying and selling companies - is very small and underdeveloped here in Japan.
The market is certainly growing; everyone is saying that restructuring will put pressure on
large companies to divest. Stock prices are so low now that if a party comes in and says, "I'll
buy your company at double the stock price," how can they be refused? And succession will
continue to be an issue as well. So everyone is predicting an increase in supply. But it hasn't
happened as quickly as people thought it would. There have been a lot of very good changes
in the Commercial Code over the past several years, but the big stumbling block is still taxes.
The people at the Ministry of Finance are like a bunch of Neanderthals compared to METI.
- Your Japanese language book, Private Equity, sold quite well here. What is the essential
message you want to convey to readers?
Investors are important! You have to give a good return to investors in order to have a
functioning private equity market. That's really it. Over the past few years there's been a lot
of talk about venture capital, venture businesses, how to grow venture businesses, and all the
trials faced by disadvantaged entrepreneurs. My book very simply says that people put
money into ventures because they want to achieve higher-than-average returns. But if
investors who have put money into venture businesses don't receive high returns, there
simply won't be any money available the next time. You can be as nice to the entrepreneurs
you want, but there won't be any money. So investors are important!
- Why is that message so important here in Japan?
Because returns on private equity in Japan have been abysmal. Disclosure is poor and
investors have not been treated fairly. This is not an investor or shareholder-centric economy.
Shareholders and investors are taken for granted. Companies take shareholder and investor
money and give them lousy returns. Under those conditions, the market is not going to grow.
So the message is be nice to shareholders, and be nice to investors!
Michael Korver
Global Venture Capital, Inc.
www.globalvc.com
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Allen Miner: Inside the Japan Venture Capital Association
Allen Miner, creator of the Venture Habitat concept and founder of SunBridge, accepted an
invitation to join the Board of Directors of the newly formed Japan Venture Capital
Association (JVCA) in December of last year. This month we sat down with Allen to hear
his thoughts on the direction of the JVCA and his role in this new organization, the first of its
kind in Japan.
- Tell us how you came to be offered a Board position at the JVCA.
Ever since I started SunBridge I've been frustrated with the lack of quality data on what is
happening in Japan's venture capital sector, so last October when I heard that the JVCA was
going to be formed, I was quite excited. I sent off a congratulatory note to President Horii of
NIF, who had accepted the chairmanship of the JVCA, to let him know that I believe
establishment of the JVCA is an important milestone for the industry and that personally I am
very much looking forward to seeing some improvement in industry data. I offered to do
whatever I can to help. I also wrote an article in Nikkei Net
(http://www.nikkei.co.jp/money1/20021112c15bc000_12.html) about the significance of the
JVCA including my hope that now, we will start to see much better data concerning the
practice of venture capital in Japan.
A few weeks later, Horii-san called me and asked if I would join the board. I was quite
surprised, and I'm still not quite sure of my role. Not only am I the only foreigner and the
smallest VC on the board, I'm the only member without a finance background, the only one
under the age of 50, and so forth. I'm a very odd bird in that group! At the moment, I'm
trying to learn how to play an effective role there, how I can get things done, how far I can go
to push an agenda, and so on. I'm still learning how to function as the member of an industry
board.
- How have the board meetings been so far? How does it feel to be the only foreigner in the
group?
I've attended three board meetings so far and I've been impressed by how proactive and
committed the other directors, presidents of older, established venture capital firms are, and
how serious they are about wanting to make the JVCA a catalyst for change in the industry,
as opposed to just an "old boys club" where you hang out and network. Despite being the
"gaijin" on the inside, I feel that I'm accepted as part of the team and have become
comfortable expressing my frank opinions and making suggestions.
Until now there has never been an official vehicle or independent forum for driving the kinds
of issues we are all interested in, so just having the JVCA is a big breakthrough. When it was
announced, I thought, "Now we're going to have big changes, it's the Big Bang in the venture
capital industry here in Japan!" Three months into it, my sense now is that, like many things
in Japan, it's going to be a long haul to make a significant difference in the industry and the
overall venture environment in Japan. But the directors all seem sincerely committed to the
process. They (we) see the JVCA as a dynamic vehicle for changing the industry and
changing the entrepreneurial environment in Japan. The leadership really has a progressive,
dynamic attitude and seems to be going in the right direction. The challenge is whether we
can get that attitude filtered down throughout the entire membership, and in fact have the
entire industry adopt that mindset and develop a set of common, progressive practices.
