Study Group for the Creation and Development of Start-ups. Final Report

Transcription

1 Study Group for the Creation and Development of Start-ups Final Report - Creation and Development of Start-ups for Innovation in the Japanese Economy - April 30, 2008 Study Group for the Creation and Development of Start-ups 0

2 Contents Introduction... 6 Chapter 1 Importance of the creation and development of ventures, and present conditions Present state of start-up creation Importance of the creation and development of ventures Roles ventures play in innovation in the Japanese economy Roles ventures play in the economic growth of Japan and job creation The roles venture start-ups play in turning the potential of individual entrepreneurs into reality Chapter 2 Expansion and enhancement of entrepreneurship education Importance of entrepreneurship education Entrepreneurship education at elementary, junior-high and high schools Present state Challenges Entrepreneurship education at universities and graduate schools Present state Challenges (1) More opportunities to take courses on entrepreneurship education (2) Development of more practical education that should help venture start-ups in the real world Education and support for entrepreneurs at the stage of considering a business start-up Present state Challenges (1) More and better entrepreneurship education for venture start-up (2) Cooperation between start-ups and entrepreneurs and effective use of private education and support organizations for entrepreneurs (3) Enhanced support by incubators for entrepreneurs other than just offering facilities 25 Chapter 3 University-originated ventures Present status (1) Present status of university-originated ventures (2) Challenges university-originated ventures face (i) Challenges in terms of people (ii) Challenges in terms of financing (iii) Challenges in terms of marketing channels (3) Viewpoints to be considered in supporting university-originated ventures

3 2. Challenges (1) Support of universities for university-originated ventures (i) Effective use of universities resources for support (ii) Use of universities names (iii) Actions to deal with challenges in financing (investment in university ventures, etc.) (2) Support provided for university-originated ventures by local governments, etc (3) Support for university-originated ventures provided by universities and local institutions in cooperation Chapter 4: Human resource strategies of Start-ups Present state (1) People as a business resource of Start-ups (2) Difficulty in securing people in competition with large companies Challenges (1) Expansion of the labor market for start-ups (2) Efforts to develop human resources (3) More jobs for women (4) Actions to counteract our aging and shrinking population (5) Effective employment of foreigners (6) Dissemination among start-ups of know-how of recruitment, human resource development, organization building, etc Chapter 5 For expansion of the customer base and market Present state (1) Japanese market emphasizes proven records (2) Japanese ventures are unwilling to expand overseas Challenges (1) Brand strategies, alliances with large companies, partnerships among ventures and SMEs, use of technology assessment services, and other initiatives for strengthening marketing of products and services (2) Effective use of public procurement and trial orders, etc (3) SBIR system (4) Treatment of new products and services at approval and under regulations (5) Aggressive expansion of business overseas by ventures themselves (6) Enhanced support for start-ups in overseas expansion Chapter 6 Enhancement of direct financing to start-ups What meaning does direct financing have for start-ups? Expansion of angel investors Current state of angel investment (1) Significance of angel investment

4 (2) Angel networks (3) Angel tax Challenges (1) Survey of realities of angel investors in Japan, and collection of cases of success / public relations campaign (2) More applicability of the angel tax system, and simpler procedures for the system 57 (3) Treatment of failed ventures (4) Efforts to expand angel networks (5) Venture capitals of types to support angel investment Increase of financing through venture capitals Present state of venture capitals (1) Amount of venture capital investment (2) Structure of the industry (3) Current status of investment of venture capital firms (4) Return on investment (5) Venture capital policies Challenges (1) Diversification of suppliers of capital (i) Capital from pension funds (ii) Capital from investors overseas (2) Collection and provision of information about venture capitals (i) Why is collection and provision of information about venture capitals necessary? (ii) Mechanisms to be prepared for the collection and provision of more information about venture capital investment (3) Further investment in companies at the early stage of business start-up (4) Development of human resources of capitalists for more hands-on support (5) Challenges in legal and accounting systems (i) Ways to apply accounting standards to venture capital investment (ii) Regulations of venture capitals Ways to increase participants in emerging equity markets and revitalize them Current state of emerging equity markets (1) Increased numbers of emerging equity markets (2) Increasing cases of companies delisted due to breaches of the law, etc (3) Retail investors support emerging equity exchanges (4) Volatile / depressed stock prices at present (5) More rigorous examination for listing (6) Difficult assignment of auditing firms

5 (7) Introduction of the internal control reporting system (8) Deteriorating listing conditions for start-ups (9) Concerns about a slump in investment in start-ups in general Challenges (1) Enhanced self-discipline and governance by start-ups themselves (2) How should listing procedures be from now on? (i) Listing procedures that strike a balance between the growth of start-ups and the protection of investors (ii) Exchange of information about listing examination procedures for better understanding of the procedures (iii) Necessary actions to solve issues with auditing firms (3) Shift of focus from listing examination to post-listing actions (i) Necessary recognition as ex post facto supervision system (ii) Study of Japanese Nomad (system for support for disclosure after listing) (iii) Voluntary efforts by securities firms and exchanges (iv) Examination of effective use of intellectual property reports and intellectual assets management reports (v) Observation of and action to outcomes of the internal control reporting systems introduced (vi) Examination of potential growth after listing (4) Efforts to increase participation of institutional investors (i) Enhanced efficiency and further globalization of exchanges to make them more attractive (ii) Examination of an analyst introduction system (iii) Development of an index of the emerging equity exchanges (iv) Liquidity provider program (v) Development of venture stock exchanges for professionals Chapter 7 Capital ties with existing companies Present State (1) Sale of Start-up stocks from venture capital funds to existing companies (2) Repurchase provisions in investment contracts with venture capitals (3) Moves of corporate venture capitals Challenges (1) Development of secondary markets for shares of unlisted Start-ups (2) Improvements in repurchase provisions in investment contracts with venture capital funds Chapter 8 Viewpoints of existing companies on ventures Present state (1) Expectations for corporate ventures

6 (2) Current state of large companies in the use of ventures (3) Background to the current situation (i) Challenges concerning the awareness of large enterprises and their governance 103 (ii) The problem of risks people have to assume when leaving a large enterprise and setting up a new business (iii) Challenges in social systems concerning corporate venturing Challenges (1) Reformed awareness and management for corporate venturing (i) Making visible how effectively a company uses its own technology assets (setting an indicator of the return on technology assets) (ii) Collecting and sharing best practices (iii) More and better arenas (platforms) for VCs and others to work as an intermediary and match business resources between companies (2) Reforms to reduce risks employees assume when leaving a large enterprise to set up a new business (3) Reforms of systems of the national government for corporate venturing, etc (i) Study of incentives for venture investment in R&D (ii) Increase of funds that deal with corporate venturing (iii) Enhanced support programs for corporate venturing (iv) Reviews of implementation of R&D programs by the government, etc

7 Introduction The creation and development of ventures, which often use and promote new technologies and/or business models and take on greater risks to tackle the challenge of new business, is essential to promote innovations in Japan s industry and encourage growth and revitalization of the whole economy of Japan. Over this decade, Japan has rapidly developed institutional and social frameworks for ventures, such as promoting the expansion of entrepreneurship education, the development of incubators, the growth of a labor market for start-ups, the abolition of minimum capital requirements, the growth of venture capitals, and the opening of emerging equity exchanges. In this sense, it could be said that dramatic improvements have been made in Japan for the creation and development of ventures. However, compared with countries where ventures play a great role in the growth of their national economies and promote innovation, such as in the United States, Japan should create more room for the growth and development of start-ups. At present, the rate of new business openings and total entrepreneurial activities are slowly rising, although there are some areas of concern, including the deteriorating conditions concerning listing on stock exchanges for start-ups. To examine and consider such circumstances, the Study Group for the Creation and Development of Ventures was established. We have reviewed what conditions ventures are now placed under and discussed what policies should be introduced. This report, the final conclusion of the Study Group, describes the challenges ventures are facing and suggests what should be done to deal with them. 6

8 Chapter 1 Importance of the creation and development of ventures, and present conditions 1 Present state of start-up creation Over the past decade, systems and institutions for ventures have been greatly developed. For instance, emerging equity exchanges were opened, minimum capital requirements for joint-stock companies were abolished, and systems for financing without the need for collateral or a guarantor were introduced. During the global IT boom around 2000, many IT service-related start-ups also came into the spotlight in Japan. In the country as a whole, however, the opening rate of establishments (the proportion of start-ups among existing businesses) stood at 5.1% ( ), smaller than the closing rate (the proportion of discontinued companies among existing businesses) of 6.2%. This has also stayed at a lower level than that in the United States (10.2%), the United Kingdom (10.0%), and France (12.1%). (The year of reference is 2004 for all three countries). The 2007 Global Entrepreneurship Monitor Report revealed that, in terms of Total Entrepreneurial Activity (TEA: the ratio of people involved in setting up a new business among those between the ages of 18 and 64 (those who are preparing a new business and those who started one within the past 42 months) Japan ranked eighth from the bottom (4.3%). The trend in the last few years, however, shows that the opening rate and TEA are both improving slowly. This fact seems to demonstrate that the efforts Japan has made to promote ventures and start-ups are gradually bearing fruit. Figure 1-1 Opening and closing rates of businesses (excluding primary industry) Opening rate Closing rate 7 (year)

9 Austria Russia Puerto Rico Belgium France Romania Sweden Japan Latvia Slovenia Italy Holland Denmark Israel United Kingdom Turkey Greece Switzerland Norway Hungary Finland Croatia Spain Ireland UAE India Serbia Portugal Kazakhstan United States Hong Kong Uruguay Iceland Brazil Chili Argentine China Dominica Venezuela Colombia Peru Thailand Source: Small and Medium Enterprise Agency, 2008 White Paper on Small and Medium Enterprises in Japan The Establishment and Enterprise Census, the primary set of statistics used to calculate opening and closing rates in Japan, is conducted once every few years. It would be desirable to publish annual statistics of start-ups in order to see how the constantly changing conditions affect the opening of businesses. Figure 1-2 International comparison of opening rates (%) Japan United States United Kingdom France Note: Average of for Japan; 2004 for the others. Sources: 2008 White Paper on Small and Medium Enterprises in Japan for Japan, and 2007 White Paper on Small and Medium Enterprises in Japan for the others Figure 1-3 Total Entrepreneurial Activity (TEA) in countries Source: Global Entrepreneurship Monitor 2007 (GEM) Note: TEA = Total Entrepreneurial Activity: ratio of people involved in setting up a new business among those between the ages of 18 and 64 (those who are preparing a new business and those who started one within the past 42 months) 8

10 Figure 1-4 Changes in Total Entrepreneurial Activity (TEA) US UK Germany Japan France Source: Global Entrepreneurship Monitor 2007 (GEM) Note: TEA = Total Entrepreneurial Activity: ratio of people involved in setting up a new business among those between the ages of 18 and 64 (those who are preparing a new business and those who started one within the past 42 months) A series of recent cases where some ventures (or former ventures) window-dressed accounts or violated the law also weakened expectations for start-ups and hurt their reputation, temporarily, but the situation seems to be recovering. Global Entrepreneurship Monitor surveys showed the percentage of people in Japan who respected successful entrepreneurs rose to 56% in 2004 from 8% in 1999 before falling to 45% in 2006, and that the figure slightly recovered to 48% in Figure 1-5 Evaluation of social status of entrepreneurs (percentage of people who respect successful entrepreneurs) (%) Japan US UK (Year) Source: Global Entrepreneurship Monitor 2007 (GEM) 9

11 2 Importance of the creation and development of ventures 1. Roles ventures play in innovation in the Japanese economy Ventures (start-up companies that launch a new business based on new business models as their core in pursuit of rapid growth) are one of the important sources of innovation of the entire economy of Japan, as they are a driver that creates innovative technologies and stimulates creative business models. In particular, ventures bring with them or create possibilities to stimulate great changes or transformations in technologies and/or business models that existing companies are not able to realize, because they take greater risks than established companies and take on the challenge of a new business with novel technologies and/or business models as their weapons. In the service industry, ventures may also contribute to the higher productivity of the whole sector as they introduce new business models and up-to-date technologies, including IT, and promote innovation in the industry. In the United States, it is said, research laboratories of major companies used to play a central role in innovation, but since the 1980s, when the US economy s industrial structure started to change, universities and start-ups have played an important part in innovation. In the ranking of the World's Most Innovative Companies published by BusinessWeek, the group of top 25 innovators includes 18 US-based enterprises, among which as many as nine were established in and after That suggests that innovation in the US economy owes much to ventures. Figure 1-6 BusinessWeek, The World s Most Innovative Companies Among the 18 US-based companies, nine were young enterprises established in or after There are no such new companies among the three companies based in Japan. Rank Company Country Established in Rank Company Country Established in United States United States United States Japan United States United States United States United States United States United States Japan United States Japan Finland United States Germany Korea United Kingdom United States United States United States United States United States United States United States 10

12 Source: 2. Roles ventures play in the economic growth of Japan and job creation Start-ups, which bring about novel technologies and new business models and, as a result, create new markets, make a great contribution to the growth and revitalization of the whole economy. The relationship in OECD members between opening rates of establishments and GDP growth shows that, in general, economies with more start-ups launched often grow faster. According to a survey in 2007 by the Global Entrepreneurship Monitor, countries with a higher GDP per capita than Japan generally have a higher level of Total Entrepreneurial Activity (TEA: ratio of people involved in setting up a new business among those between the ages of 18 and 64 (those who are preparing a new business and who started one within the past 42 months)). Ventures are also important as a source of job creation. Most of the new jobs in Japan are created by newly opened establishments. According to the National Venture Capital Association (NVCA), in the United States companies financed by venture capitals employed more than ten million people, 9.0% of those working in the private sector as a whole, in Figure 1-7 GDP growth and start-ups 図表 1-3 TEA と一人当たり GDP の関係 2007 年データに Source: OECD Science, Technology and Industry Outlook: Drivers of Growth: Information Technology, Innovation and Entrepreneurship, 2001 Edition 11

13 TEA, 2007 Figure 1-8 Relation between TEA and GDP per capita US Japan GDP per capita (US$): PPP, 2006 Source: Global Entrepreneurship Monitor 2007 (GEM) Figure 1-9 Effects on job creation of establishments opened and closed (10 years) 10 thousand jobs Jobs created Jobs lost Establishments Establishments Establishments ongoing opened closed Note: Establishments opened refer to those that did not exist as of the 1994 survey but did as of the 2004 survey. Source: Small and Medium Enterprise Agency 2007 White Paper on Small and Medium Enterprises in Japan 12

14 3. The roles venture start-ups play in turning the potential of individual entrepreneurs into reality The creation and development of ventures play an important role in turning the potential of entrepreneurs into reality; they help entrepreneurs realize their own dreams, fulfill their ambitions, put their philosophies into practice, build their own way of life, and work for communities, for instance. In 2007 the Ministry of Economy, Trade and Industry (METI) sent questionnaires to entrepreneurs who had received investments from venture capitals, and asked whether they were happy to have started a business themselves. Among the respondents, 97% answered Yes. Figure 1-10 Do venture founders feel happy to have started a business? Yes No Source: METI, 2007 Survey of Creation and Development of Start-ups (December 2007) 13

15 Chapter 2 Expansion and enhancement of entrepreneurship education 1 Importance of entrepreneurship education No start-ups could be created without entrepreneurs. Especially at the early stage of the entrepreneurial process, a start-up is inseparable from the founders themselves. The person of founder is the most important key to the subsequent birth and development of the company. As stated in Chapter 1, in terms of the number of entrepreneurs, Japan s level of entrepreneurial activity remains relatively low in the world. As for the skills of entrepreneurs, a survey in 2007 by the Global Entrepreneurship Monitor also showed that in Japan a far smaller proportion of the people between the ages of 18 and 64 thought they had the necessary entrepreneurial skills. Figure 2-1 Proportion of people between the ages of 18 and 64 who think they have entrepreneurial skills Russia Japan Taiwan Korea Hong Kong France China Germany U.S. UK Source: Global Entrepreneurship Monitor 2007 (GEM) For Japan to overcome this shortage of entrepreneurial people, entrepreneurship education has a really important role to play. Entrepreneurship education of course helps people acquire the mindset and skills entrepreneurs need and increases the number of entrepreneurial people. In addition, in Japan, where the way of life as an entrepreneur is not familiar to everyone and not everybody fully understands what benefits they might receive and what risks they should assume if they choose to live as an entrepreneur, this 14

16 type of education is also important to help as many people as possible realize they also have a real choice of living an entrepreneurial way of life. The qualifications entrepreneurs should have (i.e., entrepreneurship and entrepreneurial skills) are necessary, even if you refrain from choosing a career path to becoming an entrepreneur, to start creative and novel businesses and activities as a member of various types of economic/social organizations. Entrepreneurship education, therefore, has the benefit not only of giving birth to entrepreneurs but also of making the society and economy of Japan as a whole more creative and more vibrant. Ventures are rapidly developing, and they have the potential to be a driving force of Japan s economy. Before funding a venture, however, prospective entrepreneurs must acquire a rather high level of skills and have a clear sense of purpose. To help them obtain such skills and realize their mission, it is necessary to offer them a high level of expert education based on a high standard of professionalism, as well as general expertise on how to start a business. Figure 2-2 Qualifications entrepreneurs should have Entrepreneurship Vision/Ambition Spirit of challenge Creativity Decisiveness (quick decision-making) Tolerance of risk Leadership Dedication to teamwork Entrepreneurial skills Communication skills Planning skills Risk-management skills Skills to form alliances Knowledge of legal, accounting and financial affairs needed to create/develop a venture Linguistic skills 15

17 2 Entrepreneurship education at elementary, junior-high and high schools 1. Present state The spirit of challenge, creativity and other elements of entrepreneurship have much to do with the awareness/values and behavioral principles of people. To fully develop such personalities, it is crucial to encourage children to learn entrepreneurship at the stage of elementary and secondary education. From such a point of view, METI has provided assistance since 1999 to: (a) develop and try out educational materials and programs for elementary, junior-high and high school students and manuals for teachers; (b) invite business owners or people engaged in start-ups to elementary and secondary schools, and send teachers to start-ups for research and training; (c) implement model programs for participation/experience-style learning of entrepreneurship; and (d) commend organizations and individuals that have worked for entrepreneurship education. Thanks to such initiatives, entrepreneurship education is spreading among elementary and secondary schools to a certain extent. For instance, model programs for participation/experience-style learning of entrepreneurship, as mentioned above in (c), were carried out between 2002 and 2006 at 833 schools for 68,923 students in total. The Keizai Doyukai (Japan Association of Corporate Executives) and local New Business Conferences have been regularly sending lecturers to schools. Entrepreneurship education, however, has yet to have become prevalent among a wide range of ordinary elementary and secondary schools. For instance, among the local governments that have implemented model programs as stated above, only half continue to provide entrepreneurship education. Most of the municipalities that discontinued such education say they gave up because of a shortage of budget or a shortage of teaching hours. 16

18 Shortage of budget Shortage of teaching hours Difficulty in cooperation with other departments in the local government School s lack of understanding or cooperation Lack of parents /community s understanding or cooperation Shortage of teachers for such education Shortage of visiting lectures No need felt for such education Others Figure 2-3 Why was entrepreneurship education discontinued after model programs ended? Source: METI, Survey of Entrepreneurship Education (December 2007) In terms of a shortage of teaching hours, many pointed out duplication or redundancy between entrepreneurship and career education. Career education is provided to help young people find their own abilities, aptitudes, and ambitions and develop awareness as a worker, professional or business person. This type of education has been introduced as a result of recent concerns about an increasing number of youngsters who work part-time (Freeta) or those called NEETs (Not in Education, Employment or Training). Comparison between entrepreneurship and career education shows they share many objectives because they are both intended to support students in acquiring knowledge to collect and search for information, the ability to carry out their plans, the expertise to find solutions, and skills for communication. Career education is rapidly prevailing among schools mainly because related issues have been incorporated into the Guidelines for the Course of Study of the Ministry of Education, Culture, Sports, Science and Technology (MEXT), and because MEXT and three other ministries have jointly completed a promotion plan. For instance, in 2006, 94.1% of public junior high schools (9,528 among 10,124 schools) provided job experience programs for students, and 62.0% of public high schools (2,914 among 4,699 schools) offered opportunities for internships. 17

