By Terrie Lloyd
A recent article in Forbes magazine, titled “Searching For Entrepreneurship
in Japan” (http://tinyurl.com/nrzgma), posits that Japan is way behind the U.S.
in entrepreneurship and needs to do something about improving the environment
for breeding new companies so as to reinvigorate its economy. The article
focuses on the paucity of venture capital invested into Japanese start-ups,
which Forbes says amounts to just $3 billion a year
distributed to 3,000
companies. In comparison, it says that VCs in the U.S. invest an average of $30
billion a year into about 4,000 companies.
The article further goes on to say that Japanese VCs typically earn an Internal Rate of Return (IRR) of just 4%, compared to 17% or more by U.S. VCs, thus indicating that not only the amount of money but also the quality of companies being invested in is also weak. In other words, Japanese VC and entrepreneurship are messed up.
The Forbes article seems to have been based on the Stanford Project for Japanese Entrepreneurship (http://fsi.stanford.edu/research/staje), which is an effort by a number of Stanford and Todai academics to understand just what is going on with entrepreneurship in Japan and why there isn’t more VC money and more commercial successes coming out of Japan.
Check out the site. There is a very good PowerPoint presentation by Robert Eberhart, which spells out some possible reasons for the variance in Japanese-U.S. numbers. Forbes, on the other hand, chooses to quote a Hitotsubashi professor who reckons that Japanese start-ups are scared to launch in to the global environment, and thus wind up cannibalizing each other in the Japanese domestic markets. It is surprising that Forbes didn’t try to dig a bit deeper, because there is a story worth telling here.
I think it is true that:
a) There is a dearth of VC money available in Japan.
b) There is a dearth
of entrepreneurs.
c) There is a dearth of start-ups with global
capabilities.
Recent financials for two of the biggest VCs show a sorry picture for venture capital in Japan. The largest fund, with 3,000 investee companies as of 2006, is JAFCO. The company in FY2008 posted a net loss of 16.9 billion yen, while the largest listed VC, JAIC, has started negotiating for delayed creditor payments after posting a loss of a massive 34.8 billion yen. That’s a lot for a VC to lose in just one year.
Both companies are saying that the main reason for their travails is the terrible state of the stock markets for IPOs. There were only 49 listings in 2008, less than half that of 2007, and less than a quarter of the peak several years ago. But while they are quick to blame the markets, what other factors are at work here? Are VCs losing money because the quality of the companies they’re investing in are low, or are the quality ideas getting killed at birth because of a lack of funding?
I believe some of the major contributing factors are:
Failure to Get Past the Start Line
1. There is no doubt that there is a general lack of interest by most would-be entrepreneurs to take a risk, due to lack of role models and their brainwashing by older generations of the importance of a regular salary. Luckily, the silver lining of the recession clouds of the 1990s and now is that more and more people are being forced to realize that the system is broken, and to survive/grow they need to take charge of their own futures. Just look at the ongoing expansion in Rakuten online stores, up 4,000 last year to 27,000 retailers, to get a feel for this. An online store may not seem like an act of entrepreneurship, but for many younger Japanese and for housewives, it is a radical departure from the past. They are risking real money, the comfort of anonymity, and their recreation time to run these stores.
2. Lack of education about how to run a business. Japan still has a very low academic focus on setting up and running companies. At the kids’ level, you will seldom find schools encouraging kids to try starting their own businesses as a class project—it’s just not part of curriculum nor the Ministry of Education’s value system. This is understandable, given that the ministry comes across as one of the last bastions of socialism in this country. Later, after students graduate and start working, there is very little adult education to help people jump out on their own.
The good news, however, is that this is changing, as MBA schools become more popular. MBAs are ostensibly for the development of managerial skills, but inevitably these courses expose curious minds to alternative means of doing business, including entrepreneurship and NPOs. Some of the schools on the leading edge of promoting entrepreneurship include Globis, Keio, and Hitotsubashi. We wonder then, why Stanford felt it had to choose Todai in their entrepreneurship project?