- What are the JVCA subcommittees, and which attract your interest?
The JVCA has five subcommittees today: tax, accounting, regulatory Commercial Code,
public relations, and research and data. I have very little interest in the tax, accounting, and
regulatory subcommittees. Fortunately, there are lots of other people who do and who
understand those issues much better than I do. The research area has been of personal
interest for a long time, and I believe I can also contribute in public relations. I learned a little
about databases and about marketing in 13 years with Oracle, so on these subcommittees my
non-financial background should be a plus. Currently, of maybe 150 VCs in Japan, less than
40 are members of JVCA. There is still a lot of work to be done on proving the value of
membership in the organization to those VCs who are not yet members. That's where I hope
to contribute.
- Tell us more about this quality of data issue.
The government conducts a survey of VC activity only once annually, so by the time it's
published, it's old news. In the U.S., the least granular data is quarterly and several firms
publish VC data monthly or even weekly. Japan's survey queries the venture capital firms
rather than the companies actually receiving funds. Only about half the VCs respond to it, so
the data is incomplete. Since several VCs may co-invest in a single financing round, there is
double counting in terms of investee companies. For example, if JAFCO and Orix both invest
in the same company at the same time, it gets tallied as two different investments rather than
one round for one company. We have pretty good annual estimates on the total amount of
capital flowing into the system. We have some idea, at a very high level, of the industry
sectors into which capital is flowing. But beyond that, we know very little.
In contrast, in the United States, the data collection process is organized primarily around
querying the companies that are receiving the financing. So you know how many rounds a
company has gotten, how the size of the rounds have evolved over time, and often you know
the valuation of the rounds of investment at different stages in the company's history. There
is information on which investors came in at each stage. When you have that kind of
underlying data, there's a lot of analysis you can run on where money is flowing, how much
money is needed in the system, how saturated with well-financed startups a particular market
segment is, how much your company needs in order to be competitive, and so forth.
Finally, and perhaps of greatest importance to the industry, reliable information on fund
returns is an essential pre-requisite for institutional investors such as pension fund managers
and fund-of-funds investors to comfortably place capital in Japanese private equity funds.
- Why did it take so long for a venture capital association to form in Japan?
My understanding is that attempts have been made in the past but that one reason the
association didn't form sooner was that it would have been obligated to be under the Ministry
of Finance's supervision, which would have greatly reduced the flexibility it could enjoy.
Recent changes in the Commercial Code enabled them to organize under a new form that
allows the industry to remain under the aegis of METI (formerly MITI, or Ministry of
International Trade and Industry).
It seems obvious that this organization should exist in Japan. The oldest VC association is
probably the National Venture Capital Association in the United States, which goes back to
1973. The European association was formed in 1983. Today there are associations in Russia
and Czechoslovakia. Even China started one last summer, so the Chinese group started six
months before the Japan group did.
- What would you like to accomplish at the JVCA this year?
One key JVCA initiative this year is to help METI design and implement professional
development and training programs for Japanese venture capitalists. In connection with that,
I've been asked to lead a study mission to the United States in early May. We will attend the
annual meeting of the National Venture Capital Association, visit universities that are
particularly strong in venture capital MBA programs, and visit venture capital firms to get
their opinions as to what kind of hiring policies, education, mentoring or other things can
really add value to a venture capitalist's skill set.
My hope is that I will be able to leverage my experience and relationships from Oracle and
SunBridge, my personal interest in seeing better quality data on the venture capital industry
here in Japan, and my new role on the JVCA board to personally make a difference for
entrepreneurism in Japan. That's been my dream since starting SunBridge. But I'm still
trying to learn how to work the system!
Allen Miner
www.sunbridge.com
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Nelson Fung solves another annoying problem
Nelson Fung is a Tokyo-based entrepreneur who gained fame (but not much fortune) when
his company became the first in Japan to successfully sue a U.S. entity for illegal use of a
server to transmit spam messages. The suit was a landmark of sorts, since Nelson prevailed
with claims that had not yet been pressed successfully "in cyberspace," so to speak. His suit
claimed, among other things, Theft of Services, Misappropriation of Name and Identity,
Trespass to Chattel, and Federal False Designation of Origin and False Description.