19 Figure 2-4 Comparison between entrepreneurship and career education Entrepreneurship education Entrepreneurship education refers to education provided to train people to develop entrepreneurship and entrepreneurial skills and to be able to find their own mission, discover themselves what to do with it, and carry it out themselves. Skills and abilities entrepreneurship education is expected to develop (examples) Entrepreneurship Spirit of challenge: a forwar-looking attitude to try something new and address the challenges that emerge Ambition: Passion: Courage: Entrepreneurial skills Ability to dream: motivations and causes zeal Ability to explain a dream: Ability to realize a dream: willingness to expose themselves to certain risk imagination, creativity, problem-finding, positive attitudes, optimism, etc; communication skills, logical thinking, presentation skills, personality and honesty, etc; skills to collect information, problem-solving, ability to make plans, vitality, judgment/decisiveness, patience, etc. Career education Career education refers to education provided, based on the concept of careers, for students to support each of them in developing their careers and help them acquire the motivation and attitudes necessary to build the careers they deserve. In short, it is education to have every one of the students develop an awareness of how they should work and what job they should take. Skills and abilities for career development (examples) Skills/Abilities To develop human relations Ability to make effective use of information Ability to design the future Ability to make decisions Description Ability of students to understand themselves and others Ability to have deeper understanding of themselves and others, to appreciate the diversity of personalities of people, and to act with respect for each other Communication skills Ability of students to develop communication with members of a diversity of groups and organizations and establish rich human relations with them to attain their own growth Ability to collect and search for information Ability of students to collect and search for a variety of information about careers and jobs, to select and use the necessary information, and to consider what career they should choose and how they should live Ability to understand jobs Ability of students to understand the relation between what they are learning at school and what they will do in society and at a workplace, and to find what they should do now Ability to understand/recognize roles Ability of students to understand what roles people play in private and professional life, what they are performed for, and how they are related to each other, and to gain a deeper understanding of what roles they themselves should play Ability to implement plans Ability of students to consider objectives in how they will live and what career they should build, to prepare a career plan to achieve them, and to carry it out in, for instance, choosing something in practice Ability to make appropriate choices Ability of students to compare and examine alternatives, to settle conflicts between them, and to exercise independent judgment in order to make choices and decisions appropriate for themselves Ability to solve problems Ability of students to assume the responsibility that accompanies decision-making, and to adapt to what results from their own choices, as well as to find what they should do to realize the career they hope for and to solve the challenges involved Sources of descriptions of career education: MEXT, Manual for Promotion of Career Education at Elementary, Junior-high and High Schools - Support for Every One of the Students in Developing Awareness of How They Should work and What Job They Should Take 2. Challenges Entrepreneurship education at elementary, junior-high and high schools should now advance from the stage of model programs to the phase of penetration. Challenges that lie in the way in spreading entrepreneurship education among schools are the shortage of teaching hours and budget. Teaching hours might be secured by offering entrepreneurship education as a part of career education, which has been introduced to more primary and secondary schools in parts of Japan and has a lot in common with entrepreneurship education. To secure a budget, it is necessary to pursue entrepreneurship education that can be provided with limited financial resources by ordinary teachers. For instance, studies should be made on whether and/or how help desks for entrepreneurship education should be set up and programs should be prepared to send entrepreneurs to schools to give lectures. Opportunities for entrepreneurs to visit primary and secondary schools and talk directly with students are important, especially to show them how exciting it is to start a business and to get them interested in and attracted to entrepreneurial activities. 18

20 3 Entrepreneurship education at universities and graduate schools 1. Present state One of the factors that hold back the business start-up rate in Japan might be insufficient entrepreneurship education at universities and graduate schools. According to a survey conducted in 2000 by the Japan Small Business Corporation, in Japan only 1.6% of adults (people between the ages of 18 and 65) had attended an entrepreneur training course at a university or a graduate school. This figure is much smaller than those in the United States, United Kingdom and France, where between 14% and 21% said they had taken such a course. Another survey, conducted by the European Commission (as of 2007), showed that in Europe 34% of full-time students had received entrepreneurship education and that in the United States 13% had done so. Comparison among countries of the proportion of people who received entrepreneurship education at a university or a graduate school and the business start-up rate reveals that countries with a higher percentage of people who experienced such education often have a higher rate of business opening.s Figure 2-5 Percentages in major countries of people who attended entrepreneurship education courses at universities/graduate schools, and business start-up rates Business start-up rate in major countries Proportion of people who attended entrepreneurship education courses at universities/graduate schools Results of telephone survey of random sample of people between the ages of 18 and 65 in each of the countries Japan U.S. UK France Japan U.S. UK France Note: For Japan, the average between 2004 and 2006, and for the others, figures as of Source: For Japan, the Small and Medium Enterprise Agency s 2008 White Paper on Small and Medium Enterprises in Japan, and for the others the 2007 White Paper on Small and Medium Enterprises in Japan. Source: Japan Small Business Corporation, Survey Report: Comparison between Major Countries in Entrepreneurship and between Prefectures in Power of Entrepreneurs, (January 2001) 19

21 As seen above, entrepreneurship education at universities and graduate schools in Japan has still to reach the level of prevalence in the United States or the EU. But a steadily increasing number of universities are introducing courses for entrepreneurship education. According to a survey by the University of Tsukuba, in 2003 almost 40% of the more than 700 universities in Japan offered courses for entrepreneurship education. A survey conducted in 2007 by Daiwa Institute of Research, which covered 22 universities in Japan, found that two-thirds of the courses for entrepreneurship education were offered by graduate schools mainly for MBA (Master of Business Administration) and MOT (Management of Technology) degrees. Figure 2-6 Numbers of universities in Japan that have courses for entrepreneurship education Private Prefectural/ Municipal National FY 2000 FY 2001 FY 2002 FY 2003 Note 1: Different populations are used for years. The populations for 2000 to 2002 are from surveys by MEXT, and that for 2003 is from a research by the University of Tsukuba. Note 2: In Japan there were 87 national, 89 prefectural/municipal and 568 private universities as of May 2006, while there were 100 national, 76 prefectural/municipal and 526 private universities as of May (MEXT, School Basic Survey) Source: Daiwa Institute of Research, Growing Entrepreneurship Education at Universities (2006 spring), University of Tsukuba, Research on Challenges for University-originated Ventures and Actions for Their Development (March 2004) 20

22 Figure 2-7 Number of courses on entrepreneurship education at 22 universities in Japan Number of courses on entrepreneurship training/venture theory (survey in 2007) Does it have online syllabuses that Courses for can be undergraduates searched by outsiders? Courses for MBA Courses for MOT Other courses at graduate schools Total (excluding overlaps) Surveyed in 2006 Total (excluding overlaps) Surveyed in 2005 Total (excluding overlaps) Ritsumeikan yes Waseda yes Keio Shonan Fujisawa Campus Nihon some depts Doshisha yes Chuo yes Kyoto some depts Meiji yes Hosei no Rikkyo yes Tohoku yes Tokyo Univ. of yes Science Kyushu yes Hitotsubashi some depts Tokyo some depts Osaka some depts Tokyo Tech some depts Nagoya some depts Tsukuba some depts Kobe some depts Aoyama Gakuin no Hokkaido yes Total (including overlaps) Source: Daiwa Institute of Research, Growing Entrepreneurship Education at Universities: Follow-up 2007 (2007 summer) 2. Challenges (1) More opportunities to take courses on entrepreneurship education As described above, only a limited number of students in universities and graduate schools attend entrepreneurship education courses, and this type of education is provided mainly by graduate schools. Environments should be developed to allow more students to take such courses. Especially, more courses should be offered to undergraduates. As for entrepreneurship education courses at graduate schools, given that there is a great need for such courses for those seriously considering starting a business, studies should be started on whether and/or how graduate schools should be allowed to offer, in addition to entrepreneurship education classes for those working to attain a master s or doctor s degree, more several-- or six-month courses that people can attend at night on weekdays or on days off, even if they have no intention of obtaining a degree. 21

23 (2) Development of more practical education that should help venture start-ups in the real world Entrepreneurship education should be provided at more universities and graduate schools, and more courses should be offered. But it just as important to improve the quality of entrepreneurship education as it is to expand it. Currently, many universities offer a diversity of courses: some offer practical courses intended to support actual business start-ups; others offer courses in which venture theories are studied. With a view to helping more people start new ventures, in particular, it is desirable to increase and/or enhance practical courses where students, for instance, develop specific business plans and learn the skills necessary to set up a company in the real world. From such a viewpoint, it is also important to invite more businesspersons, including those who have started a venture themselves, to work as lecturers in entrepreneurship education courses. This is also an effective method of practical education to give students internship opportunities, for example, at venture firms. It is as important to offer more opportunities to attend courses to businesspersons who have already started a new business or are considering how to start one. The participation of such people would benefit other students as they could learn from those with the experience of business how practical skills work and how a real business operates. The attendance of both types of students in such courses could help them learn from each other and might encourage them to develop more sophisticated plans for real business. When individual universities are facing difficulties in collecting a sufficient number of students or lecturers by themselves, alliances could be formed to establish joint courses. In order to spread and disseminate higher-quality entrepreneurship education among universities and graduate schools in Japan, information about teaching techniques and materials should be exchanged between schools all over the country, and expertise in entrepreneurship education should be shared and accumulated nationwide. From this viewpoint, model programs for high-quality entrepreneurship education should be conducted, and studies should be made especially to find what programs should be developed to encourage people engaged in entrepreneurship education at universities and graduate schools in Japan to exchange information and share teaching skills. 22

24 4 Education and support for entrepreneurs at the stage of considering a business start-up 1. Present state Education and support for entrepreneurs at the stage of considering business start-ups is provided by private institutions, national and local governments, and other organizations in various forms of projects. Since 1999, hundreds of sogyo-juku (Venture Schools), providing short-term intensive training courses mainly on business planning for business start-ups, have been held at commerce and industry associations and chambers of commerce all over Japan with the financial support from the national government. They have been attended by more than 90,000 prospective entrepreneurs in total, and probably more than 30% of those who completed the courses have launched a new business. Since 2003 the government has also been conducting programs for providing consultations through the internet on procedures for setting up a company and tax, legal and accounting issues, and those for developing and supporting prospective entrepreneurs by offering internship opportunities to work closely with experienced entrepreneurs (the Dream Gate program). In addition, the government has been providing information and receiving requests for consultations through symposiums, seminars, SNS (social networking services), newsletters, websites, and other media. Private sector companies are also engaged in many projects; they give a variety of lectures to teach skills necessary to launch a new business, issue magazines to provide information concerning business set-up, and hold business plan contests. In Japan, incubation institutions have been developed all around the country since 1999, when the Act for Promotion of New Business Start-ups came into effect. There are 190 institutions that satisfy specific conditions, including support being provided by an incubation manager. When institutions that rent rooms are included, the number has reached 323. Many private sector firms employ prospective entrepreneurs and support them in starting new businesses. They function, in effect, as incubators. 23

25 Institutions Institutions: cumulative Figure 2-8 Present status of incubators in Japan Types of institutions/ their current services Support institutions that rent offices (with no supporter stationed) 42 (13%) Support institutions that rent offices (with supporter stationed) 91 (28%) 323 institutions in total Narrowly-defin ed BI institutions 190 (59%) (Note) satisfying the four definitions of BI Four definitions of business incubation (BI) institutions (1) Have offices and other facilities that can be offered to entrepreneurs; (2) Provide support by incubation managers or someone in charge of giving assistance for starting a new business and developing it; (3) Have specific restrictions for tenants; and (4) Make distinctions between companies that leave the institution as graduates and others. Numbers of incubation institutions by year of starting service Cumulative total Total of companies that entered: 6,352 Total of companies that graduated: 2,449 Among which went public (IPO) 16 (Note) Compiled data of 180 institutions that made valid responses among the 190 narrowly-defined BIs. and before Japan Association of New Business Incubation Organizations (JANBO), Report: 2006 Survey of Business Incubators (March 2007) 2. Challenges (1) More and better entrepreneurship education for venture start-up Venture start-up and other ordinary types of business set-ups have some features in common, of course, but they are, however, different in many aspects. Among others, they differ in terms of speed of growth, scale, and the employment of new or novel technologies and/or business models. As a result, they need different types of information, skills, and management. As described above, the government has given attention to business start-ups in general in terms of entrepreneurship education for people considering starting a new business because the government s main purpose has been to expand the base of prospective entrepreneurs. The government, however, should now place more emphasis on education and support for venture start-ups that aim for rapid growth. (2) Cooperation between start-ups and entrepreneurs and effective use of private education and support organizations for entrepreneurs For those who are considering whether and/or how to start a new business, it is quite useful to see veteran entrepreneurs who have launched a venture firm and gotten through a period of growth and to ask about their experience and know-how. What is important is to offer such new entrepreneurs opportunities to consult with experienced entrepreneurs and those who have worked to support venture start-ups. Occasions for people in different 24

26 industries to exchange information would also allow prospective entrepreneurs to receive advice relevant to specific sectors and have people and/or outlets in industries introduced to them. The government and related parties should work together to afford such opportunities for information exchange. Governments, national or local, and other public organizations that intend to provide appropriate services to meet the needs of entrepreneurs should not only offer them their own advice from an independent, neutral position but also make effective use of programs prepared for education and support services for entrepreneurs by private-sector organizations that, for instance, finance part of the initial capital and give hands-on support as a joint-owner of the business. (3) Enhanced support by incubators for entrepreneurs other than just offering facilities The number of incubators has increased, but they have still been slow to provide support other than their facilities and equipment (often referred to as soft-support ) for start-ups they accommodate. It is important especially for both the national and local governments to help incubation managers and other people in charge provide more and better support for entrepreneurs by developing more practical training for the people working for incubators, linkages with MBA and MOT education, and networks between them. 25

27 FY 1999 and before Chapter 3 University-originated ventures 1. Present status (1) Present status of university-originated ventures Universities, which are supposed to be a base to create knowledge and innovation, are also expected to work for entrepreneurship education and put their knowledge into practical and commercial use to return what they have obtained to communities. Most of them also function as a hub, or center, of research institutions in a community, so they are expected to work as a member of an academy-industry alliance there or as catalyst to create a new industry in the region. That is why great expectations are placed on university-originated ventures, new businesses founded by universities to use their knowledge for practical and commercial purposes. Universities, industry, and governments have made great efforts together to encourage university-originated ventures, including the 1,000 University-Originated Ventures Plan, announced in May 2001, (also known as Hiranuma Plan after the name of the then minister of METI). As a result, the number of such start-ups increased to 1,590 in March 2007, or grew almost threefold (up 170%) during the five years from Figure 3-1 Numbers of university-originated ventures (cumulative total) Total among which core ventures Core ventures: ventures founded on results of researches achieved by universities + student ventures in close relation with a university Source: METI, 2006 Basic Survey of University-Originated Ventures 26

28 The chart below shows the numbers of university-originated ventures founded in urban areas and other rural areas separately. In 2001 the number of ventures that had been established in the urban areas (339) was larger than that of those in the rural areas (259). Many ventures were then set up in rural areas, and as of March 2007 the number of start-ups there (819) surpassed that of peers in urban areas (771). In other words, ventures operating in rural areas increased more than threefold (up 220%) during the five years between 2001 and Figure 3-2 Comparison of university-originated ventures in urban and rural areas (unit: company) more than tripled (up 220%) more than doubled (up 130%) March 2002 March 2007 Urban Rural Note: Urban districts: Prefectures of Tokyo, Saitama, Chiba, Kanagawa, Osaka, Kyoto and Hyogo Rural districts: Other prefectures Source: METI, 2006 Basic Survey of University-Originated Ventures Different university-originated ventures go in different directions of growth. Some intend to go public (IPO). Others aim at growing in such a steady manner as to make a certain level of profits and create jobs in a community, which would contribute to the local economy. They pursue growth in a variety of ways for a range of purposes. 27

29 Figure 3-3 Diverse directions of growth among university-originated ventures Sales ( million) 1,145 Group of ventures that have grown large and are going ahead of others A Leading type 2 ventures High Potential Firms Put innovative technologies into commercial use to develop new vast markets, and rapidly expand business scale Description Leading type: Having already gone public (IPO) or are about to go, and having been in business for relatively long period; mainly bio-tech startups with a larger scale of business. 132 Group of ventures that receive support from VCs and pursue fast growth Rapid-growth type 49 ventures B Rapid-growth type: Supported by VCs to conduct applied research. Targeting new, developing markets. On a solid growth track. Steady-growth-in-existing -market type Group of ventures that pursue a modest but steady growth in existing markets D Foundation Firms Put new technologies into commercial use and acquired a certain scale of market and business scale Stagnant type: Many located in rural areas. In part because they are beneath the radar of VCs, They may have a serious shortage of funds. Many are stagnating.. 58 Small-scale new-entrant type E Group of small but steady ventures that nevertheless aim at entering new markets 62 ventures Lifestyle Firms Put new technologies into use but are satisfied with a level of family business Steady-growth-in-existing-market type: Operating in a modest way and targeting existing markets, few intend to go public (IPO), so out of VCs support parameters in the first place. Obtaining funds they need mainly in the form of loans ventures 37 ventures Stagnant type Group of ventures that are in serous shortage of finds whose business is stagnant C Source: Prepared by METI in reference to comments of Kanetaka Maki, assistant professor, Keio SIV Entrepreneur Laboratory Others Years Small-scale new-entrant type: Working aggressively to create new markets. But because few are intending to go public (IPO) or because they too young, they face difficulty in obtaining funds from VCs or receiving loans. Note: Results of cluster analysis of 212 university-originated ventures, which answered all of the 14 questions that characterize university ventures, including years after foundation, capital, target market, status of financing, location of headquarters. (2) Challenges university-originated ventures face In the process of their growth, from foundation through research and development to commercialization, university-originated ventures encounter three major challenges: acquisition and development of people, financing, and development of marketing channels. They have such difficulties because they are characteristically burdened with weakness resulting from people (as their management is often composed of university teachers, who in general have little experience of business management) and weakness resulting from technologies (as most of them intend to put into commercial use achievements of quite novel research that has not been much more than a seed. Such projects often require a longer lead time, which raises technological risks, and also have higher commercialization risks because new markets must be developed.) 28

30 Figure 3-4 Challenges of university-originated ventures Difficulty in acquiring and developing people (2006) (2005) (2004) Difficulty in financing (2006) (2005) (2004) Difficulty in developing marketing chalets and customers (2006) (2005) (2004) Difficulty in securing offices/laboratories (2006) (2005) (2004) Slower pace of R&D than expected (2006) (2005) (2004) Sour relationship with the university (2006) (2005) (2004) 1st 2nd 3rd N = 325 (2006) 319 (2005) 371 (2004) Source: METI, 2006 Basic Survey of University-Originated Ventures The two weaknesses that are attributed to university ventures seem to be the very factors that bring about the three challenges. (i) Challenges in terms of people At most university-originated ventures, the management is composed of teachers and students of the university. As most of them have little experience of business management, often the company is not administered well enough. Even when the venture succeeds in growing to a certain level, the management is slow to be replaced by people who can handle the business at this stage. Right-hand persons who should assist the management can be found rather easily in the field of R&D and they can be employed to supplement R&D abilities of the company. But university-orginated ventures often have difficulty in finding and employing right hands who should support them in business administration and financing. (ii) Challenges in terms of financing Many university-originated ventures face difficulties in financing at the R&D stage and the initial stage (phase of foundation including just before and after the event). The business of most university ventures is based on achievements that are themselves based on pure research. In part because they must go through a longer lead time before they are commercialized, such ventures assume higher business and technological risks. As a result, 29