Operational Hurdles
1. Then there is the bias of the financial system in not wanting to support risk takers. Now, it’s probably only natural that banks anywhere don’t want to risk their capital on start-ups, but the problem is that there is no real alternative to the banks. What VCs are active in the market nowadays tend to invest after a company has gone through the tough steps of developing a product and is already starting to record sales—in order to reduce their investment risk. To get a product up and running on in-house funding is tough and it is no wonder then, that Japanese companies are defined by Eberhart as being too founder-centric—you need to be mentally tough to make it past the start-up stage here.
2. The paucity of early-stage investment from VCs is a real problem for start-ups in the technology space in particular, since in order to create world-class products, they generally need to invest in processes and core research. Given that small companies employ most of the workers in Japan, supporting these start-ups would seem vital to the interests of the nation. I find it strange that the government doesn’t do more to kick-start their establishment. Tax preferences on angel and VC investing, special R&D funds for SMEs, and setting up a fund-of-funds to co-invest with established VCs would both be natural moves.
Indeed, in other first-world countries, government are establishing funding organizations that co-invest with private VC funds. These initiatives can be very effective and importantly for Japan send out the message that risk-taking is officially sanctioned.
3. Japanese VCs also need to change their investment and operational strategies, by putting larger amounts of cash to work in each company they jump in to, and by helping to educate the company’s management to grow in skills and vision. In so doing, they will provide both the necessary resources and also a means of overcoming the negative attitudes and fears bred by the current education system.
Some VCs are doing this already, such as Tsunami Network Partners (TNP) in Kanagawa and Sunbridge in Ebisu, but these types of firms are few and far between. More often the VCs choose to reduce risk by scattering their investments alongside other similarly minded funds, then proceed to ignore their investees post-investment.
The Forbes article does, however, miss an important source of funding for Japanese startups, as well as for foreign firms who are setting up in Japan—investment by strategic investors. While I don’t have any figures, I would guess that there are at least 1,000+ strategic investments in start-ups done by Japanese major corporations every year. The average amount is typically between 50 million yen and 100 million yen, and is made for 5-10 years. Forbes states that Japanese VCs have an IRR of just 4%, but if you’re a strategic investor, perhaps you may not want any end-game IRR on your investment at all! Instead, what you’re interested in is cash flow.
Thus, even if an investment appears to be highly valued, so long as the price being paid results in direct income and profit (by virtue of being an agent, distributor, OEM, or something similar) flowing at a rate 5%-10% higher than the cost of the money for the investment, then it makes financial sense. I suspect that if Stanford was to investigate the volume and value of strategic investments, the reason for the apparent lack of VC returns in Japan would be resolved. As a case in point, Softbank made much more money out of its implementation of the VoIP technology of UTStarcom than it did out of the gain in shares of that company—although it did well there as well. Thanks to UTStarcom’s technology, Softbank’s Yahoo BB business boomed and created a multi-billion dollar revenue channel for the group.
Lastly, what about the fact that Japanese start-ups don’t seem to be able to connect to buyers in the global markets? We think 90% of this equation is a simple lack of English-language confidence, coupled with the historic domination of profitable export business segments by the major trading companies. SMEs definitely need help to reach out to the global markets, and we’ve often wondered why JETRO, which was originally set up to promote the exports of some of the world’s now most famous brands, hasn’t been repurposed to help SMEs start their export push?
Maybe it is coming, but in the meantime, if a small company with world-class technology or products gets a call from a potential foreign customer, they do in fact get scared and hide under a shell. Usually they will either take ages to come back with a quote, or they go find an aged (retired) consultant to help them with English and export issues. As a result, the potential customer reads the lack of immediate response as lack of interest, and they go elsewhere.
Terrie Lloyd writes a weekly newsletter for entrepreneurs and business people about business and political opportunities in Japan.Now economy not good, entrepreneurs might find it hard to raise capital at this period of time.