Too Many Tiny IPOs Leave Tokyo 25 Years Behind Silicon Valley

Shinichi Fuki, president and chief executive officer of Jafco.

Photographer: Akio Kon/Bloomberg

Trace the roots of most modern Japanese tech companies back far enough and there’s a good chance you’ll stumble across a little-known venture capital firm called Jafco Co.

Since its inception in 1973, Japan’s oldest and largest VC has quietly backed almost 4,000 companies, including giants like SoftBank Group Corp., Muji stores operator Ryohin Keikaku Co. and Street Fighter games producer Capcom Co. Almost a thousand of its investments have gone public and today command a market value of about $530 billion. Jafco is Japan’s version of Sequoia Capital, the legendary Silicon Valley firm that was also founded in the early 1970s and helped launch Apple Inc., Oracle Corp. and Google Inc.

But Jafco, which oversees about 430 billion yen ($4.3 billion), is now overhauling its strategy. The firm’s investments haven’t come close to the kind of global success companies in the U.S. and China have had, part of Japan’s underwhelming track record of fostering world-beating startups. Jafco Chief Executive Officer Shinichi Fuki thinks the problem is that his country’s entrepreneurs give up too quickly on their ambitions and go public too soon. He is starting to make fewer, bigger bets on startups that will stay private longer and use the time to plot global domination, like Uber Technologies Inc. and Xiaomi Corp.

“Compared to Silicon Valley, I’d say we’re about a quarter century behind,” Fuki said in an interview at his office overlooking Tokyo’s Otemachi financial district. “Startups need to aim globally from the get-go. It’s not enough to settle for an IPO of a few billion yen. We need them to aim for IPOs that are 50 or 100 billion yen.”

Shinichi Fuki, president and chief executive officer of JAFCO Co., Ltd., speaks during an interview in Tokyo, Japan, on Monday, Sept.12, 2016.

Compared to Silicon Valley, Fuki believes that Japan's startup scene is about a quarter century behind.

Photographer: Akio Kon/Bloomberg

Jafco has been both a contributor to and victim of Japan’s mediocre startup scene. The firm’s annual return since inception is about 2.6 percent, according to Bloomberg calculations based on company documents. That's slightly off the Nikkei 225 index’s 2.7 percent during the same period and is light years behind the roughly 18 percent U.S. venture funds have delivered on average over the past three decades, according to Cambridge Associates.

Fuki, who took the helm in January 2010, says it’s not for a lack of effort. Over the decades, his fund has doled out billions to thousands of companies in industries ranging from satellites to mobile gaming. The relatively poor returns, he says, are a result of an ecosystem that allows founders to cash out early before expanding globally, which ultimately lowers the reward backers get for finding young companies with bright ideas. Only 31 percent of Japan's IPOs raised more than $30 million in 2014, compared with 92 percent in the U.S. and 67 percent in Hong Kong, according to the Securities Analysts Association of Japan.

In an effort to break the cycle, Jafco has begun channeling money into fewer startups and giving them larger chunks at earlier stages. The average initial investment size in its latest fund launched in 2013 was 280 million yen, more than double the 130 million yen from its 2005 fund. Early-stage investments made up 83 percent of deals in the 2013 fund, compared with 44 percent for the 2005 fund.

The goal, Fuki says, is to encourage Japanese founders to mimic the likes of Airbnb Inc. and Spotify AB in scaling up to a global level before aiming for profitability. In the later stages, he says Jafco is ready to follow-up with even bigger checks of several billion yen to allow young companies to take their time and stay private.

One of the startups testing that thesis is Riverfield Inc., a Tokyo-based maker of robots that aid surgeons. It has raised about 800 million yen from investors including Jafco to develop more products and push into overseas markets. CEO Daisuke Haraguchi said his company will keep raising funds privately and has no plans to go public in the forseeable future, despite successfully launching its first product last year. A revenue stream is often more than enough to get approval from the Tokyo Stock Exchange to list.

"If you IPO too early when the company’s value isn’t ripe, you’re not going to receive the amount you want or achieve the value you imagine your company has,” Haraguchi said in a phone interview. He has plans to raise money again, but will likely “filter out” funds that only offer small amounts.

The relative ease of filing an IPO in Japan dates back to 2000. Swept up in the tech bubble frenzy, the TSE introduced a program that significantly lowered hurdles for small companies to go public. It succeeded in making fund-raising easier for entrepreneurs, but that often came at a cost to their global ambitions, which were pared by the overhead of running a public company and the investor pressure for quarterly profit.

Beyond just delaying IPOs, Fuki’s willingness to play the long game has galvanized startups that are years away from generating revenue. Take Astroscale Pte, a three-year old firm that wants to clear space junk while offering protection services for satellite owners. It raised $35 million this year from investors including Jafco and next year plans to launch the world’s first satellite for mapping the more than 20,000 pieces of space debris orbiting Earth.

“Shareholders aren’t just a source of money, but should be your partner and give advice through your growing pains,” CEO Nobu Okada said in a phone interview from his company’s headquarters in Singapore. “When someone gives you a bigger chunk, there’s more commitment on their side too.”

Jafco’s strategic shift echoes the worldwide trend for venture capitalists to be more patient with entrepreneurs. Low interest rates since the financial crisis have forced traditional investors to seek yield through less conventional routes, including venture investing. The abundance of capital has bought more time for young companies to seek aggressive growth over profits, resulting in the birth of global tech superstars like Uber and Airbnb.

Uber provides a sign of how far Japan has to go. The San Francisco-based company has raised more than $10 billion since its inception in 2009 to fund its expansion around the world, more than all Japanese startups combined during the same period. Despite a valuation of about $68 billion, Uber CEO Travis Kalanick has said he plans to stay private as long as possible.

Whether Jafco can foster such hits and boost its lagging performance remains to be seen. Concentrating bets increases risk and without other VCs stepping up their investments, startups may continue to seek early IPO exits instead of pursuing big dreams. Venture funding in Japan last year amounted to about $1 billion, compared to $75 billion in North America, according to the Japan Venture Capital Association and KPMG.

Still, Fuki is hopeful. While Japan found little success as U.S. software devoured the world, its historical strength in hardware manufacturing should give it a better chance in the coming era of connected devices, according to Fuki. More importantly, he says the country’s mindset has changed and entrepreneurs are now celebrated. He says more and more talented professionals are quitting corporate jobs to try their hand at being founders.

Among them is Shintaro Yamada, who in 2012 quit a comfortable position in Tokyo to found Mercari Inc., an online flea market. The company has remained private even though it hit a valuation of more than $1 billion this year and said an IPO is unlikely in the near future.

“We’re seeing ones that have real grit start to appear in greater numbers,” said Fuki. “That’s not everything, but it’s making me think very, very optimistically about things.”

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