31 it is not easy for them to raise funds from venture capitals. (iii)challenges in terms of marketing channels Many university-originated ventures explore new markets with achievements of research and development no other has ever undertaken. They often try to develop new markets and distribution channels through people they meet and connections they built mainly in the process of R&D, and/or through companies they worked with for R&D. But the task is not easy for university ventures because few of them have sufficient resources to establish marketing channels. Most of their products are for business use, but Japanese customers often place more importance on past record and established reputation, which makes it all the more difficult for new firms to secure outlets. (3) Viewpoints to be considered in supporting university-originated ventures To help university-originated ventures solve challenges presented by their own characteristics, it is critical for universities and local governments and communities to give support to the ventures, taking into consideration viewpoints as stated below. University-originated ventures are a front runners that offer novel products, or new value, to the economy. Because one of the roles national universities should play is their part in contributing to the society by putting their achievements to commercial/business use, it is important for them to develop environments where university-originated ventures can operate smoothly. Many university ventures operate in rural areas. They are expected to revitalize local economies because their growth may encourage innovation in a community and create more R&D jobs for those who have received sophisticated education. A cluster in a community of university ventures established to put to commercial use achievements of research at a university may attract another cluster of industries, which might add value. That would also contribute to its development. 30

32 2. Challenges (1) Support of universities for university-originated ventures (i) Effective use of universities resources for support Many universities use their alumni resources for advice on business management, personnel loans, and aid in commercializing their research, as well as in R&D activities. It is important, to make effective use of such resources, for universities to develop stronger management functions and build closer cooperation with other universities, companies and local governments. (ii) Use of universities names Most of the markets university-originated ventures target are newly created markets. To explore such markets and develop marketing channels, they should work to build up the reputation of their products among customers and in markets. Some university ventures use the name of the university for their products with the expectation that it helps them enhance credibility among customers and in markets, and do enjoy certain reputation in markets. On the other hand, there are only a limited number of universities that are very willing to allow their affiliated ventures to use their names. As the name of a university has a certain level of established market value in the form of a trademark or trademarks or a proven reputation, its use by a university-originated ventures for its products may be effective in lowering barriers that may be encountered in developing markets and outlets. Permission to use the name is expected to create a ripple effect on the university itself because it may bring revenues to the school. One of the reasons few universities are willing to allow university ventures to use their names is the fear of being held responsible for defective products by customers, a situation that the universities may be ill-equipped to deal with. Against such circumstances, it would be desirable to examine risks that should be anticipated when university-originated ventures sell their products under the name of the university and study whether and/or how guidelines should be prepared so that universities and affiliated ventures will both manage such risks in an appropriate way. 31

33 (iii)actions to deal with challenges in financing (investment in university ventures, etc.) University-originated ventures play an important role in making use of knowledge universities have acquired to contribute to society. They are expected to build new industries in communities, create new jobs, and bring in other economic benefits. Most of their business, however, is based on achievements of cutting-edge research and development at universities. University ventures as such usually have much more difficulty in financing than ordinary start-ups: (i) because there are few who have the sort of keen eye necessary to understand and assess their business due to their advanced, state-of-art research and development; (ii) because it generally takes longer to complete R&D for commercialization as they try to put achievements of cutting-edge research to practical use; and (iii) because, in part as a result of the disadvantages mentioned above, risks of their business are more difficult to assess, which leads to fewer venture capitalists that are willing invest in university ventures and to limited, smaller scale of investments for those that do. Some of the universities, which are expected to use the achievements of their research and development for society, might offer financial support to ventures founded by their researchers and students. Financial aid could be provided in a variety of forms. But national universities are prohibited by the current National University Corporation Act from making equity investments, except in approved technology licensing organizations (TLOs). In order to provide national universities with more support options, it would be advisable to consider whether they should also be allowed to have equity in such ventures. To make such schemes more effective, it is also necessary to consider what arrangements should be made to help universities examine a venture s plan of business and assess its value, manage types of risk, etc., to make a good judgment before making investment. Considering this, the level of discretion and flexibility universities should retain in management of their assets should also be taken into account as they have tended to demand more discretion and flexibility since they were reorganized as independent administrative institutions. 32

34 (2) Support provided for university-originated ventures by local governments, etc. Growth of university-originated ventures helps create jobs in local communities and develop industrial clusters. Local governments and other institutions are expected to provide more support for university ventures, taking local needs into account. (3) Support for university-originated ventures provided by universities and local institutions in cooperation Those involved hope that as part of the support provided for university-originated ventures, which often face difficulty in financing at the initial stage, incubation facilities equipped with functions such as open facilities and open laboratories should be built in or around university premises so as to provide technical support by university teachers and reduce their financial burden. Studies should be conducted on whether and/or how such bases for industry-university cooperation should be developed jointly by businesses, universities, local governments and other parties concerned. In order to improve the quality of incubation, it is important to take measures to help incubation managers, who work at incubation facilities used by university-originated ventures to support them, and enhance their abilities as network constructors and producers. It is also crucial for universities, local governments, and local businesses, including financial institutions, to work together closely to provide university ventures with soft-support. 33

35 Chapter 4: Human resource strategies of Start-ups 1. Present state (1) People as a business resource of Start-ups People are one of the most important business resources, as important as funding for example, for start-ups to grow fast. Types of human recourses are more unique and more diverse than financial recourses both in terms of who and how many are needed and how or whether they can be employed. To match demand and supply requires a great deal of time and effort. Start-ups, which pursue rapid growth, might be held back by the time and effort they must spend for recruitment when they strive to grow. Whether a venture can employ the people it needs at a specific phase of growth just when they are needed is a major key to its growth. Start-ups could be seen as a business started by the founder (or the group of founders) as an individual (or a group of individuals) being transformed to one managed by a company, that is to say, an organization. Compared with established, large corporations, many ventures may need to employ people who are likely to feel more empathy with their visions and ambitions and work more closely as a team. Once a person is employed, the company is obliged to retain that person, who becomes difficult to fire if found not to share its visions or ambitions or because that person becomes is harmful to the unity of the team. From such a viewpoint who a company hires has great impact on its entire business. It is often said that a company needs to breathe in and out to grow. Start-ups should also acquire such types of people and develop the appropriate internal organization needed at each stage of development. Some are afraid, however, that Japanese companies lack a culture where people in management are replaced by those relevant at a specific phase of growth. (2) Difficulty in securing people in competition with large companies Ventures, which in general have less stable business bases and poorer brand images than large companies, have great difficulty in employing talented people. Especially, as business confidence has been improving recently and large companies have been hiring more people, start-ups have found it more difficult to acquire excellent people. According to a questionnaires survey conducted by METI in 2007 of ventures which had 34

36 received investment from venture capitals, more than 71% of the respondents felt some degree of dissatisfaction with the quality of the staff hired. Figure 4-1 What do start-ups in Japan think about people they acquired? Sufficient Insufficient DK Source: METI, 2007 Survey of Creation and Development of Start-ups (December 2007) How start-ups, engaged in higher risk businesses, should propose returns that would compensate for the risks to those whom they hope to hire is crucial. There would be some cases where remuneration could be offered as stock options, a common tool for ventures. But as start-ups in general have fewer financial resources at their discretion, most find it difficult to offer prospective employees better terms and conditions only through remuneration. As a result, an important element is what can offer in terms of non-financial rewards, such as shared vision, opportunities they have for self-realization, and skills they acquire useful for their later career. Some point out people only perceive a job at a venture more risky than it really is but that they often fail to recognize a diversity of potentials it brings to them on the career path (including those to start a business themselves or step up to another job). Others say, on the other hand, now a labor market for Start-ups is being formed mainly among those which have grown to a certain scale, especially with IT service-related start-ups, though not yet so large a market as in the United States, and that people are becoming more mobile there. 35

37 2. Challenges (1) Expansion of the labor market for start-ups As start-ups need to quickly acquire people who can be immediately effective to achieve rapid growth, higher mobility in Japan s labor market would bring great opportunities. After the burst of the economic bubble in Japan, when its financial institutions were in crisis and firms were merged, reorganized, or restructured, some of the excellent people who left the financial sector flew into start-ups. They are now drivers of growth of ventures in the country. In Japan, however, most of the technological and managerial talent is still concentrated in large enterprises. Some mechanism should be developed to induce such talent to start-ups, along with corporate venturing by large companies, which we will describe in Chapter 8. (2) Efforts to develop human resources Some say ventures are unwilling to develop human resources by themselves. Indeed some start-ups were too hasty in recruiting people but poured too little energy in training their people on their own. According to a survey conducted by METI in 2007 of ventures that had received investment from venture capitals, in order to train their employees, 58% of the companies provided in-house training, 42% asked contractors to provide a training program, 68% had an OJT plan, and 11% said they had no scheme dedicated to training. Figure 4-2 How to train employees How employees are trained? (Multiple response) (n=446) In-house training Training program by contractors OJT No training scheme Others Source: METI, 2007 Survey of Creation and Development of Start-ups (December 2007) There is a certain limit, however, to the capacity ventures have to employ talent at the ready, especially considering competition with large companies. They must work to foster their own people while developing their business. The government is also expanding support for small and medium enterprises in the field of human resource development. As 36

38 part of the 2008 amendment of the tax code, the government has decided to improve tax schemes for the promotion of investment in human assets, so that they will be more available for SMEs. Ventures are expected to make effective use of such programs and establish better systems for human resource development. (3) More jobs for women To offer more opportunities to women is another important issue for start-ups that hope to employ talented people. Many women leave their jobs when they are pregnant, have a baby, or devote themselves to childcare, but most of them also hope to work again once their children grow to a certain age. In Japan a lower percentage of highly-educated women participate in the labor force than in other countries. It is desirable to design and propose more diverse types of employment and provide talented women with job opportunities. Figure 4-3 Types of job housewives hope to have by age of youngest child No intention to have a job Full-time job, with no overtime work Responsible job, with overtime work Working at home Short-time job Age of 3 Age of 4 and older but Elementary Jr-high school and younger before elementary school school student student and older Note: Responses to questionnaires on the internet to housewife part-timers and full-time housewives whose youngest child is three years old or younger Source: AiDEM Inc., Survey of Actual Situations of Part-timers (2000) 37

39 (4) Actions to counteract our aging and shrinking population The population of Japan is rapidly aging and shrinking. The conventional recruitment strategy of start-ups, which generally employ a large number of younger people, mainly children of baby boomers (baby-boom juniors), looks to be getting more difficult to implement year by year. Figure 4-4 Population composition of Japan Age Age 2020 Age Male Female Male Female Baby Boomers Baby-boom juniors Population (10,000 people) National Institute of Population and Social Security Research Source: Reproduced from NIPSSR s website This requires that ventures should place more emphasis on how they can absorb the experience and skills of baby boomers when they leave a company, as well as how they can make better use of the generation of baby-boom juniors when they get older. The national and local governments are working hard to match the supply of senior workers and the demand of businesses through the Shin-Geneki Challenge Plan (baby boomers reemployment program) and other initiatives. Ventures should use such schemes in an effective way. 38

40 Figure 4-5 Shin-Geneki Challenge Plan Shin-geneki (boomers to be reemployed) Partner companies Boomers who left or are leaving a company National secretariat Local secretariats A coordinator asks the secretariat to introduce a shin-geneki who can work to solve a problem she found in the business. Cordinators at Community Power Cooperation Bases SMEs Boomers who left a company Alumni associations of universities and technical colleges NPOs private organizations Registered Target: registration of 30,000 shin-genekis (located in each prefecture) Agents 200 agents designated in each prefecture To match needs of both sides To provide advanced training To give counseling and manage registered people Agriculture-Commerce-Manufacturing Cooperation & Local Revitalization Local-government-base model programs (around 10 programs) Needs for shin-geneki Target: matching of 10,000 cases Effective Use of the Highly-skilled Industry-association-base model programs (around 10 programs) (5) Effective employment of foreigners Nowadays more of the start-ups in Japan employ foreigners from Asian countries, especially IT experts, who have advanced skills and entrepreneurship. In the United States, an advanced venture-industry country, foreigners also play a great part in creating and developing Start-ups. For instance, according to On the Road to an Entrepreneurial Economy: A Research and Policy Guide, Kauffman Foundation, 2007, immigrants from India and China contributed to foundation of 24% of the technology companies in Silicon Valley, a quarter of companies in which investments were made in and after 1990 by members of the National Venture Capital Association (NVCA) were established by immigrants, and 24% of the high-tech companies set up in the United States between 1995 and 2005 were started by incomers. With the view of developing a vibrant entrepreneur society in Japan with its faster aging and shrinking population, it is essential to employ in a more effective way people from foreign countries, especially Asians. Japanese Start-ups, not many of which have extended operations into overseas markets, should also globalize their people in order to advance into new global markets. From now on policymakers should consider what foreigners could do for creation and development of Japanese start-ups when they study programs for foreign workers and students. 39

41 (6) Dissemination among start-ups of know-how of recruitment, human resource development, organization building, etc. There are many venture entrepreneurs who are too busy in, for instance, business expansion, marketing, and financing to have enough time to think about recruitment, human resource development and organization building. As described above, however, there are really many cases where shortage of people hampers growth of ventures. It is necessary, therefore, to encourage venture entrepreneurs to pay more attention to such issues and help them learn more know-how and skills in these spheres. 40

42 Typical symptoms Figure 4-6 An example of recruitment know-how manual (METI, ICT Venture Recruitment Guidelines ) (i) Whether someone should be employed? /What types of people should be employed? 1. I need some of my work to be entrusted to someone, but 4 wonder what task should be transferred in what way: - I wonder how to decide what the chief executive should and should not handle; - I wonder whether the chief executive should handle a task (s)he founded the company should place more emphasis on; - The chief executive is swamped with operational affairs; - I have a task to be entrusted to someone, but cannot find a suitable person in the company; 2. If any task should be entrusted to someone, I wonder what 6 I should ask them to do to have them work as expected; - In terms of people entrusted with marketing/technological affairs/business administration; - I m going to employ someone, but wonder what experience, skills, or philosophy they should have; - I wonder to what extent I should empower someone; 3. The company has achieved a certain level of growth, but I 13 feel the quality of business is declining and its speed slowing. For instance, we receive more complaints from customers: - Planned quality or deadlines cannot be achieved; - Problems cannot be solved before founding members step in; - Products/services cannot be improved to have new features, or product/service lines cannot be expanded; - The customer base cannot be expanded; 4. The shortage of manpower hampers growth of sales: 16 - The level of anticipated orders suggests shortage of manpower that cannot be overcome with existing personnel; - Sufficient products/ after-market service cannot be manufactured/provided; - Products/services cannot be improved to have new features, or product/service lines cannot be expanded; - The customer base cannot be expanded; 5. Instructions aren t being fully obeyed by employees/ they act 17 too slowly/relations among them are not smooth; - The background of an instruction, which employees took in before told, is not recognized unless made clear; - Not every instruction is carried out; - More trouble/quarrels take place in the company; 6. The company intends to go public, but progress is slow 19 in expanding the organization, developing the system and enhancing the governance for getting listed: - No/few directors are replaced after foundation; - No person is designated to make arrangements for listing; - Preparations to go public are not completed; ICT Venture Recruitment Guidelines: Table of Contents (ii) How should recruitment be carried out? 7. I wonder how to look for employee candidates: 29 - I wonder what of the connections I have can be used for recruitment; - I wonder how to use resources of outsiders (headhunters, staff agencies, classified ads, etc.) 8. I wonder what concrete approaches I should make to a 39 targeted candidate: - I have difficulty in inviting a candidate to an interview; - I wonder how to avoid any trouble to candidates when approaching them; 9. I would like to employ the candidate, but have problems 43 in assessing him or her: - I wonder how credible the candidate is; - I (chief executive) wonder how to assess the candidate in terms of skills out of my expertise; 10. Many candidates decline a job offer we made: 51 - We fail to explain our promising future to the candidate; - Her family members make an objection: - We cannot pay as much as wanted; - We fail to resolve concerns about the company; 11. I wonder how to carry out procedures through the process 55 as described above: - I wonder what document should be presented by candidates for selection; - I wonder how to present an offer letter; - I wonder what document should be received when a person is hired; - I wonder what procedures are required by law to be completed when a person is hired; (iii) What should be done to have them work as expected after employed? 12. People we hired fail to achieve performance as expected: 60 - I wonder how to deal with them; - Especially, I wonder whether I should take a severe action, for instance, demotion or pay cut; 13. A person we hired turns out to have lower skills than 62 expected: - I wonder whether to take a severe action or provide more training; - When decided to provide additional training, I wonder how; 14. A person we hired does have skills, but they are not 63 effectively used because there are some gaps between what the management expect and what the staff hopes to do; - The person is demoralized because of some gaps between what was told during hiring and the realities; - The staff works differently from what the management expected; 15 A person we hired does have skills, but is discordant 64 with colleagues: - Does not get along with colleagues, which hampers performance of the team; - Does not get on well with specific person(s), which affects their work; 16. Many of the people we hired quit: 71 - Even when we succeeded in hiring an excellent person, they quits over something they feel discontent with; - Even when we succeeded in hiring a skillful person, they quits because they were given no opportunity to demonstrate the skills and felt demoralized; - The fact that an excellent person quit has negative impact on colleagues; - We cannot tell why they quit, and the turnover stays high. 17. We did everything we could before hiring a person, but 73 thy do not seem to do well: - Cases of regular/contract employees and executives; - Performance is unexpectedly low, and there is an indisputable mismatch. List of supporting companies 75 Recommendations from supporting companies 76 41

43 Chapter 5 For expansion of the customer base and market 1. Present state It is said that fewer of the start-ups in Japan grow to be major global enterprises than their peers in the United States or Europe, and that their growth is generally slower. Many mention as a factor behind this that an insufficient scale of resources, including money and people, that can be raised for venture businesses or the too slow speed at which they can raised. Others say, however, there is also large difference in the pace of expansion of the customer base and market. (1) Japanese market emphasizes proven records First, Japanese market start-ups, which have no or little proven record, find it difficult to have their products accepted just because they lack established performance. People and companies in Japan, as well as the government, prefer higher-quality goods and services. To put it the other way around, they avoid buying unproven goods or services. They often think that goods or services with little proven record, if they were used as part of their own products or services, would bring a larger risk to them in terms of the quality strategy for their goods and services. You could say, however, that companies, as purchasers that avoid buying unproven goods or services that have in fact good performance and quality only because they have little proven record would be weeded out one after another through competition among purchasers because they are likely to be less competitive than those which have abilities to assess by themselves the performance and quality of goods and services and buy anything good even if the products concerned have little to show in terms of their past record. Some think intensifying global competition in recent years is bringing about changes, though gradual ones, in the purchasing behaviors of Japanese companies. (2) Japanese ventures are unwilling to expand overseas Second, it is said that fewer venture companies in Japan go into foreign markets than start-ups based in other countries. Some point out the fact that Japan is the second largest economy and that has more than 100 million consumers, a scale of market that gives Japanese ventures all the fewer 42

44 incentives to go abroad because they can secure a business base in the domestic market before they take the trouble to move into a foreign country. In addition, the level of English language skills of Japanese businesspersons is indeed one of the factors that hinder Japanese companies from entering foreign markets, especially in the service sector. (On the other hand the Japanese language could be regarded as a barrier that protects Japanese service business market against foreign players.) But the recent development of the internet and other IT technologies has made far easier to do business in any part of the globe wherever a company is based and whether or not it has a marketing foothold there. The increasing sophistication, fractionalization and customization of products offer Start-ups more opportunities the chance of success as a global niche company. Some Japanese ventures, taking advantage of markets overseas, which are more willing to accept good products and services whether or not they have proven record, put their goods and services in a foreign market first to demonstrate their performance there, before they try to spread them in the Japanese market. It is difficult to say how many start-ups have gone abroad. According to a survey conducted by METI in 2007 of ventures in which venture capitals had equity, more than one-third of the respondents had done business in foreign markets (including exports). Figure 5-1 Current status of overseas business of Japanese ventures Doing business overseas Not doing business overseas, but contemplating starting Not doing business overseas, but did in the past Not doing business overseas, and not contemplating for future/dk Source: METI, 2007 Survey of Creation and Development of Start-ups (December 2007) 43

