Where are all the entrepreneurs?

By Terrie Lloyd

A recent article in Forbes magazine, titled “Searching For Entrepreneurship in Japan” (http://tinyurl.com/nrzgma), posits that Japan is way behind the U.S. in entrepreneurship and needs to do something about improving the environment for breeding new companies so as to reinvigorate its economy. The article focuses on the paucity of venture capital invested into Japanese start-ups, which Forbes says amounts to just $3 billion a year
distributed to 3,000 companies. In comparison, it says that VCs in the U.S. invest an average of $30 billion a year into about 4,000 companies.

The article further goes on to say that Japanese VCs typically earn an Internal Rate of Return (IRR) of just 4%, compared to 17% or more by U.S. VCs, thus indicating that not only the amount of money but also the quality of companies being invested in is also weak. In other words, Japanese VC and entrepreneurship are messed up.

The Forbes article seems to have been based on the Stanford Project for Japanese Entrepreneurship (http://fsi.stanford.edu/research/staje), which is an effort by a number of Stanford and Todai academics to understand just what is going on with entrepreneurship in Japan and why there isn’t more VC money and more commercial successes coming out of Japan.

Check out the site. There is a very good PowerPoint presentation by Robert Eberhart, which spells out some possible reasons for the variance in Japanese-U.S. numbers. Forbes, on the other hand, chooses to quote a Hitotsubashi professor who reckons that Japanese start-ups are scared to launch in to the global environment, and thus wind up cannibalizing each other in the Japanese domestic markets. It is surprising that Forbes didn’t try to dig a bit deeper, because there is a story worth telling here.

I think it is true that:

a) There is a dearth of VC money available in Japan.
b) There is a dearth of entrepreneurs.
c) There is a dearth of start-ups with global capabilities.

Recent financials for two of the biggest VCs show a sorry picture for venture capital in Japan. The largest fund, with 3,000 investee companies as of 2006, is JAFCO. The company in FY2008 posted a net loss of 16.9 billion yen, while the largest listed VC, JAIC, has started negotiating for delayed creditor payments after posting a loss of a massive 34.8 billion yen. That’s a lot for a VC to lose in just one year.

Both companies are saying that the main reason for their travails is the terrible state of the stock markets for IPOs. There were only 49 listings in 2008, less than half that of 2007, and less than a quarter of the peak several years ago. But while they are quick to blame the markets, what other factors are at work here? Are VCs losing money because the quality of the companies they’re investing in are low, or are the quality ideas getting killed at birth because of a lack of funding?

I believe some of the major contributing factors are:

Failure to Get Past the Start Line

1. There is no doubt that there is a general lack of interest by most would-be entrepreneurs to take a risk, due to lack of role models and their brainwashing by older generations of the importance of a regular salary. Luckily, the silver lining of the recession clouds of the 1990s and now is that more and more people are being forced to realize that the system is broken, and to survive/grow they need to take charge of their own futures. Just look at the ongoing expansion in Rakuten online stores, up 4,000 last year to 27,000 retailers, to get a feel for this. An online store may not seem like an act of entrepreneurship, but for many younger Japanese and for housewives, it is a radical departure from the past. They are risking real money, the comfort of anonymity, and their recreation time to run these stores.

2. Lack of education about how to run a business. Japan still has a very low academic focus on setting up and running companies. At the kids’ level, you will seldom find schools encouraging kids to try starting their own businesses as a class project—it’s just not part of curriculum nor the Ministry of Education’s value system. This is understandable, given that the ministry comes across as one of the last bastions of socialism in this country. Later, after students graduate and start working, there is very little adult education to help people jump out on their own.

The good news, however, is that this is changing, as MBA schools become more popular. MBAs are ostensibly for the development of managerial skills, but inevitably these courses expose curious minds to alternative means of doing business, including entrepreneurship and NPOs. Some of the schools on the leading edge of promoting entrepreneurship include Globis, Keio, and Hitotsubashi. We wonder then, why Stanford felt it had to choose Todai in their entrepreneurship project?

Operational Hurdles

1. Then there is the bias of the financial system in not wanting to support risk takers. Now, it’s probably only natural that banks anywhere don’t want to risk their capital on start-ups, but the problem is that there is no real alternative to the banks. What VCs are active in the market nowadays tend to invest after a company has gone through the tough steps of developing a product and is already starting to record sales—in order to reduce their investment risk. To get a product up and running on in-house funding is tough and it is no wonder then, that Japanese companies are defined by Eberhart as being too founder-centric—you need to be mentally tough to make it past the start-up stage here.

2. The paucity of early-stage investment from VCs is a real problem for start-ups in the technology space in particular, since in order to create world-class products, they generally need to invest in processes and core research. Given that small companies employ most of the workers in Japan, supporting these start-ups would seem vital to the interests of the nation. I find it strange that the government doesn’t do more to kick-start their establishment. Tax preferences on angel and VC investing, special R&D funds for SMEs, and setting up a fund-of-funds to co-invest with established VCs would both be natural moves.