The incident landed Nelson on the front page of the Wall Street Journal, but with typical
humility, he passed the publicity on to the California-based law firm that represented him
(you can read our late 1997 interview with him at <www.jir.net/jir12_97.html#Interview>).
Last week we caught up with Nelson in the SunBridge lobby, and chatted while admiring the
spectacular Tokyo view.
"I like solving problems that annoy me personally, and spam is one of them," says the
easygoing entrepreneur, who since the lawsuit has been a quiet yet ferociously effective
volunteer in the fight against unsolicited e-mail messaging. Recently Nelson launched a new
service that solves another personal need: he wanted to use his mobile telephone to read,
respond to, and delete messages from any of his multiple e-mail accounts. He insisted on
lightning speed, minimal packet fees, and most important, an easy-to-use interface, in both
Japanese and English.
"Everything is too complicated these days, especially software," says Nelson. "My definition
of a good piece of software is that you can use it without having to read the manual. classY
(pronounced "class Y") is very close to achieving that. None of our initial users have had to
read the manual."
Nelson, whose motto for classY software is "simplicity for everyone," is now offering the
mobile service free of charge in order to solicit user feedback. See
<http://www.classy.jp/index-en.php> for details and signup.
"Simple software for a complicated world," says Nelson.
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Cell phone trumps PC as default e-mail terminal
Since transitioning out of an Internet-centric career last summer, I've spent more and more of
my time with ordinary Japanese people and less and less with the technology cognoscenti.
This experience has helped me rediscover that a very large number of people in this country
get along just fine without computers and the Internet, thank you very much.
In good part this is due to the phenomenal uptake/diffusion of data service-capable mobile
telephones. For a great many people, the young in particular, the cellular handset now serves
as their default e-mail terminal, at home, at school and even at work. I explore this issue, and
its implication for computer literacy here in Japan, in some detail
at<http://www.japanmediareview.com/japan/wireless/1047257047.php>.
One early reader dubbed this latest article a "reality bomb." I like that description.
Foreigners living in Japan are generally far more Internet and technology-savvy than the
average Japanese consumer, and they tend to interact primarily with Japanese folks who are
also far more techno-savvy than average (I'm not saying this is good or bad, just true). The
result, in my view, is that English language descriptions of reality here tend to overstate
Japan's techno-readiness and understate its techno-backwardness.
Here's an example from last week, from a conversation to arrange a speaking engagement
with a group whose members deal extensively with technology companies:
Me: "Do you have a PC projector?"
Them: "A what?"
Me: "A PC projector."
Them: "No."
Me: "How about an OHP?"
Them: "No."
Me: "Oh... OK."
BTW, the good folks at Japan Media Review foolishly offered me a three-month trial column
slot, which I even more foolishly accepted. Let me know what you think...
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Bits and bytes
Over 100 people attended the SunBridge/JER service sector entrepreneurship event on Feb.
26, and a good time was had by all. Some of the fireworks provided came courtesy of Joichi
Ito, who was interviewed by Wireless Watch Japan crew Daniel and Larry
(www.wirelesswatchjapan.com) just prior to the event. For some of Joi's hard-hitting
comments on entrepreneurship in Japan, see the video at
<http://www.glocom.org/interviews/s_inter/index.html#0313ito>.
One of the sponsors of the event was ETIC, a non-profit organization whose mission is to
provide venture and startup firms with qualified, highly motivated interns. One of ETIC's
strengths is that they are <not> affiliated with or supported by any government organizations.
What's more, they've been around for years. Contact Sasaki-san in English or Japanese at
<kensuke@etic.or.jp> if you are interested in placing an intern at your company.
Finally, I've been considering accepting advertising and/or advertorial insertions in Japan
Entrepreneur Report. This publication has about 3,400 readers, approximately 20 percent of
whom reside in Japan. About half the subscribers live in the U.S., and the final 30 percent are
spread out across Europe, Asia and the rest of the world.
The readership boasts a heavy technology contingent, businesspeople from all different
sectors, plus venture capitalists, attorneys and other professionals, academics and journalists.
Give me a call in Tokyo at 5459.0765 or write to <clark@sunbridge.com> if you are
interested in advertising with JER.
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Tim Clark
Senior Fellow
SunBridge Corp.
Voice 813.5459.0765
Fax 813.5459.0629
clark@sunbridge.com
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Copyright 2002-2003 Tim Clark
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