Japan's Stock Market Oddities Explained

Back to Contents of Issue: August 2000

Following is an interview with Mike Yoshii (myoshii@gol.com) and Kouji Ishikawa (kishikawa@whitecase.com), attorneys at the firm White & Case (Tokyo)/Kandabashi Law Offices. This interview appeared in the May 2000 issue of Japan Internet Report (www.jir.net), a monthly newsletter published by TKAI, Inc. (www.tkai.com).

Q: Why do new Japanese companies issue so few shares?
A: This is the key question, and will take some explaining. To begin with, we should expand on the problems resulting from too few shares.

First, the high per-share price means that only large institutional investors can afford the company's shares. Individuals have no opportunity to become shareholders. Most founders of venture companies are more democratic and would prefer a wider share ownership.

Second, without enough shares, liquidity is a serious problem. Without liquidity, the share price is too volatile and unreliable. The US Nasdaq requires a minimum public share float of 1,100,000 shares; currently Mothers only requires a 1,000 share float and Nasdaq Japan has announced it will require only 1,100 shares. Spread over the minimum 300 shareholders, this is only three to four shares per shareholder. Many shareholders probably own only one share, and won't sell it.

Third, high-tech companies often merge and make alliances to grow. The main currency for this is not money, it is the company's shares. Not having enough shares is an impediment to M&A.

Fourth, enough stock options cannot be issued. When a company has only 3,000 shares, as is true for some companies listed on Mothers, its stock option pool (which is limited to 10 percent of issued shares unless special permission from MITI is obtained to increase the number) is only 300 shares. This makes it very difficult to issue reasonable numbers of options to anyone other than senior executives. If the company uses a standard four-year vesting schedule, the minimum options grant is four shares (one per year). But if the company's share price is $150,000 per share, the $600,000 value and exercise price of the options granted is too much for any employee except senior executives. And four options are not very attractive to the employee. As stock options become a key factor in recruiting and retaining key employees (which our clients believe will happen in Japan, just as in the US), companies that can issue options will attract and keep the better employees.

The venture companies listing on TSE Mothers with share prices of $100,000 or higher are the victims of a par value share capital structure. The founders did not have the money to purchase enough founders' shares at par value (for example, to issue 1,000,000 par value founders' shares would cost the founders $500 million). The founders obviously want to retain a large percentage ownership of their own company. So if the founders can only purchase a few shares, the VCs or strategic investors purchase even fewer at a very high share price. By IPO, the per-share price is extremely high.

There has been a lot of discussion of these problems, which the TSE Mothers market has highlighted. Most commentators have blamed legal restrictions. In fact, the real obstacles are the lack of information and resistance to change, not legal obstacles.

Contrary to what many Japanese founders and VCs believe, it is quite possible to increase the number of founders' shares to a reasonable level. The trick is to issue no par (mugakumen) shares rather than par value (gakumen) shares. No par and par value shares are identical in terms of value, shareholder rights, etc., and numerous listed companies in Japan have issued no par shares rather than par value shares. But one major difference is that whereas par value shares cannot be issued for less than 50,000 yen per share, no par shares can be issued for any price. In fact, some of our startup clients have issued their founders' shares for as low as one yen per share.

What confuses people is that the first 200 shares of a K.K. cannot be issued for less than 50,000 yen per share, even if the company issues no par shares. This is to satisfy the minimum 10,000,000 yen paid-in capital requirement. But thereafter, founders' shares can be issued at any price. So even if the founders have only 11,000,000 yen in capital, the company can issue 1,000,000 no par founders' shares and have a stock option pool of 100,000 options. If the company issues par value shares, for the same paid-in capital the company would issue only 220 shares, and would have a stock option pool of only 22 options.

We caution that there are a number of fairly complex legal and tax issues involved in an issuance by a K.K. of 1,000,000 no par shares. In Delaware, the same number of shares could be issued in a couple hours with 2 pages of legal documentation. In Japan, the process is much more involved and the legal documentation is 100 pages. But it can be done, and done in as little as five to ten days. We have also confirmed the legality of this structure with the Ministry of Justice and with the Examination Division of TSE Mothers. A number of our Internet company clients have decided to use this capital structure, and we have registered capital increases with one to ten million no par founders' shares with the Legal Affairs Bureau.

We should also caution that this capital structure is new and market acceptance is still unknown. Although no par shares are common, the concept of issuing a large number of founders' shares for low prices is new. Some underwriters are currently hesitant because there is yet no precedent in Japan, and they have raised issues about whether their back office and marketing departments will be able to handle IPOs of companies which have millions of shares as opposed to thousands of shares. One underwriter recently told us that it is concerned that a share price of 50,000 yen (about $500) or less per share will be viewed as penny stock, and shunned by investors. Others have told us that they do not want the company to have individual shareholders holding small lots of shares, and therefore want to keep the number of shares down and the per share price high.

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