Japanese Venture Capital

An Analysis of Start-up Investment Patterns vs. Silicon Valley

Robert Eberhart, STAJE Fellow

Stanford University

research questions

• What are the apparent differences in venture capital investment patterns in Japan versus Silicon Valley?

• How can these empirical differences be understood without cultural explanations and be consistent with the empirical data?

• Do the explanations - consistent with the observations - help us understand the future pattern of VC investment in Japan?

japan VC market

Note: Annual figures. Figures from 1991 to 2002 are for annual periods through September of indicated year. Figures from 2003 to 2006 are for annual periods through March of following year. E.g., “2006” is for the fiscal year ending March 31, 2007. Source: VEC, Japan Venture Research

Japanese VC Investment Data

0

500

1000

1500

2000

2500

3000

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Deals, Investment in Millions of Yen

Total Invested

Number of Deals

US VC marketUS VC Investment Activity

0

5000000000

10000000000

15000000000

20000000000

25000000000

30000000000

1995-11995-31996-11996-31997-11997-31998-11998-31999-11999-32000-12000-32001-12001-32002-12002-32003-12003-32004-12004-32005-12005-32006-12006-32007-12007-32008-12008-32009-1

0

500

1000

1500

2000

2500

DealsAmount Invested

japan VC IRR

Comparative IRR

Syndication

• Syndication– In US, most deals– One contract,

several investors– Claimed uncommon

in Japan

– 1 SOURCE: Japan Venure Research 2009

• Preliminary Survey data:– 60-70% of Japan VC

deals are de facto syndicated1

– Three to four firms per deal

• With similar term sheets• A de facto lead• “ Lead” assigns director

and coordinates

– Lacks the form of a US syndicate but is same function

empirical data revisited• Start with 2800 deals and @Y95M per deal

– With de facto syndicates, we recalculate to obtain:– Actual NET: (approx.) 1500 deals, $1.9M per deal

• Versus US, 2006:– 3080 deals with $7.1M per deal

• So, truer picture is:– in Japan’s economy

• deals are roughly equal, given relative economy size• but average deal size in Japan is 1/4 of US

– What can explain this empirical difference?

empirical summary• Any explanation of Japan VC patterns must

account for:– Comparatively different deal size

• US: $23.5 billion into 3080 deals (2006)• Japan $2.8 billion into 1500 deals (2006)

– Long term Japanese IRR is lower than U.S.• Japan LT Avg, life of fund = 3.9%1,2

• U.S. LT Avg, life of fund = 16.5%2

1 SOURCE: Japan Venture zResearch

2SOURCE: Martin Haemmig 2009

is current literature explanatory?

• Institutional Environment– Lack of Syndication

• No common contracts• Japanese VC’s do not assign a

director

– Ownership at IPO• Japanese firms at IPO greater

founder control

– Structure of VC firms• Shareholder =>Risk

diversification strategy • Japanese VC JPF structure

=>Internal VC staff to find and persuade investments

– Tax Implications

• Cultural Explanations– Japanese entrepreneurs

resist loss of control– Japanese VC’s are risk

averse• Salary motivations• culturally

– Poorly developed reputation markets for VC’s • Entrepreneurs cannot

decide which VC => less opportunism

Do these explain the data?

analysis• The current

explanations:1. Suggest a reduction of

the supply of funds, which

2. Implies a higher return to reflect attracting the smaller supply.

3. However, Japan has lower return…so inconsistent with many explanations

Now what?

• What is the explanation of the differences?

• What can we learn?

Heterogeneity can explain culture

• Cultural explanations may actually be path dependencies within a heterogeneous industry structure

• Can find a behavior depending on the founding date and strategy of a VC firm

• ex. “Salaryman type portfolio investment”– In some firms, not others,

not in new firms– Persists in some firms (path

dependence)

• Each period of VC foundation has its own institutional path dependencies

• Appears cultural because a cultural explanation can be supported by behavior of some firm.

heterogeneity in governance

heterogeneity in strategy

Lower return from lower costs

• agency cost differences can explain lower returns

• Opportunism and agency costs– VC and entrepreneur’s interests are not aligned– opportunistic behavior

• VC

• Common shareholder

opportunism• IN US

– VC’s control common shareholder opportunism by

• Preferred shares• Obtaining early control

via – large investment– Preferred shares

– Common control of VC is less effective

• Shareholder activism not favored by courts

• In Japan– VC’s almost always common

shareholders• less divergent interests

– More important - less ability to control through share acquisition

• Must acquire common shares for control

• Rights in law for significant minorities

• Silencing requires coalition of 71% or greater

• Shareholder activism can be expressed effectively extra-legally

mitigating opportunism

• U.S.– VC can control with

sub 50% ownership and preferred rights

– Vocal minority can be silenced with involuntary buy-out

– Courts rely on common shareholders selling to get out

• Japan– sparse preferred so

VC needs 50%+ to control

– To silence a minority must control more than US

– Courts generally hear remedies to unfair practice

conclusions

Key points• Japan VC’s have less motivation to seize explicit

control– Common shareholder (all), less divergence of interest– Legal differences reduce ability to control in Japan

• With less need (or ability) to mitigate opportunistic agency costs, Japanese VC’s obtain less control

• Lower money needed to mitigate agency costs => less risk => less return

conclusions• Cultural explanations

– Inconsistent with IRR data

– Can be explained by heterogeneity of VC firms

• Many apparent differences are differences of form not function

• Agency costs, from opportunism mitigation tactics, may explain the difference:– US structure creates need for

control by VC’s to mitigate • Common sh’rdr opportunism• Operationalize VC opportunism• But, not req’d or available in

Japan

– Is consistent with empirics– Explains why Japanese

founders come to IPO with more ownership

the future• Because of the agency

cost situation in Japanese VC investment

• And because of heterogeneous VC systems

• Japan has the ability to adjust to new economic reality … perhaps easier than US VC firms

• Predictions of a VC shakeout in US

• Predictions of second lost decade in Japan

• But entrepreneurship is an element of recovery.. VC is a catalyst

Thank you