Indeed, in other first-world countries, government are establishing funding organizations that co-invest with private VC funds. These initiatives can be very effective and importantly for Japan send out the message that risk-taking is officially sanctioned.

3. Japanese VCs also need to change their investment and operational strategies, by putting larger amounts of cash to work in each company they jump in to, and by helping to educate the company’s management to grow in skills and vision. In so doing, they will provide both the necessary resources and also a means of overcoming the negative attitudes and fears bred by the current education system.

Some VCs are doing this already, such as Tsunami Network Partners (TNP) in Kanagawa and Sunbridge in Ebisu, but these types of firms are few and far between. More often the VCs choose to reduce risk by scattering their investments alongside other similarly minded funds, then proceed to ignore their investees post-investment.

The Forbes article does, however, miss an important source of funding for Japanese startups, as well as for foreign firms who are setting up in Japan—investment by strategic investors. While I don’t have any figures, I would guess that there are at least 1,000+ strategic investments in start-ups done by Japanese major corporations every year. The average amount is typically between 50 million yen and 100 million yen, and is made for 5-10 years. Forbes states that Japanese VCs have an IRR of just 4%, but if you’re a strategic investor, perhaps you may not want any end-game IRR on your investment at all! Instead, what you’re interested in is cash flow.

Thus, even if an investment appears to be highly valued, so long as the price being paid results in direct income and profit (by virtue of being an agent, distributor, OEM, or something similar) flowing at a rate 5%-10% higher than the cost of the money for the investment, then it makes financial sense. I suspect that if Stanford was to investigate the volume and value of strategic investments, the reason for the apparent lack of VC returns in Japan would be resolved. As a case in point, Softbank made much more money out of its implementation of the VoIP technology of UTStarcom than it did out of the gain in shares of that company—although it did well there as well. Thanks to UTStarcom’s technology, Softbank’s Yahoo BB business boomed and created a multi-billion dollar revenue channel for the group.

Lastly, what about the fact that Japanese start-ups don’t seem to be able to connect to buyers in the global markets? We think 90% of this equation is a simple lack of English-language confidence, coupled with the historic domination of profitable export business segments by the major trading companies. SMEs definitely need help to reach out to the global markets, and we’ve often wondered why JETRO, which was originally set up to promote the exports of some of the world’s now most famous brands, hasn’t been repurposed to help SMEs start their export push?

Maybe it is coming, but in the meantime, if a small company with world-class technology or products gets a call from a potential foreign customer, they do in fact get scared and hide under a shell. Usually they will either take ages to come back with a quote, or they go find an aged (retired) consultant to help them with English and export issues. As a result, the potential customer reads the lack of immediate response as lack of interest, and they go elsewhere.

Terrie Lloyd writes a weekly newsletter for entrepreneurs and business people about business and political opportunities in Japan.

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Latest 15 of 16 Total Comments Show All

nurse13 at 08:58 AM JST - 11th June

Stanley50, that's funny. Interesting article indeed.
SebastianFlyte at 10:27 AM JST - 11th June

If this really mattered then US companies would dominate, yet when we look at the real winners we mostly see Japanese companies.
jonnyboy at 11:54 AM JST - 11th June

If this really mattered then US companies would dominate, yet when we look at the real winners we mostly see Japanese companies.

american companies suffer due to the individual greed within the system. look at the automakers. japanese companies might lack flair but at least they pull in the same direction
sydenham at 12:04 PM JST - 11th June

It's not that Japanese companies do badly overall, the big ones at least, it's that there is so much potential for the entrepreneurial secto that is wasted through lack of support and lack of confidence. Imagine if they were equal to their American counterparts in the global arena in both of these respects. It's kind of a scary thought.
DJJapan at 01:10 PM JST - 11th June

Sydenham: Which means that if we as foreigners offered them that gateway of opportunity then they really do have a chance. The only problem that they have depending on the type of product that they have can sometimes be the reverse scenario of having to deal withthe legal process and hurdles of getting their product into a country. Being a Shochuu lover I had the idea of trying to get Shochuu into the U.S. The bigger manufacturers already do this but the smallers ones and usually better ones aren't willing to go the further step because of what is involved and therefore keep it domestic as it may in the long run limit their expansion, but in return keep it simple. Shouchuu comes under the distilled spirits law in the U.S so for each type of product that is introduced in has to go to a government approved laboratory, then a law firm and the bottle size is also decided. From my discussions with the manufacturers they could be flexible with the bottle size, but it was all the other details that boggled them and since it is in another language plus the fact that they already have a limited production they easily give up and can't create the real potential market that is there. In the case of Sake this isn't the case because it is considered a wine and therefore doesn't have the same amount of hurdles to go through. I have dealt with JETRO myself and from my perspective they are 1) Only there to maybe look at the big Japanese companies and 2) Are about as helpful as tits on a bull.