45 2. Challenges (1) Brand strategies, alliances with large companies, partnerships among ventures and SMEs, use of technology assessment services, and other initiatives for strengthening marketing of products and services In order to sell more in the Japanese market, start-ups that don t have track records should, for instance, develop a brand strategy for exposing their products through exhibitions, seminars, and mass media, arrange an alliance with a large enterprise for achieving more confidence, form a partnership with other ventures and SMEs for offering more diverse and/or sophisticated products, and use technology assessment services for demonstrating the level of their technologies. In terms of alliances with large firms, a survey by the Organization for Small & Medium Enterprises and Regional Innovation, JAPAN (SMRJ) revealed only 27% of big businesses had been in any alliance with SMEs or ventures in the previous three years. They are expected to change their way of thinking. On the other hand, the greatest proportion of large enterprises that had allied with an SME or a venture mentioned Business did not go as scheduled as the major difficulty they had encountered. This suggests ventures also have something to improve. To encourage partnerships among ventures and SMEs, the government has prepared support programs. They are expected to use such initiatives in an effective way to develop cooperation among them. Technology assessment still has something to be improved in terms of its cost efficiency and objectivity. But now you can find a few assessment service institutions that perform rather inexpensive and objective evaluations of technologies. Further development of such services is desirable. 44

46 Figure 5-2 How do large enterprises see partnerships with start-ups? Business did not go as scheduled. Both companies had different cultures. It took long to build a consensus in the company. It took long to build a consensus in between the companies. The partner lacked strength to develop business. Arrangements/rules between the companies were unclear. The partner lacked an established internal control system. Products/services developed through the partnership had trouble. We had difficulty in finding a partner. People in the company were not enthusiastic. Technologies/products lost some competitiveness during the period of partnership for commercialization, etc. It took long for the partner to build a consensus in it. Our know-how, seeds, or technologies were leaked. The partner changed its business policies. The partner was not enthusiastic. Others UK Answers from large enterprises that were asked, What problem/difficulty did you have in partnership you had with SMEs/ventures (multiple-response) Source: Adapted from SMRJ, 2004 Small & Medium Enterprise Environment Survey: Challenges of Partnership between SMEs/Ventures and Large Enterprises, and Support to be Provided (March 2005) (2) Effective use of public procurement and trial orders, etc Start-ups that lack track records could develop business and realize growth by achieving public procurement from national or local governments or other public institutions, using this as a springboard to expand their business base into other customers and improve their products and services. That would be one of their options. A survey conducted by METI in 2007 of ventures which had received investment from venture capitals showed how many of them had made sales efforts targeting public institutions and what percentage of them had succeeded. Almost half of the respondents tried to sell their products or services to public organizations, and 80% of the prospective vendors succeeded in selling. 45

47 Figure 5-3 Have you ever tried to sell your products or services to public institutions? Yes No DK Source: METI, 2007 Survey of Creation and Development of Start-ups (December 2007) Figure 5-4 As a result of the efforts, have you succeeded in selling? Yes No Source: METI, 2007 Survey of Creation and Development of Start-ups (December 2007) Under WTO Government Procurement Agreements, the government is obliged in principle to adopt competitive bidding for procuremenr. Under such restrictions, it endeavors to buy as much as possible from SMEs by, for instance, setting procurement targets from SMEs according to the Act on Ensuring the Receipt of Orders from the Government and Other Public Agencies by Small and Medium-sized Enterprises. In 2000, the government also introduced special measures to offer SMEs that have a high level of technology more opportunities to participate in bidding, and in 2004 it adopted measures to expand its IT-related procurement from ventures. With other programs and initiatives, the government is working hard to provide SMEs and ventures with as many opportunities as possible to acquire orders from public institutions. 46

48 Extended to all sectors Local governments are also obliged in principle to adopt competitive bidding for procurement by WTO Government Procurement Agreements and the Local Autonomy Act. After the 2004 amendment of the Enforcement Ordinance of the Act, prefectural governments are allowed to offer negotiated contracts to suppliers who the governor or other authorized persons recognize as those who are producing a new products to enter a new business segment when the prefecture buys such a product. According to the amendment the Trial Order system has been introduced by 41 prefectures as of March If, however, a government gave excessive favors to start-ups in its procurement, lower-quality or over expensive goods or services might be supplied as a result. Procurement of public institutions from start-ups should be implemented in light of its purpose, compensation for their intrinsic lack of record, and the procurement system should be made better to offer companies that have excellent technological capabilities more opportunities to participate in bidding. Figure 5-5 Special measures for offering SMEs with high-level technologies more opportunities to participate in bidding Outlines of special measures for SMEs with high-level technologies on qualifications for participation in bidding Introduction of special measures In 2000, with the view of offering SMEs with excellent technological capabilities more opportunities to participate in bidding, On More Opportunities to be given to SMEs and other Suppliers with High-Level Technologies to Participate in Bidding was adopted. * Decided by the board of secretaries of the Liaison Committee of Ministries and Agencies for Promotion of Computerization of Procedures for Government Procurement (excluding public construction work) Special measures SMEs are allowed to participate in a higher grade of bidding by either: Receiving additional points to be given according to results of technical evaluation conducted in grading bidding participants in terms of qualification, which assesses their skills on the basis of 100 points (15 points added to bidders that have three patents or more applicable to the project to be bid); or Submitting a past record that demonstrates they have manufactured some products according to an equivalent or higher level of specifications than specs for those to be bid. Additional measures for 2006 The special measures above had been applied exclusively to manufacturing of products of precision machines and four other sectors. The application was extended to manufacturing of products, sale of products and provision of services, etc. in any sector. Extended sectors for special measures Sectors for procurement by the national government Products (27 sectors in total) Services (15 sectors in total) Manufacturing Sale of Provision of services, of products products (*) etc. Five sectors for special measures Medical equipment, etc. * Applied only to sale of products manufactured by the company itself Extended to all sectors Medical equipment, etc. Extended to all sectors Software development, etc. Major sectors for procurement of products medical equipment, computers, other machinery among which initial five sectors receive special treatment Major sectors for procurement of services precision machinery, industrial machinery, electrical/ telecommunication equipment, nonferrous metals/metal products, furniture/utensils software development, information processing, etc. Source: METI, Study Group for Promotion of Public Procurement from Start-ups, (Handout 2, first meeting) Figure 5-6 Measures to expand the government s IT-related procurements from ventures On Measures to Expand the Government s IT-related Procurements from Ventures (extracts) 1. Opportunities for joint ventures to participate in bidding In terms of bidding for projects that are announced with specific technical requirements, such as assignments of high-level IT experts, opportunities to participate in the competitive bidding for each of the projects should be given to joint ventures that satisfy requirements for the project after reviewing, among others, their responsibility control systems and ways to secure necessary services after the contract is implemented. 2. More flexible administration of qualifications of bidders The system of qualifications for participants in competitive bidding should be managed in a more flexible way after 47

49 reviewing applicants in terms of specific technical standards, including their past contracts with private organizations, record of development of equivalent systems, high-level IT experts to be assigned to the project, and results of improvement in software processes. 3. Review of order unit In terms of orders for IT systems, pilot procurements should be carried out by the Cabinet Office and other selected ministries to find a way of procurement that would help adopt excellent technologies from as many companies as possible and which could avoid impairing the economic efficiency of procurements with an aim to examine further in what unit an order should be made. 4. Support for ventures in cash management Many ventures have difficulty with cash flow when they receive a contract from the government under the term of a year-end payment. To alleviate the problem, simpler procedures should be introduced for payment by a rough estimate to adopt such payments for more contracts, with care paid to progress management for projects; Ministries and agencies generally conclude with suppliers a contract with a proviso that prohibits them from transferring their payables to anyone (nontransferable receivables clause). A decision has been made recently that nontransferable receivables clauses should be repealed only if payables are transferred to a financial institution or a credit guarantee corporation. Examination should also be made whether suppliers should be allowed to assign their receivables to specific institutions. Source: On Measures to Expand the Government s IT-related Procurements from Ventures, agreements of the IT-related Liaison Committee of Ministries and Agencies Figure 5-7 Implementations of Trial Order July 2003 Inaugurated by Saga Prefecture first in Japan April 2004 Adopted by Gunma and Tokushima November 2004 The Local Autonomy Act amended FY 2005 Adopted by Toyama and 22 other prefectures As of April 2008 in operation in 41 prefectures in Japan As of October items are designated (approved) in total. Source: adapted from the website of Saga (3) SBIR system The Small Business Innovation Research (SBIR) system is a technological development contract scheme that the national government has introduced to promote development of technologies by start-ups and help them put the technologies to commercial use in the private sector or receive procurement orders by public agencies and institutions. In the United States, the federal government introduced a SBIR system in 1982, and now 11 federal agencies with R&D budgets over US $100 million participate. They are obliged to assign SMEs 2.5% of the budget for R&D activities that they contract out to other institutions, and SMEs are elected through competition. It is said that when a start-up succeeds in receiving a contract through SBIR, the fact is considered a demonstration of the SME s technical strength and works to a degree as a certification or signal in obtaining investment from venture capitals or helps bring its products to market afterward. At agencies engaged in a great deal of procurement, such as the Department of Defense and 48

50 the National Aeronautics and Space Administration (NASA), it is believed that adoption for SBIR often leads to success in receiving an order for procurement. Institutions that spend a lot in R&D, such as the National Institutes of Health (NIH), are said to often give an R&D contract at the third phase. Figure 5-8 SBIR system in the United States The scheme is applied to SMEs (which employ 500 people or less), and has the following characteristics: Public invitation to application (for projects) Selection through competition at three phases Phase 1: Stage of feasibility study (financial support of not more than $100,000) Phase 2: Stage of full-scale R&D/designing of prototype (financial support of not more than $750,000) Phase 3: Stage of putting to commercial use achievements of R&D by SBIR (aid for commercialization, no financial support) Procedures taken by SBIR agencies R&D topics given by each agency (Technical Topics) Public invitation Application Adoption Examination Application Adoption Examination Procurement by the government, or sale in commercial market Flow of activities of Start-ups Requirements for application With 500 employees or less Based in U.S., for profit Phase 1 Feasibility study Implementation period of 6 months Financial support of $100,000 or less Phase 2 Stage of full-scale R&D/designing of prototype Implementation period of 2 years Financial support of $750,000 or less Phase 3 Commercialization No financial support Government procurement The Japanese government has also introduced its own version of SBIR to spend some of the R&D budget on SMEs and support their R&D activities for commercialization. Different from the US version, Japan s system has no obligatory target for the R&D budget that should be assigned to SMEs. In 2006, the government spent 41,100 million yen on SMEs, about 3% of the science & technology promotion budget. In 2008, a new model program of multi-phase competitive selection was introduced. In the program technical assignments are set, based on procurement needs, and a feasibility study is carried out to select the appropriate high-quality R&D activities. The scheme is more similar to the US SBIR. The government should continue to offer sufficient support in development of innovative technologies that could be put to practical and commercial use. (4) Treatment of new products and services at approval and under regulations When a start-up starts to manufacture, sell, and/or supply new products or services, it often takes more time and effort than existing enterprises to complete procedures to acquire permits and/or licenses necessary for the manufacturing, sale, and/or supply due to combination of novelty of the goods and/or services and lack of a past record. There may also be regulations that were established before the type of goods or services were anticipated. National and local governments should act as flexibly and quickly as possible even in 49

51 cases for which no precedent can be found, though consideration should be paid to the relevant permissions and regulations. (5) Aggressive expansion of business overseas by ventures themselves Expansion of business overseas is an inevitable stage of progress for start-ups to grow to a certain level and play a role as true front runners that should lead innovation in the economy of Japan. Ventures should not stay still in the Japanese market, but instead should work aggressively to expand their business overseas for further growth and development. (6) Enhanced support for start-ups in overseas expansion As a program to support Japanese ventures overseas, the Japan External Trade Organization (JETRO) has in place, among others, incubation programs in the United States and United Kingdom, and programs for venture entrepreneurs for research and trading overseas. SMRJ also offers support by working in partnership with private-sector venture capitals to finance funds which make investment mainly in companies that are expanding business overseas, or by employing management consultants for ventures under business counseling programs. As stated above, there are still only a small number of Japanese ventures that extend operations into overseas markets. Considering the present state of things, more support from the government in this domain would be desirable. In particular, more support should be given for expansion of business in Asia as the market is gaining more and more importance for Japan s economy. Start-ups that are entering a foreign market face difficulties not only in setting up an office and employing people there; many say it is also difficult to form connections and establish close relationships with people in related industries and in networks of supporters for Start-ups, and to perform effective public relations activities. From such a viewpoint, supporting organizations should maintain themselves relationships with such networks in the host country and provide comprehensive support services, to introduce start-ups that plant to start business overseas to relevant people there who they can consult with; to offer them opportunities to take part in on-the-training or hands-on training; to help them improve business plans; and to back up their public relations activities for their products and services. 50

52 Stages of starting-up /seed Early stage Stage of expansion Going public Millions yen Tens of millions yen Hundreds of millions yen Billions yen Equities raised Chapter 6 Enhancement of direct financing to start-ups 1 What meaning does direct financing have for start-ups? Many start-ups face difficulties in financing at the start-up and expansion stages. Particularly, most ventures have only limited abilities to raise funds through indirect financing mainly because they have few particular assets, meaning few properties to be put up as collateral, because few of them make enough revenues from which loans and interests can be paid, and because, even with good sales, they need as much of their revenues as possible to be reserved for growth. It would be no exaggeration to say that how much a start-up can raise through equity and other direct financing decides whether it successfully grows at the earliest stage. For start-ups that seek to raise risk money through direct financing, there are diverse types of financing methods to choose according to the stage of development and the level of risk in their business, such as raising funds from retail investors (angel investors), receiving investment from venture capitals, and listing stocks on a emerging equity exchange. What is crucial is to develop environments where they can find a financing method appropriate to them at any stage of development. In the following sections in this chapter, we examine the current state of angel investment, venture capitals, and emerging equity exchanges to find their challenges, and discuss what should be done to tackle them. Figure 6-1 Financing of start-ups at each stage of development Public offering Venture capital External capital Funder s family and friends, etc. Business angels Equity capital Starting-up 160,000 companies (annual average between 2001 and 2004) Venture s stages of growth Venture capitals (total) 2,500 companies (2006) Emerging equity exchanges (*) IPOs 155 companies (2006) * Emerging equity exchanges refers to Mothers, Hercules, JASDAQ, Centrex, Ambitious, and Q-Board. 51

53 2 Expansion of angel investors 1. Current state of angel investment (1) Significance of angel investment For start-ups angel investors not only play financial roles as suppliers of risk money, which is difficult to obtain at the early stage of business start-up. Most angels also support them in business operations. Engagement they have in their business and advice they give as a shareholder work to transfer their business experience and expertise to the ventures and help them with business administration. Especially in Silicon Valley and other places where ventures have been created and grow constantly for a long period of time, many venture founders, once achieving success, invest money they earned in the business in enterprises of other new entrepreneurs and offer them what they learned from their own experience to help them create a new business. There has been an ecosystem, or eco-cycle, formed among venture entrepreneurs. Angels, however, are not limited to those who have a tremendous amount of income or wealth, for instance successful business owners. Surveys in the United States and the United Kingdom reveal that average angels had an annual income of 10 million yen or so and net asset of 100 million yen or less, belonging to the upper middle-class. There are also data that indicate that in the United States 230,000 angel investors supplied 3 trillion yen to 50,000 ventures, and that in the United Kingdom 20,000 angels provided 100 billion yen for 3,500 start-ups. That suggests in those countries angels in a range of income bands play a great role in creating and developing ventures. In Japan there are probably cases of angel investment made by, among others, business owners and executives who have themselves started a venture business. But we have no data that show specifically how much has been invested. Many suppose enthusiasm for such investment activities is lower than in the United States or United Kingdom. (2) Angel networks Some angel investors form angel networks, webs woven among investors to acquire and exchange information about investment and best-practice know-how. In the United States and Europe there are each more than 200 angel networks formed, and they are building partnerships with each other and being organized. 52

54 Angel networks work to offer more opportunities of investment to individuals who lack information or skills full-fledged angels should have, and help them acquire such knowledge and techniques. They are believed to be quite useful to expand the angel investor base. For retail investors with sufficient abilities, angel networks as a group of people who have different business experience and expertise are also helpful as they can find more easily experts who perform due diligence and provide consulting for diverse types of companies they invest in, which would bring them a higher rate of success in angel investment and a larger return on such investment. In Japan there are more than ten or dozens of angel networks. Nippon Angels Forum is one of them. Japan has more room left for growth of such activities than the United States and Europe. Figure 6-2 Numbers of angel networks in the U.S. and Europe Numbers of angel networks in Europe Numbers of angel networks in the U.S. Source: Europe eban (European business angel network) (2005) U.S. Center for Venture Research and Kauffman Foundation (04-05 data) (3) Angel tax Japan and other countries, recognizing what important roles angel investors play in creation and development of start-ups, have introduced angel taxation, tax treatment designed to promote angel investment. Since 1997 when it adopted an angel tax system, Japan has added a series of amendments. In 2003, it introduced the three following measures: (a) For a year when an investor makes angel investment, he or she can defer the amount of the equity which does not exceed gains she realized in the year from sale of other stocks to the point of time when it is sold; (b) If he or she achieved any gain from sale of the equity, the taxable capital gains are 53

55 halved; (c) If he or she sold the equity with loss, the loss is permitted to be carried forward three years from the following year. Angel taxation in Japan, however, is only used for a small amount of investment. In 2006, the favorable tax treatment only applied to angel investments of a little less than 1,300 million yen. Even in 2005, when the all-time record was set, it failed to reach 2,500 million yen. Especially, recent records show investments the angel taxation appears to fluctuate just in line with changes in prices in the stock market. The linkage is believed to take place because the treatment of investment being deterred for the year when the equities are purchased (mentioned above in (a)) is linked to gains realized in the year from sale of stocks. Against such a background, the government and the ruling coalition parties, recognizing that more attractive incentives must be offered to increase angel investment, have decided to introduced an income exemption system as part of the 2008 amendment of the tax code. Under the system an angel who made an angel investment in a start-up established within past three years which satisfies specific conditions is allowed to deduct from his or her total income for the year of investment the amount of money substantially equivalent to the investment (less 5,000 yen, with the upper limit of 10 million yen), and he or she can choose either the new exemption system or the existing treatment, as stated above in (a). Introduction of the income exemption system should provide a greater incentive for people who refrain from selling any stocks and, naturally, have no profits made in trading, though such people have so far been refused tax advantages offered for the year of investment. It is also supposed that people in parts of Japan who intend to support a company with something gleaming in its foundation, including friends of the founders, should be encouraged by the tax treatment in quite an effective way to make investment, and that it should make great contribution to revitalization of local communities. Several parts of the world the United Kingdom, France, South Korea and Taiwan- have already introduced a system designed to offer taxpayers a credit equivalent to a specified percentage of investment they made (or to deduct it from their total revenues). The income deduction system Japan is introducing should offer its taxpayers tax treatment not less favorable than in such places. Considering such circumstances, it is desirable that tax reform bills should get through the 54

56 Diet as early as possible to introduce the income deduction system (still under deliberation at the Diet as of April 24, 2008). Figure 6-3 Investments in Japan which the angel tax is applied to, and a tax price index Million yen Green Sheet Designated funds Direct investment JASDAQ index (right-hand scale: 1 = March 1998) FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 * Figures for each year may be revised up as they are counted as of the date investment was made. (Investment made in March 2007 may be reviewed in July 2007.) Figure 6-4 Outlines of the 2008 reform of the Angel tax system (introduction of the income exemption system) Existing system (angel tax) Favorable treatment Radical expansion FY 2008 (income deduction system added) Favorable treatment (Investors choose each of the favorable treatment A or B.) (1) At time of investment made The amount of investment is deducted from gains made in the year from sale of stocks. (2) At time of the equity sold ( 1) (i) When sold at a profit Taxable gains from the sale is halved. (ii) When sold with loss The loss can be carried forward for deduction three years from the following year. (1) At time of investment made The amount of investment less 5,000 is deducted from the total income made in the year. * The upper limit is (the total income 0.4) or 10 million, whichever is smaller. (2) At time of the equity sold ((i) Preferable treatments for profits are abolished.) ( 2) When sold at a loss, the loss can be carried forward for deduction three years from the following year (maintained) *2 The amount of money that was deducted from the total income is subtracted from the acquisition cost for calculation. (1) At time of investment made The amount of investment is deducted from gains made in the year from sale of stocks. (maintained) (2) At time of the equity sold ((i) Preferable treatments for profits are abolished.) ( 1) When sold with loss, the loss can be carried forward for deduction three years from the following year (maintained) *1 The amount of investment that was deducted from stock sales gains is subtracted from the acquisition cost for calculation. The favorable tax treatment A is applicable to a case of investment by a company which a designated capital fund has equity in or which is designated as Green Sheet Emerging when the case satisfies specified conditions. 55

