1. Japanese Venture Capital An Analysis of Start-up Investment Patterns vs. Silicon Valley Robert Eberhart, STAJE Fellow Stanford University

2. 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?

3. 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

4. US VC market

5. japan VC IRR

7. Comparative IRR

8. 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 syndicated 1 –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

9. 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?

10. 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

11. 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?

12. 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

13. Now what? What is the explanation of the differences? What can we learn?

14. 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.

15. heterogeneity in governance

16. heterogeneity in strategy

17. 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

18. 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

19. 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

20. conclusions

21. 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

22. 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

23. 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

24. Thank you