Startups, Venture Capital, and the state of Corporate Law in Japan
Mr. Naoki Shimazaki, Partner, Morrison & Foerster LLP

Financing for a company, whether it is done in Japan or the US, publicly or privately, in debt or equity form, almost always involves the services of an attorney. Corporate and securities law is a living entity that can change each year depending on the activity in the legislature making an attorney’s consul indispensable. In a sense, lawyers make venture capital happen: not just by facilitating the actual transaction with the necessary legal documentation but by advising clients on how to navigate the vagaries of the law to arrive at the most appropriate form of financing. For foreigners trying to understand the legal framework for venture capital in Japan, the task is further complicated by the nuances of Japanese corporate culture and attitudes. A true understanding of Japanese corporate and securities law can only be had by an insider- someone who like, Mr. Naoki Shimazaki, has spent time in Japan working with Japanese corporate attorneys and clients. For close to 8 years, Mr. Shimazaki, an American, worked in Japan where he was licensed as a Foreign Legal Consultant (Gaikokuho Jimu Bengoshi) and became the first foreign lawyer to take an executive position in the Japan Federation Bar Association (Nichibenren). Mr. Shimazaki recently gave a presentation entitled “Recent Developments in Venture Capital Funding in Japan” at the Keizai Society where he discussed the latest legal developments with respect to startups and venture capital. This month’s Bridge Builder features key highlights from Mr. Shimazaki’s presentation.

Mr. Shimazaki’s discussion concentrated on explaining the previous state of startup-related legislation and how new reforms have changed the legal environment. First, he discussed stock options-which prior to 1997, did not even exist. “Warrants” could be issued but only if they were initially attached to another security such as a bond. These warrants, says Mr. Shimazaki, could be later detached from the security and repurchased by the issuing company for use in incentive programs. But this approach was difficult, complex and expensive, causing the business public to clamor for something else. The result was a 1997 revision of the law allowing Japanese companies to issue a limited form of stock options. But this proved unsatisfactory as well: the options could only be given to employees (not consultants), were limited to 10% of outstanding shares, and each required specific shareholder approval for each grant (instead of approval of a “pool” of options, as in the US). However, in 2002 the law was finally changed to remove these restrictions leading Japan to a stock option framework that is now close to provisions common to US startups.

Mr. Shimazaki then tackled the issue of preferred stock, important to VCs in the US because of the liquidation preferences and voting rights it affords. In Japan, however, preferred stock is a rarely used security due to its inflexibility; instead, Japanese VCs mostly use convertible bonds and common stock with similar provisions attached. Japanese VCs, according to Mr. Shimazaki, traditionally invest small sums in a large number of companies and are not as heavily involved in management. Thus the VCs in Japan have less of a need (or interest) for the higher level of voting rights and other rights afforded by preferred stock in the US. In 2003 however, the law changed to allow Japanese preferred stock to have many of the voting rights seen with US company preferred stock. Mr. Shimazaki commented that while it is still rare to see preferred stock in Japan, the new law could change the traditional reliance on alternatives.

Finally, Mr. Shimazaki focused on the “the one-yen company” provisions, popular with the Japanese media because of its symbol as a dramatic shift in the ease of corporate formation. Formation of a corporation in Japan used to be a cumbersome and expensive process. An incorporator had to have at least 10 million yen ($90,000) in capital upfront and he could only use in-kind contributions (for a business plan or patent for example) under the guidance of a court appointed appraiser. Initial shares had to have a minimum price of 50,000 yen, which meant that a company only had 200 shares to start (making it very difficult to allocate shares). But thanks to reforms taking place between 2001 and 2003, forming a company in Japan has gotten dramatically easier. You still need the 10 million yen minimum capital but it can be paid over a 5-year period now, with only 1 yen required at startup. In-kind contribution rules have also been relaxed (the appraiser need not be court appointed) and also gone is the minimum issue price.

Mr. Shimazaki concluded his presentation by emphasizing that even though Japan has changed its venture capital framework to more of a “US-style”, it’s still too early to tell whether the changes will have the intended impact. The downturn in the Japanese IT industry combined with the lack of entrepreneurs in Japan willing to go down the startup path could mean it will be some time before results appear. As the proverb Mr. Shimazaki so aptly referred to says “you can lead a horse to water, but you cannot make him drink.”

For more information on the Keizai Society, please visit them on the web at www.keizai.org . Mr. Naoki Shimazaki, who is located in the Palo Alto office of Morrison & Foerster LLP can be reached via e-mail at nshimazaki@mofo.com.

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