57 Requirements for ventures Losses from stocks sold Gains from stock sold At time of equity investment Figure 6-5 Angel tax systems in countries U.S. England France S. Korea Taiwan Investments are deducted from capital gains (carried forward). 20% of the investments (up to 400,000) are deducted from the income tax. Investments are deducted from capital gains from other stocks (carried forward; the income tax reduction above is applicable together). 25% of the investments (up to 20,000; Doubled for a couple) is deducted from the income tax. 10% of the investments is deducted from the total income (up to 50% of the total income). 10% of the investments made in specific industries is deducted from the income tax. (deductible up to 50% of the total income tax; the rest can be carried forward four years from the following year.) Tax exemption for half the gains from stocks held for 5 years or more Tax exemption for gains from stocks held for 3 years or more Tax exemption for gains from stocks held for 8 years or more Tax exemption for gains from stocks held for 5 years or more Losses from stocks sold can be offset against other incomes. Losses can be carried forward indefinitely. Losses from stocks sold can be offset against other incomes. Losses can be carried forward indefinitely. Losses from stocks sold can be offset against other incomes. Losses can be carried forward 5 years Total assets of $50 million or less; Equities issued on and after August 11, 1993; 80% or more of the assets are used for designated industries (sectors other than finance, agriculture, hotels and restaurants), etc. Total assets of 70 million or less, and less than 80 million even after the investment; Operating in the UK; Operating in designated industries; Financing for operations in designated industries; Applicable only to purchase of newly issued common stocks, etc. Unlisted companies headquartered in EEA which are subject to corporate tax; More than 75% of the equity is owned by individuals or specific family companies; With less than 250 employees; With annual sales of 50 million or less, or total assets of 43 million or less SMEs that satisfy one of the three requirements below: With 50 million won or more invested and 10% or more of the equity owned by start-up investment companies (SICs), etc.; With annual R&D expenses of 50 million won or more (5% or more of the sales), and recognized as excellent by the Small Business Corporation, etc.; Companies guaranteed by the Korea Technology Credit Guarantee Fund (KOTEC), or those with loans of 80 million won or more and accounting for 5% or more of the total assets from KOTEC Companies founded under the Taiwanese Corporate Law for economic development and industrial sophistication; Applicable to more than 150 items in 7 manufacturing and 12 technology service sectors. Specifically, information hardware, telecommunication device, consumer electronics, precision electronic devices, precision machinery/equipment, aerospace, bio-medical/special-use chemicals, and other manufacturing sectors, and internet software, internet services, and other sectors. 56

58 2. Challenges (1) Survey of realities of angel investors in Japan, and collection of cases of success / public relations campaign As mentioned above, there is no sufficient survey or data on the realities of the angel investment situation in Japan. In the United States, everybody knows the success of Google was supported by an angel investor, Andreas Bechtolsheim, the first person who made an investment in the company. Such a positive perception of people about angel investment helps motivate them to be angel investors themselves. Japan should examine in more detail about the realities of angel investment in the country, as well as collect cases of successful start-ups that achieved rapid growth and conduct public relations campaigns to have them widely known as part of efforts to have angel investment take root in the society and culture of Japan. (2) More applicability of the angel tax system, and simpler procedures for the system If the income deduction system as described above is introduced in 2008, the angel tax system would work as a stronger incentive and boost angel investment. After the introduction of the system, aggressive public relations efforts should be made to have the taxation known by venture entrepreneurs, existing and potential angel investors, licensed tax accountants and start-up supporters. In addition, consulting and other services should be provided for those who intend to receive the favorable treatment to encourage more people to use the system. Under the current angel tax system, many people complain that complicated procedures must be taken before a taxpayer receives a tax break. In order to encourage more angel investors to use the system, studies should be conducted on how to make simpler as wide a range of procedures as possible. (3) Treatment of failed ventures As start-ups in which angel investments are made are challenge businesses that face higher risks, the majority of them fail. Few of the failed companies, especially smaller ones, are liquidated through legal proceedings. Most of them, instead, are left as zombies. In the United States, the tax code allows taxpayers to regard investment in such companies as deductible expense in relatively simple ways, by, for instance, declaring it on a tax return. Japan should consider whether and/or how to introduce some 57

59 measures to allow such equity to be deductible. (4) Efforts to expand angel networks In order to expand the angel investor base, more aggressive activities of angel networks would be effective. Especially for Japan, where there are still only a limited number of angel investors who have themselves founded a start-up, it is quite important to develop environments where people with diverse types of backgrounds and experience can take part in angel investment. In order to make the activities of angel networks in Japan more energetic, it would be effective to form partnerships between such networks based in parts of Japan and help them share information about start-ups and best practices for angel network management. It would also be helpful to encourage them to interact with angel networks in the United States and other advanced angel networking countries and conduct surveys to learn their advanced skills to manage networks and angel investment techniques, such as convertible loan stock. Another effective way is to work to have angel investment activates understood by SME owners and other people who may potentially have interest in angel investment. Examination should be conducted on what the government should do to support such efforts. (5) Venture capitals of types to support angel investment In order to make more energetic activities of angel networks in Japan, it would be effective to form partnerships between such networks based in parts of Japan and help them share information about start-ups and best practices for angel network management. It would also be helpful to encourage them to interact with angel networks in the United States and other advanced angel networking countries and conduct surveys to learn their advanced skills to manage networks and angel investment techniques, such as convertible loan stock. Another effective way is to work to have angel investment activates understood by SME owners and other people who may potentially have interest in angel investment. Examination should be conducted on what the government should do to support such efforts. In the United States and Europe, some angel networks own venture capital funds, referred to as sidecar or affiliate funds, as a tool for making angel investments, and such funds are now becoming more common. In Japan, Nippon Angels Forum, an angel network, has a sidecar fund. On the other hand, some of the venture capital funds there which raise 58

60 money mainly from retail investors provide services similar to those of angel networks. Such convergences of angel networks and venture capital may help angel investors learn the expertise venture capital funds have on venture investment, and in turn allow venture capitals to use the business experience people in angel networks have and knowledge and know-how experts there possess when they perform diligence or provide business advisory services. In order to encourage more aggressive use of the scheme of venture capital in angel investment activities, an examination should be conducted on what the government should do to support efforts in this sphere. For instance, MSRJ s program of investment in funds should be used in an effective way to provide support for angel investment. 3 Increase of financing through venture capitals 1. Present state of venture capitals (1) Amount of venture capital investment Venture capital funds in Japan have investments of 1 trillion yen on an outstanding basis. Compared with the scale of venture capital investment in the United States or Europe, which amount to more than tens of trillions yens, the gap remains very large. The ratio of such investments to GDP has also stayed at quite a low level among advanced countries. In terms of ratio to GDP, there is great room for more investment to be made. Figure 6-6 Venture capital investments outstanding: comparison between Japan, the U.S. and Europe US Europe Japan Source: Venture Enterprise Center, Survey on Current Status of Investment of Venture Capitals and Other Funds ; NVCA Yearbook 2007; EVCA Yearbook 2007; Translated as: $1= 119; 1= 158 For the United States, investments made by VCs exclusively in the country, and for Europe, investments including those by private equities and those made overseas. For Japan, investments including those made by turn-around buy-out funds for 2003 and before, and investments excluding those made by such funds for 2004 and after (including investments overseas for all the years). Data of investments outstanding in Japan are as of March 31 each year. 59

61 Figure 6-7 Ratios to GDP of annual totals of investments by venture capitals in developed countries Israel (1) United States Iceland Canada OECD19 (2) OECD23 (4) Korea (3) Sweden United Kingdom Netherlands Finland European Union Europe Australia (5) Norway Spain Denmark France Belgium Ireland Euro area Germany New Zealand (5) Italy Portugal Switzerland Czech Republic Austria Poland Greece Hungary Japan (5) Slovak Republic (2) Structure of the industry Ratio 2000 to 年 GDP ~2003 of average 年の平均投資額 investments が GDP に占める割合 between 2000 and 2003 Notes: (1) ; (2) Europe, Canada and United States; (3) ; (4) Europe, Czech Republic, Hungary, Poland, Slovak Republic, Canada, and United States; (5) Source:OECD, The SME Financing Gap (2006) Percentage of GDP Many venture capitals in Japan are subsidiaries of securities companies, banks, or other financial institutions or industrial corporations. In the United States, by contrast, most venture capitals are independent, operated by a capitalist as an individual. The composition of financiers of venture capitals in Japan also shows most of their funds are raised from financial institutions or industrial companies, their parents, and that other financiers, such as pension funds, major investors in the United States and Europe, have only marginal shares. 60

62 Figure 6-8 Structural proportion of venture capitals in Japan and the United States by attribute Breakdown Others Independent Attribute Share Government-affiliated Others Industrial corporation-affiliated Others Financial institution-affiliated Industrial corporation-affiliated Financial institution-affiliated Breakdown Attribute Share Bank-affiliated Securities-affiliated Insurance-affiliated Independent Note: Structural proportion of investments outstanding by attribute (as of March 31, 2007) Source: Counts by METI, adapted from 2006 Survey of Venture Capitals Nikkei Financial Daily, July 3, 2007 Note: Structural proportion of investments outstanding by attribute (as of end of 2006) Source: NVCA Yearbook 2007 Figure 6-9 Structural proportion of financiers of venture capitals in Japan, the United States, and Europe Industrial Corporation 2% Individual 10% December 2003 University foundation/ U.S. Pension endowment (Dollar term) fund 21% $10.96 Billion 42% Financial institution/insurance 25% Gov-affiliated institutions 8% Individual 9% Others 16% Pension fund 26% December 2006 Europe (Euro term) Billion Fund of Financial funds institution/ 17% insurance 24% Pension fund 5% Others (other VCs, foreigners, etc.) December % Japan Financial (Yen term) institution (bank/ billion 2,305 億円 securities) 31% GP 18% Individual 4% Industrial corporation Foundation/ 19% endowment 1% Source: NVCA Yearbook 2004 Source: EVCA Yearbook 2007 Source: Venture Enterprise Center, 2006 Survey on Current Status of Investment of Venture Capitals and Other Funds (December 2006) (3) Current status of investment of venture capital firms Many venture capital firms in Japan make small amount of investments in a large number of companies. Their investment in a company averages less than 100 million yen, less than one-tenth of that in the United States and one-fifth of that in Europe. Shares of companies they invest in by stage of development in terms of money invested show a higher proportion of investments are made in companies at an early stage after starting-up than in Europe and the United States. 61

63 million yen Figure 6-10 Average investment in a company by venture capitals in Japan, the United States and Europe US Europe Japan Source: Venture Enterprise Center, 2006 Survey on Current Status of Investment of Venture Capitals and Other Funds (December 2006); NVCA, Yearbook 2007; EVCA, press release (June, 2007). For Japan, data are as of FY 2005; for the U.S. and Europe, as of Calculated by dividing annual investments by the number of companies in which they are made. Translated as $1= , and 1= (average rate in 2006). Figure 6-11 Shares of companies in which investments are made by stage of development in terms of money invested Japan U.S. Jun 00 Sep 01 Sep 02 Sep 03 Mar 04 Mar 05 Mar 06 Investment Starting-up - 4th year 5th - 9th year for starting-up 10th - 14th year 15th year and after Europe Source: Venture Enterprise Center, 2006 Survey on Current Status of Investment of Venture Capitals and Other Funds (December 2006); NVCA, Yearbook 2007; EVCA, press release (June, 2007). 62

64 (4) Return on investment Returns on investment of venture capital firms vary greatly year to year due in part to fluctuations in the stock market. That makes a general description difficult, but the level of returns Japanese venture capitals earn from their investment remains lower than that of their peers in Europe or the United States. As a cause of the lower return some point out lower risk appetite of people and institutions in Japan that invest in venture capitals. It is also attributed to the fact that the only way for venture capitals to realize profits from their investments is to list the stock on an exchange for start-ups. Others point out that as most of Japanese venture capitals are set up by financial institutions or other corporations as subsidiaries, they accept a large number of people from the parents, transferred temporarily or permanently to work as venture capitalists, not all of whom, however, have received a sufficient level of education needed to successful or skillful venture capitalists. Figure 6-12 Return on investment of venture capitals in Japan, the United States and Europe US (VC) Europe (VC) Japan (VC) 1 year 3 years 5 years 10 years 20 years Years of management Source: Venture Enterprise Center, 2006 Survey on Current Status of Investment of Venture Capitals and Other Funds (December 2006); NVCA, Yearbook 2007; EVCA, press release (June, 2007). * ROIs are the average of IRRs (internal rate of return) weighted by the amount of investment. Note: For the U.S., data are between October 2005 and September 2006, for Europe, as of 2006, and for Japan, as of

65 (5) Venture capital policies The history of venture capital in Japan started with small and medium business investment and consultation companies founded by the government in 1963 (Tokyo, Osaka and Nagoya SBICs). Since 1972, when private sector venture capitals started to grow, the industry has been expanding with development of legal and regulatory arrangements, such as the amendment of the Antitrust Act in its treatment of venture capitals (their relation to the clause prohibiting holding companies, etc.), and introduction of the system of limited liability partnership (LLP) for investment. SMRJ and the Development Bank of Japan (BDJ), together with private sector investors, are working aggressively for projects to form venture funds under the scheme of investment LLPs. They are working, you could say, to prime the pump to enable money to be injected from the private sector, and help more venture funds to be formed in Japan. 64

66 2. Challenges (1) Diversification of suppliers of capital Venture capitals in Japan still have a shortage of funds to invest. (In other words, with more money supplied to them, they could invest more in start-ups.) Measures should be taken to attract more diverse types of suppliers of capital to the venture capital industry and have them invest more in venture capitals, so that more investment will be made in Start-ups. Figure 6-13 Balance of venture capitals between money supplied and companies to invest in Others 8.0% Money supplied and investments made are in balance. 36.0% With more money supplied, wish to invest more 48.0% N=25 Enough money supplied, but insufficient companies to invest in 8.0% Source: Questionnaires by METI to JVCA members (September 2007) (i) Capital from pension funds In Japan, pension funds, a major category of suppliers of money to venture capitals in Europe and the United States, have the potential to invest more. At present, there are only a limited number of pension funds in Japan which invest in Japanese venture capital firms. In particular, public pension funds are prohibited from investing in venture capital, a type of investment in unlisted stocks, by the Government Pension Investment Fund (GPIF) as part of its management policy. Nowadays, on the other hand, with the view to investing in more diverse asset classes and diversifying risks, an increasing number of pension funds are investing in alternative forms of assets. Some data suggest that in 2007 three quarters of the pension funds were engaged in alternative investment. Most of their investments, however, were made in hedge funds, and only a fraction of the money came to venture capital firms. 65

67 * Alternative investment: refers to investments in financial instruments other than stocks, bonds and other conventional assets that are traded mainly on exchanges, which are highly liquid as a result, and have long histories as investment vehicles. They are put in a portfolio in the hope of diversifying risks. Some of the typical alternatives are venture capital firms and private equities, such as buy-out funds, real estate funds, and hedge funds. 66

68 Figure 6-14 Alternative investment by corporate pension funds Share of corporate pension funds investing in alternative assets No plan of such investment Under consideration Investing in alternative assets Types of alternative assets they invest in Hedge fund Domestic/overseas REIT Real estate funds Emerging stock Private equity CDO Inflation-indexed bond Others Types of private equities they invest in Domestic venture capital Oversea venture capital Domestic buy-out Overseas buy-out Domestic fund of funds Overseas fund of funds Others Source: Daiwa Fund Consulting, Pension Newsletter: featuring Alternative Investment (October 2007) For venture capitals to raise more money from pension funds, further efforts should be made to make them more attractive as an investment vehicle when compared with hedge funds, which offer a relatively steady return in a rather short lock-up period, or stocks in emerging economies, which have been realizing high yields in recent years. 67

69 There are also many challenges in terms of the disclosure of information and public relations, such as the absence of benchmarks for venture capital investment, insufficient information about investment tools, and the lack of transparency of the information disclosed. In terms of public pension funds, a recommendation has been made recently that they should be allowed more discretion in management of their reserves and be authorized to invest in alternative assets, so that they are managed in a way suitable for one of the largest pension funds in the world with the view to keeping pension financing in a sound condition, as well as granting more to future pensioners and reducing the burdens of present contributors ( For Reform of Management of Public Pension Funds, Second Report of the Working Group on Financial and Capital Markets, Expert Committee on Reforms Addressing Globalization, Council on Economic and Fiscal Policy, April 2008). Present obstacles that outright prohibit pension funds from investing in venture capitals should be removed soon. (ii) Capital from investors overseas Investments from overseas in Japanese venture capitals account for only 3% of the total capital they have received. According to the current tax code of Japan, a venture capital formed under a Japanese partnership scheme which a foreigner (non-resident) has invested in is regarded as the permanent establishment of the foreigner (referred to as Item-1 PE), and profits from the fund are taxed by Japanese tax authorities. Furthermore, in order to secure the taxation, they started in 2005 to impose a 20% withholding of income tax on the distribution to foreigners of business profits from such partnership agreements. Some point out such measures as major factors that have kept foreign investors away from investment in venture capitals in Japan. Foreigners would invest more in Japan and the money could be used effectively to promote innovation of Japan s economy and revitalize it only when they recognize new businesses in Japan to be finally attractive. Policies and programs to realize this situation should be introduced. (2) Collection and provision of information about venture capitals (i) Why is collection and provision of information about venture capitals necessary? In the United States and Europe, there are databases, such as VentureOne and Thomson Financial that store information, including records of return on profit of start-ups and investments in them. Their services are commonly used by venture capitals when they 68

70 make decisions on investment in start-ups and by institutional investors in making investment decisions in venture capitals. They are an important part of the infrastructure that circulates money from institutional investors to venture capitals, and from venture capitals to start-ups. In Japan records of return on investment in the venture capital industry should also play an important role to encourage institutional investors, especially pension funds, to increase investment in the sector. Databases of such records would help venture capitals use their limited resources in an efficient way to make decisions on investment and achieve high performance in their investment. In addition, venture capital data bases would be needed for the industry as a whole to train excellent venture capitalists. To obtain promising venture capitalists, it is essential to prepare environments that help them set up their own venture capital in future. (ii) Mechanisms to be prepared for the collection and provision of more information about venture capital investment In Japan, since 1985 the Venture Enterprise Center (VEC) has been conducting questionnaire surveys on venture capitals to examine the current status of VC investment and offer compiled data. The Japan Venture Capital Association (JVCA) has also been carrying out research on its members to survey their investment activities. Recently the Japan Venture Research (JVR), an incorporated NPO established by researchers studying start-ups and people involved in the sector, has started to build a database of information about capital policies of companies venture capitals made investments in from their foundation through listing, based on prospectuses for issuing securities. The Organization for Small & Medium Enterprises and Regional Innovation, the Japan (SMRJ), an independent administrative institution which implements programs of investment in venture capitals to secure smoother supply of capital to start-ups, collects information about investments made by venture capitals it financed and reviews their performance as part of its policy assessment. In order to collect and provide information on venture capital investment in a more effective way, people and organizations as mentioned above that have been supplying such services in Japan, among others, should work to establish mechanisms to collect and 69

