Back to Contents of Issue: February 2002

An in-depth look at how revisions to the Commercial Code in Japan affects capitalization restrictions

by Stephen J. DeCosse and Bruce W. MacLennon


The vagaries of the Japanese Commercial Code -- a topic of perennial interest to nearly all foreign venture capitalists and entrepreneurs in Tokyo -- make for great conversation at cocktail receptions frequented by these two groups. When the investor and the entrepreneur have finished scratching their heads over valuation, two common follow-up questions are: 'How do we structure the capitalization of the company in a way that gets the investor his shares yet fulfills the needs of the founder?' and: 'How do we put in place a stock option plan that gives us sufficient flexibility to give incentives to the execs, techies, suppliers and others that we want on our team?'

As every entrepreneur who has faced these questions when negotiating a potential investment with a foreign VC knows, the Commercial Code has not always been a strong ally in the fight to get things done in a way that satisfies both the VC and the entrepreneur, but a series of Commercial Code amendments currently under way will change that significantly. This article gives a snapshot of one group of amendments: Firstly, those affecting capitalization issues, some of which came into force in October 2001, and some of which are slated to come into effect early enough in the first quarter of 2002 to permit companies to take advantage of them at their 2002 annual meetings. A second group is those affecting stock options, which are likewise slated to come into force in the first quarter of 2002 at the same time as the second group of capitalization reforms. We'll look at the second group in a future article.


Currently, the Commercial Code restricts the number of shares a company can issue in a given capital increase to four times the number of shares that the company already had outstanding. The restriction is set in the company's articles of incorporation. Moreover, until October 1, 2001, the Commercial Code also imposed a minimum limit of JPY50,000 on the price of stock issued to incorporate the company (the minimum price did not apply to post-incorporation issuances.)

Since the Commercial Code also requires that a kabushiki kaisha, or 'joint stock corporation' (the entity of choice among most entrepreneurs seeking to attract foreign capital) be capitalized at a minimum level of JPY10 million, this meant that most companies were incorporated with 200 shares at a price of JPY50,000 per share. Consequently, the number of shares the company could issue would be limited to 800 shares from the outset.

If a company wanted to capitalize at, say, 1 million shares, it would have to traverse a long, drawn-out series of issuances, each time amending the articles to increase the authorized shares (which requires a shareholders' resolution each time) until, several weeks or even months later, the process is finally done and the company has its 1 million shares issued. Needless to say, this was a risky and expensive option, but the only one available if a company wanted to issue a large number of shares at a per-share price lower than JPY50,000.

With the reforms that came into force last year and those slated for the first quarter of 2002, all that is changing. As of October, the requirement that shares issued upon the incorporation of the company have a minimum per-share price of JPY50,000 no longer exists, and the maximum limit on authorized shares is due to be scrapped early next year. The latter change will apply only to companies whose articles require board approval for a shareholder to sell or otherwise transfer shares, but the vast majority of Japanese kabushiki kaisha impose this restriction on transfers.

As a result, companies seeking to create a large pool of relatively inexpensive stock may now issue their 1 million shares upon incorporation, or at any time after incorporation, in one lot at whatever price they (and the National Tax Agency) deem appropriate given the value of the company, whether that be JPY1 per share or the old standard JPY50,000. Currently, a company is still limited to four times the outstanding when stipulating the maximum number of shares of authorized capital in its articles. If, for example, the company issues 1 million shares on incorporation, the authorized limit will be 4 million shares, perhaps enough for most emerging companies' purposes. In any event, the cap will be repealed next spring, and any problems stemming from the maximum authorized share restriction will disappear.


Until last October, companies seeking to implement a stock split were constrained by the Commercial Code requirement that each share of stock after the split have a minimum book value of JPY50,000. This meant that, for a 2-for-1 split, each pre-split share of stock had to have a book value of at least JPY100,000. This effectively put the kibosh on many an emerging company's plans to resort to a stock split in order to increase the number of outstanding shares and/or reduce the per-share value of its stock. The minimum value requirement has been abolished, making it much easier for a company to use the stock split option to achieve these objectives. Moreover, the approval process has been streamlined: The board of directors can approve the increase of the maximum number of authorized shares stipulated in the articles in connection with a stock split. Until October, the amendment of the articles to change the number of authorized shares for any reason required a two-thirds vote of the shareholders.


The old par value system whereby a company's articles could stipulate that its shares were either par value or non-par value, and if par value, state the yen amount of that value, was a bothersome gnat but did not actually restrict the issuance of stock in any real way. The problem was that companies typically would set a par value for their shares that corresponded to the minimum incorporation issuance price: JPY50,000. Shares would then be issued later at different prices depending upon the valuation of the company, sometimes higher than par value, sometimes lower.

This was not prohibited, but people automatically thought that because a company's shares had a par value of JPY50,000, then that represented the actual value of the shares, which in reality was almost never the case. The bottom line is that the old system was repealed in October because it created confusion and its relevance had been increasingly called into question. @

Stephen J. DeCosse is a partner and Bruce W. MacLennan is a senior associate at the law firm of Morrison & Foerster in Tokyo.

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