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.