71 provide such information in a desirable manner. (3) Further investment in companies at the early stage of business start-up Some point out that in the United States, among others, while the amount of money venture capitals manage has increased mainly due to the growing inflow of capital from pension funds, fewer of these are engaged in hands-on support, one of features they originally had, and that they make fewer investments in start-ups at the early stage of business start-up, which has made it more difficult for the start-ups to raise money. In Japan, venture capitals make a higher proportion of investment in start-ups at the early stage of business start-up than their peers in the United States and Europe. Granted that the total amount of investment of the industry itself is much smaller, but it is expected to grow. However, investment in start-ups at the early stage of business start-up might decline as it has in the United States and other countries. With the view to providing them with the capital they need, further policies and programs should be introduced to encourage investment in such companies. SMRJ finances hands-on venture funds, which invest mainly in start-ups at the early stage of business start-up. The independent administrative institution is expected to increase such investment. (4) Development of human resources of capitalists for more hands-on support For venture capitals to raise the level of potential that start-ups have for growth and, as a result, to provide investors greater returns on investment, hands-on support (or support that venture capitals provide directly for start-ups in terms of their business management) is be essential. In part because such services have been offered to start-ups by banks, venture capitals have not provided sufficient hands-on support. In order to attract investors in competition with other financial vehicles, venture capitals should give more hands-on support to ventures and achieve better performance in management of funds. For venture capitals that provide hands-on support, it is critical to secure venture capitalists, people who work for them for investment in venture capitals. Venture capitals should endeavor to enhance their system of inner incentives for the purpose of calling in people with experience and skills, such as those who have 70

72 themselves founded a start-up. They should also work to train their own people to be capitalists. JVCA also works to develop human resources. For instance, it sponsors training seminars and certification examinations for venture capitalists. The association is expected to continue such initiatives. Graduate schools offering MBA and MOT degrees are introducing courses of education designed for venture capitalists to strengthen their comprehensive competence. MSRJ conducts programs of investment in capital funds (see above (3)) to primarily supply capital to those independent venture capitals and emerging venture capitals with little past record of investment that the organization recognizes as having great ability to foster growth. The programs play a part in developing a pool of capitalists. It is desirable to maintain such a point of view in making investments. In addition, it might be necessary to consider some policies and programs to back up training or other educational activities carried out to produce more capitalists. (5) Challenges in legal and accounting systems (i) Ways to apply accounting standards to venture capital investment Financial Accounting Standards should be applied in such a way as venture capital investment is treated in an appropriate manner. Reviews must be conducted on accounting practices to clarify points of issue, and arrangements should be made to introduce necessary legal, regulatory, and institutional systems. For instance, when a venture capital assesses the fair value of unlisted shares issued by a company in which it has invested, if the investor has acquired a position which allows it to see in detail how the business is operated because, for instance, it has sent someone to the company as a director, or because it has been providing hands-on support for the company, the investor may be able to judge whether fair value of the stocks could recover, because the venture capital can obtain medium- and long-term business plans and anything necessary from the company just as a case where it would have invested in a company founded for a specific project. Seen from such a viewpoint, even under the current system, when the fair value of shares issued by a company in which a venture capital invested in has declined to less than 50% of the acquisition costs, it may not always need to recognize the difference as a loss. That is, the reporting of the difference as a loss might not be needed when the investor reasonably anticipates that losses the company has accumulated since its foundation could be resolved in a certain period of time, and that its subsequent 71

73 financial performance could avoid falling far below the level that was estimated in the business plan, for example. The current system, on the other hand, requires listed venture capitals to consolidate accounts of investment partnerships in which they are a general partner (GP) into their own financial statements. Some point out problems that take place when venture capitals are obliged to consolidate investment partnerships only because they are GPs, such as (a) that the accounting treatment may make financial conditions and earnings of the listed venture capitals less transparent because fees and interests paid and received between the investment partners and venture capitals are internalized; and (b) that consolidated assets of venture capitals that serve as GPs in a small number of investment partnerships may fluctuate widely every time a partnership is founded or dissolved, which would not correctly represent the realities of their business. For the time being, to cope with such problems, venture capitals consolidate accounts of investment partnerships in which they serve as GPs into their financial statements according to accounting standards, with their unconsolidated statements added for reference. In the medium and long term, studies should be conducted on standards that decide, among others, in what case they should be consolidated and in what case they should not, so that accounting disclosure can better represent realities of their business. (ii) Regulations of venture capitals Regulations of venture capitals are being tightened. For instance, with the Financial Products Trading Act, venture capitals are also required to be registered or reported according to the Act. When regulations are introduced, it is important to pay due attention both to the benefits they bring, such as protection of investors, and to compliance costs which those regulated would bear and restrictions imposed on their acts, and maintain an appropriate balance between them, so that the regulations will not exceed a necessary level. For instance, when a venture capital forms a fund with money raised from outside investors (the main fund), it may prepare another fund (a parallel fund) which offers membership exclusively to its venture capitalists (executives of the venture capital) and make investments in the same companies which the main fund invests in, so that it will provide incentives for venture capitalists and attract talent. But such executive funds usually do not include professionals, and they are not eligible for exceptional operations permitted only to qualified institutional investors, so they must be registered. Obviously this represents excessive regulation. An executive fund that is managed by general partners of the main fund or their executives and offers membership exclusively to executives of the GPs should be exempted from registration. 72

74 4 Ways to increase participants in emerging equity markets and revitalize them 1. Current state of emerging equity markets (1) Increased numbers of emerging equity markets In Japan, there have been a total of seven emerging equity markets founded: the Mothers (Tokyo Stock Exchange) and Centrex (Nagoya Stock Exchange) exchanges, the two first emerging equity exchanges opened in 1999; JASDAQ (reorganized from the OTC market); NEO (opened in 2007) Hercules (Osaka Securities Exchange, opened in 2000); Ambitious (Sapporo Securities Exchange, opened in 2000); and Q-Board (Fukuoka Stock Exchange, opened in 2000). Since 2000, more than 1,000 stocks have been listed on the seven exchanges, with 100 to 150 new listings each year after The number of companies listed has come quite close to those on similar exchanges in the United States and Europe. They deserve credit for, over the decade, having rapidly improved the environment for start-ups in financing in the stock market. On the other hand, some point out problems, for instance, that the rapid increase of emerging equity exchanges has made them less distinctive or less unique; and that excessive competition among them has led some to too-lax listing examinations. Figure 6-15 List of emerging equity exchanges in Japan Emerging equity exchanges in Japan (in no particular order) Exchange Listed stocks Opened in Exchange Market capitalization Trading value Turnover per stock per stock ration of ( 1 million) ( 1 million) trading (%) Mothers (TSE) November 1999 Mothers (TSE) Hercules (OSE) May 2000 Hercules (OSE) Centrex (NSE) October 1999 Centrex (NSE) Q-Board May 2000 Q-Board Ambitious April 2000 Ambitious JASDAQ February 1963 JASDAQ NEO August 2007 NEO (Ref.) TSE 1 May 1878 (Ref.) TSE 1 (Ref.) TSE 2 October 1961 (Ref.) TSE 2 Emerging equity exchanges overseas Exchange Listed stocks Opened in Exchange Market capitalization Trading value Turnover per stock per stock ration of ( 1 million) ( 1 million) trading (%) NASDAQ (US) February 1971 NASDAQ (US) AIM (UK) 1995 AIM (UK) GEM (Hong Kong) November 1999 GEM (Hong Kong) * Adapted from statistics carried on websites of the exchanges and NOMURA CAPITAL MARKET REVIEW, Nomura Institute of Capital Market Research. * Trading values are monthly figures for March (For foreign exchanges, monthly averages between January and March 2007.) * Market capitalizations and listed stocks are as of March 31, * Market capitalizations and trading values are translated at the exchange rate as of March 31,

75 (2) Increasing cases of companies delisted due to breaches of the law, etc. Recently several cases occurred where companies listed on emerging equity exchanges were accused of, or delisted due to, for instance, misstatements, window dressing, or links to antisocial organizations. Such problems are not necessary unique to emerging equity exchanges, but tend to come up more often than in major exchanges. In emerging equity exchanges, it is pointed out, such troubles arise due mainly to excessive competition among the exchanges, premature listing of companies before they acquire adequate business bases, or lack of a fully developed management awareness, and substandard examination and auditing systems at some securities underwriters and auditing firms. Figure 6-16 Companies delisted due to breach of the law, etc. Proportions to the companies delisted of those due to disclaimer of audit opinion, misstatement, protection of public interests/investors, and breaches of listing agreements A. Companies listed on the major exchanges Companies delisted from the major exchanges a. Companies delisted for reasons above b. Proportion to the listed companies B. Companies listed on the emerging equity exchanges Companies delisted from the emerging equity exchanges a. Companies delisted for reasons above b. Proportion to the listed companies Adopted by METI from the website of kabu.com Securities and those of the exchanges (3) Retail investors support emerging equity exchanges Most of the transactions on the emerging equity exchanges are conducted by retail investors, and only a limited number of institutional investors take part in the trading. This is attributed to their smaller market capitalization and lower liquidity, which hinders them from meeting the needs of institutional investors in terms of money management. The phenomenon brings the contrast between the emerging equity exchanges in Japan and those in the United States and Europe, such as NASDAQ in the United States, and AIM in the United Kingdom, where institutional investors play a major role in transactions. The central role retail investors play in emerging equity exchanges in the country is also mentioned as one of the causes of wild fluctuation of stock prices there. Especially, with the recent spread of stock trading on the internet, the number of day traders, individuals who continually buy and sell in a short period of time, is increasing. Some believe they are another factor that makes share prices volatile. 74

76 Figure 6-17 Compared shares of transactions by type of investor (trading value basis, 2007) Unit: % Financial institutions Investment trusts Business companies Others companies Securities firms Individuals Foreigners Total Source: websites of the exchanges TSE 1 TSE 2 Mothers JASDAQ Hercules Note: The shares are calculated only with payments made by buyers through brokers. (4) Volatile / depressed stock prices at present With some companies having been delisted due to breaches of the law or for other reasons, and others having lowered earnings estimates immediately after being listed, emerging equity exchanges are losing the confidence of investors. In addition, general conditions of the market are deteriorating due mainly to problems with the subprime loan market. As a result, stock prices at the emerging equity exchanges are still depressed, having peaked out at the end of 2005 before falling down to just over 20% of the record high in April

77 Figure 6-18 Stock prices at the emerging equity exchanges Stock prices at exchanges (monthly basis) JASDAQ(right-hand) TOPIX Hercules Mothers 1997/Jan 1998/ Jan. 1999/ Jan. 2000/ Jan. 2001/ Jan. 2002/ Jan. 2003/ Jan. 2004/ Jan. 2005/ Jan. 2006/ Jan. 2007/ Jan. 2008/ Jan. Index: closing Mothers Index: Hercules index Index: closing TOPIX Index: JASDAQ index index (all listed stocks) (right-hand) Source: Statistics carried on websites of Bloomberg, AMSUS and the exchanges (5) More rigorous examination for listing With an increasing number of listed companies accused or having been delisted due to, for instance, misstatements, window dressing, or links to antisocial organizations, the emerging equity exchange are examining listings more carefully, and securities underwriters and auditing firms are becoming more cautious. Some start-ups, among others, claim that listing examinations are becoming more rigorous. No change has been made in anything about formalities stipulated in the criteria for listing (rather, some of the standards are relaxed), but parts relating to examinations of substantiality (viewpoints such as appropriate disclosure of conditions of the company and information of its risks, soundness of the business, and public interests / investor protection) are getting stricter. Especially among venture capitals and start-ups, a majority say listing that examination has gotten much tougher than a few years ago. Issues that have gotten tougher include the internal control system checks, links for to antisocial organizations, and scrutiny of business plans. All these are important, but checking for relationships to antisocial groups is pointed out as an increasingly urgent problem and JASDAQ mentions it explicitly as one of its delisting criteria, and other exchanges are also putting forth more efforts to tackle the problem. Some say, on the other 76

78 hand, there are cases where start-ups are required to develop a internal control system they are unable to put in effect, where an unclear definition or range of antisocial organizations to be examined, puts them to trouble in deciding specifically what they must do, or where an exchange that demands excessive feasibility in business plans refuses even a reasonable degree of future uncertainties about growth when such uncertainties are present for start-ups, by their very nature. Figure 6-19 Changes in listing examinations by exchanges in the start-up stock market Venture capitals perceive as: Others Same as before 4.0% 0.0% More rigorous than a few years ago 96.0% N=25 Source: Questionnaires by METI to JVCA members (September 2007) 77

79 Start-ups perceive as: Others 2% DK 32% More rigorous than a few years ago 64% Same as before 2% N=57 Source: Questionnaires by METI to Japan Venture Conference (October 2007) (6) Difficult assignment of auditing firms Furthermore, with cases of misstatements and window-dressing having occurred in the start-up stock markets, auditing firms are becoming more cautious as to whether to undertake the auditing of a start-up immediately before or after its listing. An increasing number of start-ups feel it is getting more difficult to find an auditing firm that accepts them. Fees auditing firms require from start-ups are also rising compared to a few years ago. Figure 6-20 Changes in attitudes of auditing firms to private companies Venture capitals perceive as: Others N=24 Same as before Auditing fees have risen More often refused auditing than a few years ago Source: Questionnaires by METI to Japan Venture Conference (October 2007) 78

80 (7) Introduction of the internal control reporting system In addition, the internal control reporting system has been introduced according to the Financial Products Trading Act, which applies to listed companies from the first business year that begins on and after April 1, There are worries that the system might drive listing costs up further, or that it might make it more difficult to secure an auditing firm. (8) Deteriorating listing conditions for start-ups With more rigorous examination for listing pointed out, as described above, along with falling or depressed stock prices at present, the increasingly difficult assignment of auditing firms, the introduction of the internal control reporting system, and other difficulties, the conditions for start-ups attempting to list are significantly deteriorating. The situation has gotten much tougher than a few years ago for start-ups that endeavor to raise money at a start-up stock exchange. Figure 6-21 Numbers of public offerings on start-up stock exchanges Offerings Q-Board Ambitious Centrex Hercules Mothers NEO JASDAQ -31.6% from a year ago Adapted by METI from data released by the exchanges (9) Concerns about a slump in investment in start-ups in general As conditions are thus getting tougher in a variety of aspects for start-ups that intend to go public on a emerging equity exchange, there are concerns emerging not only that start-ups might have more difficulty in raising money from an emerging equity exchange, but also that the impact might extend to venture capitals and angels, which at present make profits from capital gains they earn mainly by taking start-ups public on a emerging equity 79

81 exchange. In particular, when venture capitals commit themselves to earning a certain percentage of profits on their investments, a depressed offering price leads to a diminution of the money venture capitals can afford to invest. Greater impacts of such shrinking investments are felt, it is said, especially by start-ups in the biotechnology sector. With such difficulties left unsolved, the impact on direct facing may become severe. 2. Challenges (1) Enhanced self-discipline and governance by start-ups themselves The recent loss of confidence in emerging equity exchanges, and depressed trading volumes and prices have resulted mainly from window-dressing, misstatements and links to antisocial organizations by start-ups listed there. They should, keeping these lessons in mind, work to secure the sound functioning of emerging equity exchanges, which represent their most important tool for gaining capital and achieving credibility. For instance, start-ups and their management should develop their own awareness of compliance issues, disclose information of the company from the viewpoint of investors about anything at any time, and have independent directors appointed who should monitor management as outsiders. They should recognize that it is critical for them to develop adequate management control systems. In the first place, no capital could be raised in a stock exchange without participation in it of buyers of stocks, or investors. Start-ups that finance in the stock market should maintain good communication with investors and offer them sufficient information. (2) How should listing procedures be from now on? (i) Listing procedures that strike a balance between the growth of start-ups and the protection of investors It is indeed important to conduct listing examinations from the viewpoint of appropriate disclosure about conditions and risks, financial soundness, and the public interest and investor protection. But excessive, unnecessarily rigorous listing examination might impose too heavy a burden on start-ups that intend to go public. There is disagreement, about whether listing examinations are actually getting more rigorous nowadays or they are merely adhering to the same criteria but becoming deeper. If, however, an exchange s stance on implementation of listing examinations were largely swayed by several cases of breaches of the law or the mood prevailing in the 80

82 market, this would not be desirable to promote growth of start-ups in the sense that it would ruin predictability about listing. Larger swings or unpredictability with implementation policies would ultimately hamper venture capitals from supplying capital to start-ups, which might impact the whole venture capitals financing system. In terms of financial and capital market regulation, it is important, needless to say, to pay due attention both to fairness and transparency in the market and the protection of investors, as well as to compliance costs market participants pay and restrictions imposed on their behavior, and strike an appropriate balance between all of these. If such balance is lost in emerging equity exchanges in Japan, there would be a rapidly increasing number of Japan-based start-ups that will raise capital from an emerging equity exchange overseas or move their headquarters abroad. Such movements would be a great problem for Japan in securing competitiveness in the global financial and capital market and from the viewpoint of revitalizing our economy as a whole. In view of this, exchanges are keenly expected to conduct listing examinations in a way that balances the need to grow start-ups while protecting investors. For instance, some say that there are cases where, in terms of internal control systems, relations with anti-social organizations, or inaccurate business plans, start-ups are required to develop unworkable internal control structures where an unclear definition or range of antisocial organizations to be examined puts them to trouble in deciding specifically what they must do, or where an exchange that demands excessive feasibility in business plans refuses even a reasonable degree of future uncertainty in terms of growth. Exchanges are expected to take measures to solve such problems. Exchanges are also developing mechanisms to tackle antisocial groups. They are expected to work together with related parties and make further efforts to support companies in preparing internal systems that protect them from harm. When the statutory annual securities report a company attaches to the application for listing carries a note of significant doubt, there is little chance, it is believed, that the listing will be approved. Some claim that whenever a significant doubt related to financial conditions exists, such as difficulties in raising new capital, if it is judged that the doubt would be removed by the listing, once it is approved, the application should be treated at the listing examination as if the note of doubt about its going concern had not been made. The Financial Service Agency (FSA) should not supervise or inspect exchanges, securities 81

83 firms or auditing firms in a way people concerned are held accountable in an unnecessarily harsh way for cases of a listed company that was accused or delisted due to, for instance, a breach of the law. Instead, the Agency should adopt a risk-based approach, which makes clear what areas and items have greater impacts on users and markets for focused supervision and inspection. (ii) Exchange of information about listing examination procedures for better understanding of the procedures It is necessary to promote better communication between parties related to the start-up stock market and eliminate poor public relations and avoidable misunderstandings among them. For instance, exchanges should play a central role in providing parties related to the start-up stock market, such as start-ups that raise capital from exchanges, and securities firms, auditing firms and attorneys that support them in listing procedures, with opportunities to exchange opinions regularly. It is also important for exchanges to explain, in what cases listings would be rejected through listing examination at explanatory meetings and other occasions for applicants for listing, on listing manuals and guidelines, and in FAQs and the like, with as many examples as possible given. (iii)necessary actions to solve issues with auditing firms In view of the responsibility of auditing firms and accountants, it is reasonable to a certain degree for the firms and accountants as individuals to select clients on the basis of their level of audit risk. On the other hand, in view of the statutory requirements clients must satisfy when listed with the assignment of auditor, the auditing firms and accountants as a group have social responsibility to the economy as socio-economic infrastructure and public institutions to provide companies that hope to go public with the services they need. The auditing firm and accountant community should take action to deal with difficulties which at present many of the companies hoping to go public encounter when assigning an auditor. Especially, it seems necessary to promote and develop auditing firms specialized in services for start-ups. The concern is that the tightened compulsory rotation of auditors might lead to a smaller number of auditing firms and accountants that undertake audits of start-ups. Considering the characteristics of ventures, most of which are yet to have a full-fledged corporate structure, it might be necessary to examine whether the regulation for obligatory auditor rotation should be relaxed in terms of companies that are preparing for an initial public 82

