VC Outlook

Back to Contents of Issue: January 2001

Partial foreign ownership in Japan's tech startups will lead to greater disclosure, a global perspective, and more flexible, accountable management.

by Louis Ross

Louis Ross ( is managing director of Obsidian Capital Limited, a global private equity/venture capital group. Earlier he was an equity strategist with Merrill Lynch Japan, as well as a research fellow at the University of Tokyo.

TRYING TO DO DUE DILIGENCE in Japan is difficult. Disclosure of company information in this country has never been wildly popular, and determining the true value of a firm -- even a large public one -- has never been easy. Nevertheless, thoroughly researching a young company, particularly a Net startup, is a must. Just ask the unfortunate venture capitalists who sunk money into Liquid Audio Japan. Of course, no market can completely eradicate misinformation, but much can be done to keep things generally honest. The authorities are one source for promoting such honesty -- skilled VCs are another.

Within public companies in Japan, wide-scale restructuring has already led to greater adherence to corporate governance issues. Shareholders are increasingly challenging decisions by management, and the significant rise in foreign shareholdings -- nearly doubling to over 20 percent, from 8 to 9 percent as recently as 1997 -- has put more pressure on corporate Japan to change. During the same period, cross-shareholding decreased from more than 50 percent to about 35 percent, as companies restructuring their operations and cleaning their balance sheets liquidated such relationships.

The best value-add sectors in the Japanese economy -- the high-tech ones -- are the most competitive from an international standpoint and have a higher percentage of foreign share ownership. From this it can be deduced that foreign investors in the private equity arena will focus on Japan's tech startups and play an increasingly important role in shaping the corporate governance of these companies. Partial foreign ownership in these startups will lead to greater disclosure, a more global perspective, and more flexible, accountable management. As in the public realm, outside scrutiny will lead to greater efficiency and openness.

The fledgling market for new issues in Japan via the (relatively) new Nasdaq Japan and Mothers exchanges will not be kind to companies incapable of solid profitability and significant future growth potential. And they will not be kind to companies with questionable management and a resistance to opening themselves up to investor scrutiny. Japanese startups are thus well advised to focus early on accumulating a global, diversified investor base in order to increase the likelihood of post-IPO success. A policy of relative openness and generous disclosure can only enhance the reputation of the management and create increased interest once the company goes public.

Only underwriters and select private investors have the kind of access needed to accurately measure a company's potential success. During their due diligence process, the most important factor they must consider is the management team, which, in the Internet industry, is typically young and unproven. Can it be trusted? Will and has it delivered on its promises?

Early-stage VCs generally exert the most influence over a startup, and thus are usually in the best position to answer such questions. They can influence the direction of the young company, help make crucial business decisions, facilitate key introductions, and lead the way to the promised land of the public markets. It is in the startup's own interest to be as forthcoming with these investors as possible.

Japan's public corporations are buying in to the idea of full disclosure -- it's time for startups to follow suit. Public companies, no longer able to depend on traditional bank relationships and cozy cross-shareholding, are placing a greater importance on investor relations, corporate governance, and openness. Japan's private companies should realize that it serves their own interest to condition themselves in the same manner, so that when the time comes to go public they'll be an attractive investment opportunity for the after market.

But they should start the process from the beginning, when they're dealing with those early-stage VCs.

The truth will emerge eventually.

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