> Lastly, what about the fact that Japanese start-ups don’t seem to be able to connect to buyers in the global markets? > If they were to show some sort of decent presenation and exitement about what they are doing or what they have done then perhaps they would. I called another company about another really potential opportunity for their product. They had just started out and I told them that I would like to have the chance to promote it overseas. It was probably a 2 person operation and I did speak in fluent Japanese as well as discussed with the secretary and she said that she would pass on the details to the company owner and get back to me. I called 3 or 4 times. Now you would think that perhaps at a thought of expansion he would have called me back straight away. This didn't occur and yet they now have their homepage written in English as well as Japanese. For what purpose? Because I called and thought that they may get more overseas inquiries? They plant their seeds for the products that they have but they don't plan their business which is based on mostly passion or handed down from their parents to go a further step than what they are doing for fixed customers, but can't easily make the transformation from local to worldwide because of the wall that is in front of them. This of course is not only limited to Japan, but so many bankruptcies could be avoided if they just gave themselves a further scope of opportunity. The company that I work for manufactures a product that when it started that product it was for internal use. One day an American came along and said he would like to be able to buy and sell that product in the U.S. They agreed. Now that product is the largest manufacturer in the world for it. They gradually expanded over time and it is in it's own right a success. This occured in the 1970's when there was no such thing as internet and the main international communication technology then was Telex machines. We have the internet and less barriers for communications, but the cultural, language and general mindset has maybe only given reason to put up more walls perhaps?
hakujinsensei at 03:04 PM JST - 11th June

I think it is a matter of perception. In Japan things are integrated vertically so the concept of entrepreneurship is just perceived different. there is plenty of e-ship going on here it is just done so thru relationship and under the umbrella of a large company. this is something that is not bound to change for quite a while so if you are looking for a new business model, be prepared for a long wait... you would be better off trying to create a market for nattou and spoiling the beans locally in the country of your choice ; )
OneForAll at 03:58 PM JST - 11th June

Have you seen the foreclosure data in the USA? If this is entrepreneurs in action, I wouldn't follow.
sydenham at 07:13 PM JST - 11th June

There's been this idea around for a long time that investing in stocks is too risky, too. It's definitely a different perception.

In reality, though, entrepreneurship has always been a small scale thing. Mom and Pop shops abound, including restaurants, hairdressers etc, to a far greater extent than they do in the west. I just think there's less of the Anglo-Saxon expansionist mentality too. maybe that idea of keeping social cohesion plays part of it.

i dunno.
WMD at 08:27 PM JST - 11th June

Great article as always Terrie. When are you bringing out a book of all your many articles?
GW at 08:54 PM JST - 11th June

DJJapan

great post & very accurate, as a fellow shochu fan I agree its a shame the smaller producers cant/dont seem interested in over seas markets, I think good shochu wud do well, great tastes, lots of ways to enjoy, various levels of alchohol...........
M51T at 06:17 AM JST - 12th June

A friend went to Japan to buy a technology patent, but spent the whole week being wined and dined and hostessed without any real business being negotiated. Frustrated, he's nearly secured a Chinese deal over the internet.
GW at 08:54 AM JST - 12th June

m51t

unfortunately a lot of the wining/dining here isnt designed to be a good host as much as its to take time away from as you say getting down to the business at hand. When I first landed on these isles I worked in an office where overseas visitors were a common sight, every night they were out & golf was always on & next thing you know they were saying good by & you cud tell they were a little dazed & confused & nothing much ever happened.

But the goal for the J-company was 100% success as they didnt want any chgs to the way the biz was going, that same company is now about 1/3 maybe a 1/4 of the size it was in the early 90s, as time past more & more deals werent renewed, many decided to establish their own offices so in the end its slowly backfired, learned a lot at that place but it was good that I left as there is no future what so ever there now, maybe a few more years before they will close up I predict
ephesus at 04:48 PM JST - 12th June

This is probably the best article i've ever read on japantoday. And I was just coming to check if there was an article about the two Japanese smuggling 1.35 billion USD in Italy. A pleasant surprise.
teleprompter at 05:22 PM JST - 12th June

"...Japan is way behind the U.S. in entrepreneurship and needs to do something about improving the environment for breeding new companies so as to reinvigorate its economy."

Japan Inc. is lucky, relatively speaking, that we in America have such an anti-capitalist president and Congress.
taikan at 05:57 AM JST - 13th June

Americans tend to patronize large chain stores and service businesses than the Japanese do. Although the people who started those large chains were entrepreneurs, the people who manage those stores today are not. On the other hand, Japan is full of small, neighborhood stores and service businesses, each of which is owned by an entrepreneur. The fact that many Japanese entrepreneurs appear to be content to make a living, rather than intent on creating a bigger business and getting rich, may be due to cultural differences.

Cultural differences may also make it more difficult for entrepreneurs in Japan to start businesses that are designed to be national or global in scale. Silicon Valley has many people who started multiple businesses that received VC funding and that failed. Some of them nevertheless were able to get VC funding to start yet another business, perhaps one that succeeded on a long-term basis. Is it likely that an entrepreneur whose first business (or two) failed would be able to attract capital from a Japanese venture capitalist, especially if the business(es) that failed had been funded by a venture capitalist?