84 offering. (3) Shift of focus from listing examination to post-listing actions (i) Necessary recognition as ex post facto supervision system Cases of companies that were delisted because they turned out, once listed, to have failed to satisfy listing standards should be recognized as demonstrating a shift to an ex post facto supervision system. Anyway, cases of failure to meet listing criteria should not be a reason for the hasty introduction of stronger and stricter listing examinations before contemplating other measures. (ii) Study of Japanese Nomad (system for support for disclosure after listing) With the view to supporting listed companies in terms of maintaining their capacities for disclosure after going public, instead of excessively tightening examination for listing, Japan might as well examine whether it should also introduce a system under which third parties (advisors) help companies with disclosure, something like the Nominated Adviser (Nomad) of AIM in the United Kingdom, the OTCQX system made by Pink Sheets in the United States, and the GEM system in Hong Kong. A Japanese Nomad system, however, should be designed as an addition to be made to the existing system, where listing examination and other procedures are implemented in a strict way, or as mere rigid regulation. It should, instead, be constructed as a voluntary scheme that offers start-ups another option along with the existing mechanism and which gives them incentives. Another issue is how they should be offered benefits that offset the increased costs of the introduction of a Nomad system. The proposed amendment of the Financial Products Trading Act, now before the Diet, is to introduce a system similar to Nomad into professional exchanges (see (4) (v)), a category of bourse to be founded under the amended Law. While monitoring how the system is operated in professional exchanges, examination should be conducted whether and/or how a mechanism of third parties (advisors) offering support for disclosure should be used in other exchanges. (iii)voluntary efforts by securities firms and exchanges Whether a Japanese Nomad is introduced or not, securities firms, which sponsor ventures 83

85 and other companies for listing, should more willingly provide them with support and advice for their disclosure after they are listed. The Tokyo Stock Exchange obliges companies listed on Mothers to hold more than two explanatory meetings per year three years after listing. In April 2004, JASDAQ also introduced a system that requires all its listed companies to have two IR meetings a year (four meetings per year for companies listed on the NEO, established in 2007), and, along with the system, it set up a special unit to provide the companies with necessary services. The free services for all the listed companies, JQ IR Support Service, include lectures by IR experts, seminars where IR practitioners offer their experiences as a lesson for others, and a website dedicated to IR, which provides investors and the companies with opportunities to communicate. It also has a system of annual commendation to have examples that should be guides to IR activities that should be made widely known and that should promote more aggressive efforts, so that its listed companies will offer more and better IR services and, as a result, that the JASDAQ itself will function better. With such initiatives in mind, exchanges should provide companies listed on them with more support in disclosure activities they perform for investors, such as IR meetings held for them. (iv) Examination of effective use of intellectual property reports and intellectual assets management reports JASDAQ already has a free analysis service provided for companies listed on the exchange to evaluate their intangible value that are not expressed on financial statements, such as know-how, R&D capacity, and royalty of employees. Now examination should be conducted in a positive manner on how intellectual properties reports and intellectual assets management reports can be used effectively as disclosed information that demonstrates the potential of a company for growth based on its technologies. (v) Observation of and action to outcomes of the internal control reporting systems introduced In Japan an internal control reporting system comes into operation this year according to the Financial Products Trading Act. In the United States, the introduction of a similar system under the Sarbanes-Oxley Act led to increased costs companies subject to the law must bear to cope with the new system and which has postponed application of the Act to SMEs. We should carefully observe how things go after the reporting system comes to effect, especially how it is enforced in terms of companies listed on emerging equity exchanges. An increasing number of people are concerned whether the introduction of the internal 84

86 control reporting system to companies listed on emerging equity exchanges might cost them a lot. Examination should also be conducted on whether and/or how start-ups should cope with the system as relevant to their needs. If the internal control reporting system should turn out to place too heavy a burden on companies listed on emerging equity exchanges, it might be necessary to review whether it should be applied in a uniform manner. (vi) Examination of potential growth after listing Emerging equity exchanges should decide whether a company should be listed not on the basis of its performance at the time of listing but rather in view of its potential and prospects, and indeed they have been conducting examinations in such a manner. It would make sense, accordingly, if reviews are conducted in a certain period of time after a company is listed to see how fast it grows after the listing and to compare its outlook given when listed with its actual performance. However, if, for instance, formalistic standards are applied in a strict manner to assess the growth of a company in a certain period of time after it is listed and if the results are used to decide, say, whether it should be delisted, that might lead to an unhelpful focus revenues and/or profits, resulting in more cases of window-dressing, unreasonable mergers, and the like. To avoid this, careful examination should be conducted on what criteria should be laid down for review of growth after listing, how the review should be conducted, and in what manner its results should be dealt with. 85

87 (4) Efforts to increase participation of institutional investors (i) Enhanced efficiency and further globalization of exchanges to make them more attractive In the United States and Europe, arguments are emerging about global competition among emerging equity exchanges. To encourage more institutional investors to take part in emerging equity exchanges in Japan and also to boost their brand image, they should invite foreign companies with large market capitalizations to list their stocks there. For that purpose, they need to accept disclosure according to the International Accounting Standards (IASs) and United States Generally Accepted Accounting Principles (US-GAAP), provide disclosure documents in English, and take measures to complete listing examination in a shorter period of time. The acceptance of IASs and US-GAAP is especially important. At present, foreign companies that intend to list their stocks on a Japanese exchange before being listed on any other bourse must have their financial statements audited every two years according to Japanese accounting standards, so in substance it takes at least two years to complete preparations for listing there. Admission of the foreign standards resolves the problem. As efforts are being made to harmonize Japanese standards themselves more closely with IASs by 2011, there would be little necessity left to adhere to the current indigenous standards. If more foreign Start-ups, especially Asian ones, are listed on emerging equity exchanges in Japan, it is expected that more capital from overseas institutional investors will flow into Japan s emerging equity exchanges for Asian ventures, and that trading volumes will grow with a larger number and greater variety of investors. Some point out that Japan s emerging equity exchanges are smaller than their overseas peers, and that there are too many of them. It is necessary to reexamine what roles they each should play from the viewpoint of their scale, global competitiveness and efficiency. Local exchanges, on the other hand, might be given a more ambitious position with the view of working to revitalize local communities. When examination is conducted on how Japan s emerging equity exchanges should be, such points of view must be considered in a comprehensive manner. (ii) Examination of an analyst introduction system As part of efforts to increase investment in small and medium cap stocks, NASDAQ founded the Independent Research Network (IRN) in September 2005 as a joint-venture with Reuters. IRN acts as an intermediary for small and medium cap companies listed on 86

88 the exchange that are not covered by analysts to look for and ask one to write a report on such companies. Introduction of such a scheme into Japan s emerging equity exchanges might help encourage institutional investors to invest more. As there are some concerns that the engagement of exchanges in such businesses might be inconsistent with the scope of business stipulated in the Financial Products Trading Act (Article 87-2), some measures should be taken to make it clear that exchanges are legally allowed to provide such services. From the viewpoint of economies of scale and efficiency, it might be a better option if several emerging equity exchanges form a partnership for such a business. (iii)development of an index of the emerging equity exchanges At present institutional investors, including public pension funds, have investments in small and medium caps. But the benchmark, typical index, for small and medium cap investment, Russell/Nomura Small Cap Index, is dominated by stocks listed on the TSE 1st Section. That is part of the background that hinders investment trust managers, who are assessed by institutional investors in terms of their management performance, from aggressive expansion of investment in companies listed on emerging equity exchanges, even though they are also classified into small and medium cap. With the view to addressing the problem, the emerging equity exchanges might be able to jointly develop a unified stock market index. In November 2007, Standard & Poor's started to release the S&P Japan Emerging Stock 100 Index, index consisting of the top 100 companies among those listed on a Japanese emerging equity exchange in terms of market capitalization after floating stock adjustments which maintain a certain level of market liquidity. In March 2008, Nikko Asset Management listed an ETF that tracks the index on TSE. The release and effective use of such indexes is expected to be helpful to encourage public pension funds other institutional investors with large capital to expand investment in stocks on emerging equity exchanges. (iv) Liquidity provider program 87

89 With the view of inviting more institutional investors, it is important to provide more liquidity to emerging equity exchanges. On April 1, 2008, JASDAQ started the Liquidity Provider Program, a mechanism to offer secures firms trading fee discounts as an incentive to supply liquidity. A wide range of study should be further conducted on new schemes to make exchanges more liquid. (v) Development of venture stock exchanges for professionals Development of exchanges exclusively for professionals is effective to supply long-term stable capital to Start-ups and relax listing examination and disclosure procedures, because such exchanges have no need to consider the protection of ordinary investors. On such exchanges you could expect more reasonable stock pricing because professional investors assess share prices. In the Plan for Strengthening the Competitiveness of Japan s Financial and Capital Markets, announced by the FSA in December 2007, the Agency declared that it would develop a framework of exchanges based on new rules that should expand the range of market participant to designated investors (or professional exchanges ). Amendments to the Financial Products Trading Act necessary to set up such exchanges are now under deliberation before the Diet. The amended Law, once the bill passes the Diet, is to allow exchanges to be designed in a way their features as a professional market can be exploited effectively: stocks listed there are exempted from the internal control reporting system; quarterly reporting can be replaced by annual disclosure; and disclosure documents written in English can be accepted. TSE plans to set up sometime in 2008 a new start-ups exchange based on the framework together with the London Stock Exchange. In developing structures of professional exchanges, formalistic standards for listing examination should be significantly relaxed and they should exempted from the internal reporting system, quarterly reporting, and other obligations laid by the Financial Products Trading Act especially with the view of making clear advantages they offer as professional market. In addition, they should also provide obvious benefits in terms of the length of time for procedures. For instance, they should enable companies to raise capital in not more than three months after their listing examination started. Institutional investors based in Japan are more averse to risks than retail investors, and their presence is marginal in the emerging equity market. In developing professional exchanges, therefore, it is crucial to attract professional investors overseas. For that 88

90 purpose, in developing venture stock exchanges for professionals, they should accept disclosure according to the IASs and US-GAAP and disclosure documents written in English. Study should be conducted on, among others, whether and/or how some policy incentives should be given to stocks listed on professional exchanges in order to encourage investment in them. 89

91 Chapter 7 Capital ties with existing companies 1. Present State (1) Sale of Start-up stocks from venture capital funds to existing companies In Japan, venture capital funds rely mainly on public offerings as a way to recover investments ( exit ), and they rarely sell equity directly to other companies with profits. Usually stocks are sold to other companies to stop loss. In the United States, in contrast, venture capital funds sell more often and more in value directly to other companies than through public offerings, and there is little difference between public offerings and sales to other companies in terms of proceeds per case. In almost 70% of the cases where stocks of a company were sold to other companies, the proportion of proceeds to investments exceeded 1. These facts demonstrate that sale to other companies is considered as one of the desirable exits for venture capital funds. Figure 7-1 Venture capital funds ways to recover investments ( exits ) Public offering Bankruptcy/liquidation/depreciation Resale to owners, etc. Sale to secondary funds, etc. Sale to other third parties Others Note: Some of the companies are counted twice or more. Profit/loss Companies Share in the total Profit/loss per company ( 1 million) ( 1 million) Source: Venture Enterprise Center, Survey on Current Status of Investment of Venture Capitals and Other Funds (December 2007) 1st quarter 2nd quarter 3rd quarter 4th quarter annual total Unit in value: $1 million 2006 Public offering Public offering companies average in companies average in companies average in companies average in value value value value In many cases of M&A, proceedings are not disclosed. The averages in value are calculated by dividing the total proceedings in disclosed cases by the number of companies. Source: NVCA, THOMSON Venture Economics 90

92 Figure 7-2 VC s proportions of proceeds from sale of Start-up stocks to other companies to the investments Year smaller from 1 to 4 from 4 to times of than TVI times of TVI times of TVI or larger Source: NVCA, THOMSON, National Venture Capital Association Yearbook 2007 (April 2007) In the United States, however, it was in the 1990 s when sale to other companies started to grow fast, and it has not been long since it became a major way to recover investments. In Japan, many venture capital funds were formed around 2000, the days of the IT bubble. Now that many of them are reaching maturity they need to take some actions to liquidate stocks of companies they invested in. It is anticipated, therefore, that more of the stocks will be sold to other companies. However, according to a survey conducted in 2007 by METI, which asked Start-ups whether they considered sale of their stocks to other companies as part of strategies or business plans for future growth, only 3.8% replied that they did. This suggests most of the Start-ups regard sale of their shares from venture capitals to other companies as undesirable. 91

93 Figure 7-3 Cases of sale of stocks of companies venture capitals have investments in, and their average proceeds (time series) in the United States Price(Average) ($ Millions) Total Number (year) Source: NVCA, THOMSON, National Venture Capital Association Yearbook 2007 (April, 2007) Figure 7-4 Start-ups view of sale of their shares from venture capitals to other companies Strategies/business plans for future strategy (n=442) Considering IPO Considering sale to other companies Considering acquisition of other companies No specific plan Others Source: METI, Questionnaires Survey on Creation and Development of Start-ups, (December 2007) (2) Repurchase provisions in investment contracts with venture capitals Some point out that repurchase provisions in investment contracts with venture capital funds lead to an unhelpful obsession with public offerings, narrowing options of exiting of venture capital investment other than placing the equity in the market. A repurchase provision refers to a stipulation in an investment contract concluded between a venture capital fund and a company it invests in that if, among others, it fails to have its 92

94 stocks listed, the company or its management shall buy back the shares the fund owns. In the United States, it is not very common that an investment contract with a venture capital fund contains a clause requiring redemption of shares, and usually such a contract has no stipulation that individuals in the management shall buy them back. The type of causes is believed to be unique to Japan. According to a poll to general partners (GPs) of venture capital funds SMRJ has financed, around 70% of the respondents placed a repurchase provision in their investment contracts, and 7% of them had exercised the claim for repurchase. Depending on requirements for exercising a repurchasing claim and ways to set a repurchase price, a repurchase provision allows a venture capital to secure upside benefits without assuming any downside risk. From the viewpoint of Start-ups, some argue that such clauses are undesirable in terms of appropriate sharing of business risks between Start-ups and venture capitals. On the other hand, seeing the issue from the side of venture capitals, many claim that repurchase provisions are necessary for the purpose of encouraging Start-ups to work hard to go public and securing liquidity of shares a fund owns when it is about to reach the maturity date. (3) Moves of corporate venture capitals Nowadays in the United States, and also in Japan, an increasing number of business corporations, especially large companies, form a corporate venture capital, venture capital fund they found exclusively for themselves. In the background of such moves lies the fact that large companies are compelled mainly by increasingly fierce global competition and shortening product life cycles to discriminate their contents of R&D more clearly and produce achievements in R&D more quickly, while they struggle to select business segments and concentrate their resources on them to cut down on R&D expenses. Large enterprises make investments through corporate venture capitals with the view of selecting, among new technologies which are being developed by Start-ups they have investment in, those which have reached a certain level of maturity and should satisfy their needs to acquire them. 93

95 Figure 7-5 Numbers of corporate venture capitals based in the U.S. by year of foundation Source: adapted from a study by NIST/ATP & MIT Sloan 94

96 2. Challenges (1) Development of secondary markets for shares of unlisted Start-ups In Japan, as described above, venture capitals depend largely on public offerings as exits of investments they have in Start-ups. Seeing from the side of Start-ups, some say that this compels them, without careful consideration placed on what phase of development they are at, to go public on an emerging equity exchange before the maturity date of the venture capital fund, and that as a result they may fail to achieve full growths. From the viewpoint of venture capital funds, their performance is largely influenced by a climate for listing in the emerging equity market, which might lead to diminished attractiveness of venture capital investment for institutional investors. From now on it is necessary to diversify exits of venture capital investment other than public offering by, for instance, taking advantage of moves of large enterprises setting up corporate venture capitals, and to offer venture capitals more routes to successful investment. Especially, as many of the venture capitals formed around 2000, during the IT babble years, come to maturity in coming years, it is an urgent task to form secondary funds for liquidation of their assets. The government should also examine what policies and programs it should offer to encourage such moves. (2) Improvements in repurchase provisions in investment contracts with venture capital funds The repurchase provision seen in investment contracts with venture capital funds was invented in the days when their ways to recover investments ( exits ) were limited almost exclusively to public offerings. Some improvements must be made in it to give the act of selling shares to other companies the position as another desirable exit. In the first place, what side effects a repurchase prevision causes depends largely on what specific content the stipulation has. Especially important elements are requirements for invoking the repurchase clause and ways to set a repurchase price. According to interviews with major venture capitals, repurchase clauses can be classified into several types in terms of their exercise terms and conditions, as stated below. Most repurchase provisions specify as requirements for exercising a claim for buyback two cases: (1) Where the Start-up breached the law or the investment contract; and 95

97 (2) Where it fails to go public; and some also include the case: (3) Where the fund is about to reach the maturity date. Repurchase provisions that fall under the requirement (2) are further divided into: (i) short-of-effort type, where the repurchase clause is invoked when the Start-up avoids going public though its profits, financial position, and other conditions of its business satisfy requirements for listing; and (ii) formalistic-standards type, where the clause automatically comes into effect unless the company gets listed before a specific date. Most venture capitals adopt the former, short-of-effort. Figure 7-6 Short-of-effort type and formalistic-standards type (i) Short-of-effort type Case 1: Where the Start-up avoids going public though its profits, financial position, and other conditions of its business satisfy requirements for listing; Case 2: Where the Start-up gives up going public for a business strategy reason though its profits and financial position satisfy requirements for listing at a specific point of time; Case 3: Where although the Start-up s profits and financial position satisfy formalistic conditions for listing, and the venture capital fund concludes that it should be able to start or continue preparations for listing on the basis of assessment of the managing underwriter and past examples of listing, the company avoids starting preparations or procedures necessary for going public, refusing to make reasonable efforts to achieve its listing; (ii) Formalistic-standards type Case 1: Where the Start-up fails to go public by a specific point of time; Case 2: Where the venture capital fund has reached the conclusion that performance of the Start-up, conditions of the stock market or any other issue present the company significant difficulty in going public by a specific point of time; Among them, Type (1) is excluded from the analyses below because it represents exceptional cases, such as where a company totally fails to perform a contract. In the following paragraphs, we examine how repurchase prices are set in cases of Type (2) and (3). In most cases of (2)-(i) short-of-effort type, a repurchase price is set at the acquisition 96

98 Fair price cost the venture capital fund paid (or the cost plus accrued interests) or one of assessed stock prices that are calculated by a variety of methods at the time of buyback claim, whichever is the highest. Figure 7-7 Repurchase price in the short-of-effort type Highest among the prices below: (i) Acquisition cost the VCF paid ( : plus accrued interests) (ii) [Acquisition cost the VCF paid] 1.2 (iii) Price calculated by the method used by the VCF when it acquired the equity (iv) Net assets per share (v) Price calculated by the comparable business sector method (vi) Nearest transaction price (vii) Price assessed by a third party designated by VCF (viii) Price assessed by a third party Company A Company B Company C Company D Company E Company F Company G Company H Company I Company J Company K * Most-favored-nation treatment * * * * In no case of (2)-(ii) formalistic-standards type a repurchase price is set at the acquisition cost the venture capital fund paid (or the cost plus accrued interests). In most cases a buyback price is settled at one of assessed stock prices that are calculated by a variety of methods at the time of buyback claim, whichever is the highest. Figure 7-8 Repurchase price in the formalistic-standards type Highest among the prices below: (i) Acquisition cost the VCF paid ( : plus accrued interests) (ii) [Acquisition cost the VCF paid] 1.2 (iii) Price calculated by the method used by the VCF when it acquired the equity (iv) Net assets per share (v) Price calculated by the comparable business sector method (vi) Nearest transaction price Company L Company M (vii) Price assessed by a third party designated by VCF (viii) price assessed by a third party *Most-favored-nation treatment * In Type (3), where funds are about to reach the maturity date, though the number of samples is limited in the first place, a repurchase price is set, in a case, at the acquisition cost the venture capital fund paid (or the cost plus accrued interests) or one of assessed stock prices that are calculated by a variety of methods at the time of buyback claim, 97

99 whichever the venture capital fund chooses after talks with the Start-up. Figure 7-9 A case where the fund is about to reach the maturity date (one sample only) A price the venture capital fund choose among those below: (i) Acquisition cost the VCF paid ( : plus accrued interests) (ii) [Acquisition cost the VCF paid] 1.2 (iii) Price calculated by the method used by the VCF when it acquired the equity (iv) Net assets per share (v) Price calculated by the comparable business sector method (vii) Nearest transaction price (vii) Price assessed by a third party designated by VCF (viii) Price assessed by a third party Realities of pricing for each type of repurchase as described above suggest attention should be given to the following issues. First, in cases of (ii) of Type (2), where Start-ups fail to go public, and those of Type (3), where funds are about to reach the maturity date, a repurchase price is set at the acquisition cost the venture capital fund paid (or the cost plus accrued interests) or one of assessed stock prices that are calculated by a variety of methods at the time of buyback claim, whichever is the highest (or a price the venture capital settles). The practice might be unfair in the sense that although a repurchase provision is invoked as a result of external environments regardless of efforts the Start-up itself made, all the consequent downside risks are passed onto the venture. Second, in cases of Type (2) ((i) short-of-effort type and (ii) formalistic-standards type), where Start-ups fail to go public, and those of Type (3), where funds are about to reach the maturity date, when a repurchase price is set at one of assessed stock prices that are calculated by a variety of methods at the time of buyback claim, whichever is the highest (or a price the venture capital settles), that might consequently make it difficult for the venture capital fund to sell the shares to other companies as a way to recall its investments ( exit ). That is, even when the shares can be sold to other companies at a higher price than one which would have been realized had the company be listed, it rarely exceeds the highest price among assessed prices that are calculated by a variety of methods stipulated in the repurchase provision. (It would be more likely, instead, that the price falls somewhere 98

100 near the median or the mean.) Under the contract, investors in the venture capital could recover more of their investments by requiring the Start-up or the management to buy back the shares than selling them to other companies. The two issues we have discussed above suggest that in cases of (ii) of Type (2), where Start-ups fail to go public, and those of Type (3), where funds are about to reach the maturity date, it might be more appropriate if Start-ups and venture capital funds, using assessed stock prices calculated by a variety of methods at the time of repurchase claim as bases, talk to decide a price at which the shares should be bought back (or a fair price at the time). In cases of (i) short-of effort-type of (2), where Start-ups fail to go public, it might be more desirable if the shares are bought back at a price which the Start-up and venture capital fund set through talks between them, using assessed stock prices calculated by a variety of methods at the time of repurchase claim as bases, or the acquisition cost the venture capital paid (or the cost plus accrued interests), whichever is higher. 99

101 Chapter 8 Viewpoints of existing companies on ventures 1. Present state (1) Expectations for corporate ventures While innovation is expected to play a role in creating new industries, private sector companies have their own focus and often lack the resources to develop new business. Inevitably they are required to convert their business management systems into those which exploit aggressively external resources for growth by, for instance, fusing their own knowledge with that in different fields or making effective use of funds raised from outside sources. But some private sector companies, in their R&D and commercialization, adhere to the principle of technological or operational self-help, keep research results idle inside the company, or place emphasis only on the current profitability with the result that they reduce investment in new business. Such a phenomenon, often called big company disease, has been pointed out as a limiting factor. Figure 8-1 How are R&D achievements dealt with when not used for business? (All sectors) Often licensed for a fee Often the R&D continued below the surface (for future use) Often made public and, if required, licensed to other companies Often the R&D discontinued, without any results left Source: Japan Research Industries Association 100

102 Figure 8-2 Factors hindering R&D achievements from being used for business Yes No Inclination to give priority over existing business segments Understanding of the leadership Funds secured to commercialize the achievements Worries about risks (e.g. risky due to few precedents) Source: Japan Research Industries Association To solve such problems, industry has cooperated with academia and formed strategic alliances to create innovation. An influential management method that is now attracting attention is corporate venturing, where large companies exploit external organizations such as ventures in a strategic way, to develop, for instance, new businesses. The areas of manufacturing techniques and advanced technologies are characterized especially by: (1) that they require a stock of technologies, and large-size research equipment as a prerequisite; and (2) that it takes longer to put them to commercial use. Large enterprises own a great amount of such technology assets and equipment. Ventures have roles to play in creating new, next-generation industries. Building cooperation between a large company and a venture as a base for steady growth of the small company would be quite effective in creating such industries. Much hope is placed on corporate venturing. In addition, corporate venturing works to revitalize existing companies, helps independent entrepreneurs develop their skills and expertise, and incubates Start-ups. 101

103 Figure 8-3 Cooperation between large companies and ventures Policies for university-originated ventures and TLOs Technological seeds Development Business University/Public Venture Emerging company labo Industry-academics cooperation Existing company s Existing corporate Existing corporate research dpt. development dpt. new business Large-enterprise-originated venture Technological seeds Development Business University/Public Technical Listing/Growth transferring Venture Emerging company labo spin-out Absorbed Cooperation Existing company s Existing company s Existing company s research dpt. development dpt. new business (2) Current state of large companies in the use of ventures An increasing number of private-sector companies recognize how important effective use of academic institutions, such as industry-academics cooperation, and open innovation is, while few have actually participated in corporate venturing. Some companies have made minor investments in Start-ups based in Japan or overseas to collect information. But strategic venturing, or spinning off part of a company s own resources to tackle new business with risks, has just made a beginning. Figure 8-4 Support for external ventures Supporting now Not supporting Source: Adapted from data produced by the Japan Techno-Economics Society 102

104 Figure 8-5 Whether large enterprises have a system to support spin-offs (spin-outs) Yes No Source: Japan Research Industries Association (3) Background to the current situation (i) Challenges concerning the awareness of large enterprises and their governance The management method of corporate venturing, where external ventures are effectively used in a strategic way, poses risks, but also brings about a diversity of benefits as mentioned below. Large enterprises overseas, especially in the United States, have adopted the strategic use of ventures as part of their business management. In Japan, companies that have introduced advanced management of technology (MOT) are trying the method mainly by bringing in external ventures. <Effects of corporate venturing (examples)> Effect of fusing knowledge and people from different fields to induce innovation; Enhancement of profitability (focusing on core segments for higher efficiency of business, and putting unused in-house resources to profitable activities); Quicker decision-making in the management; Use of external resources for reducing investment risks and costs; Spinning-off for slashing fixed costs; Effective use of in-house human resources (baby boomers, etc) (prevention of unintended outflow of engineers); 103

105 Reform of corporate culture, and improvement of corporate image (more diverse career paths) Yet, for all these benefits, Japan has only a relatively small number of large enterprises taking advantage of ventures. A factor pointed out as lying behind the current state of things is that while more people are recognizing how critical the open innovation is and some companies have indeed made attempts, such as acquiring technologies from other companies or selling theirs to others, ventures are yet commonplace and enterprises have accumulated only a small amount of know-how in management of corporate venturing. Some point out that corporate governance works as another factor. Large enterprises could set up a venture (large-enterprise-originated venture), to aggressively spin off some of their technologies they couldn t fully exploit because of lack of resources in the company to obtain external resources to put the technologies to commercial use more quickly. But technology assets (patents, etc) they have themselves are left off the balance sheet in the first place, so they are less visible. As a result, there are few positive attitudes towards attempts to spin off technology assets and set up ventures by management, and the disadvantages by not doing this are hardly recognized explicitly either. (ii) The problem of risks people have to assume when leaving a large enterprise and setting up a new business Some point out that it is easier for people in the the U.S. and other countries to leave a company set up a venture because the environments there offer more opportunities to take on another challenge should they fail. In the U.S. talent, including engineers, are quite mobile in general, and angels willing to support start-ups can be found. In Japan, the general perception is that if people fail in a business they started after leaving a company, they are exposed to great risks. When an engineer who has been working in a big company that guarantees a stable means of living leaves the company to set up a large-enterprise-originated venture, the engineer is assumed to lose a significant part of the stability of his or her life after going independent. To encourage people to pull out from big companies and create ventures, systems should be designed in a way that features of such ventures, such as partnerships with a large company, can be taken advantage of, as well as improving the general social environment toward risk-takers. Especially, large companies should examine how their personnel systems could be redesigned to allow, for instance, people who have departed from them and set up a large-enterprise-originated venture to continue to work for them. A factor lying behind the rapid increase of university-originated ventures to 1,590 as of the end of the March 2007 is that universities permit their teachers who set up a venture to keep on working for them, 104

106 People who have no opportunity to exhibit their full abilities in a company Barrier of the companies personnel management policies (It keeps talented researchers inside even by changing a topic for study) Barrier of control of employees having another job/loaned to another company (Unclear management rules, etc.) Agreements for prohibiting ex-employees competing with the company (Preventing them from working for a peer for a specific period after resigning the company) Development/commercialization out of the organization New technologies invented by an employee in a large company (unused by the company) Rules for employees invention (The intellectual property right belongs not to the inventor but to the company.) Confidentiality agreements (Which limit use of knowledge she obtained in the company) Agreements prohibiting licensing, etc. (The company has no incentive for success.) Spinning-off of technologies for development and commercialization which helps them secure more economic stability. (iii)challenges in social systems concerning corporate venturing Large companies usually have their own rules to manage their technologies and people. For technologies, they specify rules for employee inventions, confidentiality agreements with ex-employees or others, and patent licenses. For people, personnel management policies, rules for employees holding another job and those loaned to another company, and agreements with ex-employees to prohibit them competing with the company are established. Such rules and agreements have worked effectively to protect resources. But in some cases they rather work to hinder companies from proactively spinning out some of the resources, especially setting out a venture. Figure 8-6 Barriers reducing mobility of technologies and people Level of development of rules for spinning out technologies Responds from 17 large enterprise to questionnaires (by JATES) A variety of barriers reducing mobility of technologies Stock-take/assess technologies in the company? Consider spinning-off? Use technology assessment by a third party? Have a successful case of spinning-off? Have rules for granting IPs? Yes No NA Level of development of rules for spinning out people Responds from 17 large enterprise to questionnaires (by JATES) Have rules to prohibit another job? Have rules for leaves taken by employees about to leave the company to work for another? Use a personnel system to support ventures? Yes No NA A variety of barriers reducing mobility of people Actions under personnel policies on venture start-ups 0% 20% 40% 60% 80% 100% Ask to resign immediately Put forward to the in-house venture system Allow to continue working for the company Employ as advisor, etc., if asked Offer other treatment NA Source: NEDO, Report of the Large-Enterprise-Originated Venture Study Group (March 2008) In the dynamic venture culture of the U.S., venture capitals and technology consultants make effective use of their ample know-how to work as an intermediary between large enterprises and ventures, producing business environments where corporate business resources can be easily matched to those sought. In Japan, however, while venture capitals 105

107 for start-ups in general are growing, there are still a small number of venture capitals dedicated to corporate venturing undertaking partnerships between large enterprises and Start-ups, by, for instance, an existing company spinning off a venture or an established company taking in a start-up. At present private sector companies are unable to work actively to match their demand and supply of external resources. To make technologies more mobile, NineSigma, InnoCentive, Big Idea Group, yet2.com, the Innovations Exchange, and other platform providers are working as as intermediaries to provide themselves opportunities for open innovation. Companies committed to open innovation not only use their own researchers to solve problems in their R&D, but also exploit such platform providers to take advantage of opportunities to work with other companies, inventors, and ventures that propose an excellent solution. 2. Challenges Just as with parents and children, a large enterprise (parent) that works hard to bring up a group of Start-ups (children) would be well supported by their offspring in future. To develop a socio-economy which realizes the win-win growth of large companies and ventures is a policy challenge that must be addressed by society as a whole. For large-enterprise-originated ventures to be created to develop autonomously, it is necessary to develop a mechanism which guarantees that efforts made each by companies, people, and the government receive positive recognition from society as a whole, or a social-economic system friendly to corporate venturing (an eco-system). (1) Reformed awareness and management for corporate venturing (i) Making visible how effectively a company uses its own technology assets (setting an indicator of the return on technology assets) To encourage management to take risks such as spinning off technology assets to start a new business, that is, setting up a large-enterprise-originated venture, it is effective to make visible technology assets that have been left off the balance sheet and invisible, making an inventory in terms of both quantity and quality, and assessing how potentially valuable they are for business. The visualization helps the company pay positive recognition to taking risks and to assess how much they would lose potentially if they refrain from such attempts. In addition, external assessments, if introduced, are expected to work as pressure on the management to make more effective use of technology and other assets. Some of the progressive companies which commit themselves to MOT have been taking 106

108 stock of technologies they own, producing intellectual properties reports, and making other efforts to have their own intellectual properties reflected in investor relations, and more of such companies are engaging themselves in such activities. What will be important is for an increasing number of companies to introduce something that should help make visible their technologies and intellectual properties, something objective and easy to see even for outsiders just like the return on assets (ROA). For that purpose it would be effective, for the government and the private sector to work together and examine, for instance, how publicly available data of patents can be used in an effective way to quantify the level of quality and quantity of patents a company owns and calculate a new, transparent indicator. An example is the rate of return on total technology assets (computed by dividing net profits from total technology assets by the assets (patents)). The issue is also important part of effort to strengthen MOT in Japan, which, as pointed out, lags behind the United States and Europe. Figure 8-7 Examination of an indicator that expresses potential value for business of technology assets a company owns (Making visible the level of its technology assets being used in an effective way) Examination on an indicator that expresses potential value for business of technology assets a company owns (Making visible the level of its technology assets being used in an effective way) Example: Rate of return on technology assets Net profits from technology assets Technology assets Technology assets Value for business R&D expenses Technology assets (The way technologies (R&D management) (Business model) are used for business) (ii) Collecting and sharing best practices For corporate venturing (strategic use by large enterprises of ventures), there are some best practices which make both large enterprises and ventures more likely to succeed, or achieve win-win success, in terms of: how license conditions, including those for patents, should be; what equity position a parent company should have; how a parent company should be involved; development of marketing channels and support for back-office operations, such as labor management and legal affairs; how individual employees should be given an incentive to start-up a new business through, for instance, allowing them to continue to work for the parent company or granting rewards for success; and how IPOs and/or repurchase terms and other exits for venture capitals should be designed. As Japan has only a short history of corporate venturing, its government and private sector 107

109 should work together to collect know-how of the management method, cases of success and failure, and other information about, what technologies and/or business segments are suitable for corporate venturing, and have them widely shared by private-sector companies. 108

110 Corporate venturing helped the parent: undertake a business segment that would have been difficult to enter (riskier or unfamiliar sector); put to commercial use a technology that had been left unused as it was out of its core business, and make greatly significant contribution to the society; gain access to a niche market that would have been difficult to enter; develop a business segment that would have been difficult to enter; Corporate venturing: helped the parent spin off part of it for quicker decision-making; helped the parent spin of part of it to do business with those out of the keiretsu; helped the parent reform its culture and improve its corporate image; helped the parent reduce fixed costs; brought the parent capital gains; helped the parent expand markets and enhance its brands; worked in a win-win way with the First Refusal Right clause, which brought benefits to both sides when having succeeded; Corporate venturing: helped the parent turn unused IPs to sources of license fees; allowed the parent to license non-core technologies for free, making greatly significant contribution to society; allowed the parent to transfer for free technologies that it would not have been able to use without engineers had it continued to hold, making greatly significant contribution to the society; helped the parent transform IPs that had been unlikely to generate revenues into potential future profits (share warrant, etc.); The parent held a stake of 12.5% or less, allowing the venture higher independence; The stake of the parent was limited to 33%; The parent held a stake of 50% or less, staying at the position of minority investor, only retaining a say to important matters; The parent held a stake of 50% or more to assume the responsibility to the venture; A stock option plan was introduced to give incentives; The parent had a career development program for business start-up; The parent offered its people opportunities to experience business on the ground in the U.S.; The venturing helped the parent make effective use of its human resources; The parent had systems for setting up in-house ventures, allowing its people to continue to work for the company after starting a new business, and/or loaning them to a venture; The venturing brought in capital from external sources (R&D-oriented funds or credible industrial corporations, etc.); The venturing helped to obtain support and co-developers from companies that would be a user; Commendation and awards granted by agencies and organizations favorably impressed financial institutions; The venturing helped obtain financial support or orders for procurement from public institutions; Figure 8-8 Imaginary issues of best practice of large enterprises and ventures Technology/Business Management/Operation Intellectual property Equity investment Human resources Eco-system (iii) More and better arenas (platforms) for VCs and others to work as an intermediary and match business resources between companies Arenas (platforms) are needed for venture capitals and technology consultants to work as a moderator or an intermediary on behalf of a large enterprise, a venture, universities or others, and match needs with business resources, including its own assets, for example, technologies, or those which someone outside the organization owns with the view to helping it create new business. In the United States, the Department of Commerce plays a central role, working in cooperation with the Massachusetts Institute of Technology (MIT) and others, in promoting corporate venture capitals. In Japan, where corporate venturing has only a short history, the government and private sector should work together to offer more and better areas (platforms) for business resources to be matched in and between companies. Specifically, forums should be set up to promote corporate venturing, and programs should be introduced to encourage companies to employ traders of technologies, who support open innovation. Such arenas are expected to be used to encourage private-sector companies to apply in an effective way achievements of publicly-funded research programs to solve challenges they encounter in their R&D activities. 109

111 Figure 8-9 Imaginary creation of arenas for moderators and intermediaries to work Venture SMEs companies Universities Large enterprises Publicly-funded research institutions Corporate venturing WIN-WIN Forum (tentative name) Functions as a market to Venture capitals To share best practices trade technologies, products Consultants through such arenas and services. is also useful. (iv) Creation of open places for Start-ups to meet large enterprises Not a few start-ups, however, hope to talk directly with large enterprises, especially without any intermediary between them, for fear that their unique technologies or ideas might be revealed or leaked to a third party. But most of such ventures have no channel or opportunity to contact a large enterprise they have in mind. (And not a few large companies have points of contact publicly available to such ventures.) Some point out that is one of the factors that hinder corporate venturing from developing as expected. In the Kansai region, such a state of things led to the creation of Digital Concept Partners (DCP), which came into operation in As part of the Industrial Cluster Project, the open matching system works to support major companies and ventures in corporate venturing in the home information appliance sector. It has produced results, attracting entries from ventures overseas, as well as those in Japan. (As of March 2008, 180 proposals from Japanese companies, including ventures, and 60 plans from foreign companies, or 240 offers in total, were received.) To spread similar mechanisms to other sectors is necessary as part of measures to promote corporate venturing in Japan. 110

112 Figure 8-10 Digital Concept Partners To find opportunities to do business or form a partnership with large enterprises, and raise their level of abilities and awareness Companies offering a proposal SMEs and ventures in Japan and overseas (2) Filtering (1) Consult (3) The idea is polished up. DCP secretariat (In charge of domestic businesses) Kansai Institute of Information System & Industrial Renovation (KIIS) (In charge of foreign businesses) Osaka Chamber of Commerce and Industry (OCCI) Group of experts on technology, IP, market, etc. (4) Offer a proposal (5) Have an interview or business talks (When the proposal is turned down, a report is sent to explain why and give advice, etc.) Companies receiving a proposal Sanyo, Sharo, Matsushita Electric Industrial, Icom, Espec, NTT DoCoMo Kansai, Osaka Gas, Omron, Kyocera, silex, Sumitomo Electronic, Dainippon Screen MFG, Pixela, Hitachi, Funai Electronic, Murata Manufacturing To explore excellent suppliers, partners and business seeds in Japan and overseas To complement the mechanism above, regular meetings are held to release and exchange information about technologies and business plans. The meetings are attended by Risona Bank, the Kyoto Shinkin Bank, Hanwa, Japan Venture Capital Association, and other supporting companies that offer financial and marketing aid. (2) Reforms to reduce risks employees assume when leaving a large enterprise to set up a new business When engineers and other employees leave a large company to start up a new business, they assume a variety of risks. Some measures are needed to reduce such risks. On the one hand, large companies should take some voluntary actions. For example, they should offer such employees a guarantee of living, or a parallel means, for a certain period of time; they could be loaned by the large company to the start-up, or allowed to continue to work for the big enterprise. Other examples could be large enterprises effective use of in-house training programs, or introduction of a system for in-house quasi-venturing. On the other hand, more diverse career paths should be offered. For instance, graduate schools for businesspersons should be enhanced. In this respect, the national government and other institutions could give more support to graduate schools that teach businesspersons management of technology (MOT) useful to corporate venturing. (3) Reforms of systems of the national government for corporate venturing, etc. (i) Study of incentives for venture investment in R&D In this age of global innovation, we should examine, referring to cases overseas, what systems will be appropriate to Japan for investments to be made more smoothly in ventures set up for research and development, with a view to preventing the country from being avoided by those who conduct large-scale R&D with higher risks and to exploiting the mechanism of corporate venturing to use innovations and set up new businesses in Japan more quickly. 111