First “Council of Experts on Venture Capital” meeting held

On April 30, 2024, the first “Council of Experts on Venture Capital” meeting was held, co-hosted by the Financial Services Agency and the Ministry of Economy, Trade and Industry.

Background

In the “Plan for Realizing an Asset Management Nation” (December 13, 2023, New Capitalism Realization Council), it was stated that “In order to promote venture capital investment, an environment will be developed by formulating principles for venture capitalists.”

Additionally, in the “Report of the Financial System Council’s Working Group on Market Systems — Task Force on Asset Management” (December 12, 2023), it was deemed appropriate to establish principles that indicate the fundamental approach required for the operation of venture capital firms (VCs) that aim to procure funds from institutional investors both domestically and internationally, based on global practices, in order to enhance the attractiveness of VCs as an asset class that contributes to long-term asset management and support the development of the VC industry.

For this reason, the “Council of Experts on Venture Capital” will be held with the aim of obtaining recommendations on matters that should be included in the principles for venture capitalists, while leveraging the knowledge of private experts.

Structure

1. The members of the Council of Experts shall be as follows:
   Masashi Kataoka, Head of Alternative Investment Department, Dai-ichi Life Insurance Company
   Maiko Katadae, CEO, CORE Partners LLC
   Reijiro Samura, Representative Director, A.I. Capital
   Mitsue Tanaka, Partner, Mori Hamada & Matsumoto
   Ryo Tamaki, Standing Audit and Supervisory Committee Member, SmartHR
   Takako Fujimoto, Partner, Deloitte Touche Tohmatsu
   Toru Masuda, Executive Officer, Sumitomo Mitsui Trust Bank
   Yusuke Murata, Representative Partner, Incubate Fund
   Yoshio Yamaguchi Head of Corporate Investment Division II, Development Bank of Japan
   Dai Watanabe Managing Partner, Delight Ventures
2. The chairperson of the Council of Experts shall be Professor Hiroto Koda of the Kyoto University Graduate School of Management.
3. The chairperson may request the attendance of relevant parties as necessary.
4. In principle, the Council of Experts shall be open to the public.
5. It shall be co-hosted by the Financial Services Agency and the Ministry of Economy, Trade and Industry. The secretariat work will be carried out by the Financial Services Agency.
6. The observers of the Council of Experts shall be as follows:
   Trust Companies Association
   Startup Ecosystem Association
   Life Insurance Association
   Japanese Bankers Association
   Japan Association of Corporate Directors
   Japan Exchange Group
   Japan Venture Capital Association
   Fintech Association

Operational Guidelines

• Article 1: The procedures for proceedings and other operations of the Expert Panel on Venture Capital shall be governed by the provisions of these Operational Guidelines.
• Article 2: The Expert Panel shall be convened by the chairperson. The chairperson may convene the meeting using information and communication equipment if deemed necessary. The chairperson shall promptly publicize the date and time of the Expert Panel meeting through appropriate means as determined by the chairperson.
• Article 3: The chairperson shall serve as the chair of the Expert Panel and preside over the proceedings.
• Article 4: The chairperson may request the attendance of scholars, experts, personnel from relevant administrative agencies, and other appropriate individuals, and hear their opinions as necessary.
• Article 5: The Expert Panel meetings shall be open to the public. In addition to the provision of the preceding paragraph, the chairperson shall determine necessary matters regarding public access.
• Article 6: The minutes of the Expert Panel meetings shall be prepared and published for each meeting.
• Article 7: The materials of the Expert Panel meetings shall be published. However, the chairperson may decide not to publish all or part of the materials.
• Article 8: In addition to the provisions of these Operational Guidelines, the chairperson shall determine necessary matters concerning the Expert Panel.

Explanation from the Secretariat

The Financial Services Agency (FSA) provided introductory comments for the first meeting of the Council of Experts on Venture Capital held on April 30, 2024. The main topics covered in the document are summarized as follows:

Background and History

The document outlines the background and history of discussions on promoting the asset management industry in Japan, including the recommendations made by the Working Group on Market Systems and the Task Force on Asset Management under the Financial System Council in December 2023. These recommendations aim to realize a “virtuous cycle of growth and distribution” by enhancing asset management companies, facilitating the supply of growth capital to companies, and delivering returns to households through the investment chain.

Environment Surrounding Venture Capital

The document provides an overview of the current environment surrounding venture capital (VC) firms in Japan, including:

1. Funding sources for startups: The document highlights the increasing trend in funding raised by domestic startups, with the amount approaching 1 trillion yen in 2022. VC firms play a significant role in funding domestic startups, accounting for 37% of the total investment amount.
2. Composition of VC funds: While the majority of VC funds in Japan are relatively small (less than 10 billion yen), a significant portion (36.4%) of VC funds in the US exceed $100 million in size.
3. Investors in VC funds: The document compares the composition of investors in VC funds between Japan and the US. In Japan, corporations and banks account for about half of the investors, while in the US, pension funds, foundations, endowments, and insurance companies make up approximately 60% of the investors.

ILPA Private Equity Principles and Related Matters

The document introduces the ILPA (Institutional Limited Partners Association) Private Equity Principles, which are best practices for non-listed equity investments. The Principles cover areas such as transparency, governance, and alignment of interests between general partners (GPs) and limited partners (LPs).

Additionally, the document outlines the ILPA Reporting Template Guidance, which aims to standardize reporting practices in the private equity industry and facilitate the provision of necessary information to LPs.

The document also refers to a proposal made by the Startup Committee of the Japan Corporate Governance Network on April 25, 2023, titled “Recommendations for Enhancing the Venture Ecosystem in Japan.” This proposal addresses topics such as corporate governance for startups aiming for global markets (“G-type startups”), the expected role of investors in supporting these startups, and the necessary governance practices for domestic VC firms to attract global investors.

Overall, the document provides background information and discusses various aspects related to the development of the venture capital industry in Japan, with a focus on improving governance, transparency, and attracting institutional investors to support the growth of startups.

Explanation from the Ministry of Economy, Trade and Industry

The document discusses the efforts by the Japanese government to promote the supply of risk money (venture capital) to startups. Here are the key points:

1. Startups play a crucial role as drivers of economic growth, job creation, and solving social challenges. However, Japan lags behind other countries like the United States and Europe in terms of venture capital investment in domestic startups.
2. There is a lack of funding supply for startups in later stages, hindering the creation and growth of mega-startups that can compete globally. Attracting large institutional investors and foreign investors is essential, but few domestic general partner firms (GPs) can receive funds from domestic and foreign institutional investors.
3. To address this, the government is working to promote investment from domestic and foreign institutional investors through initiatives such as:
   — LP (limited partner) investments through the Innovation Network Corporation of Japan (INCJ) and the Organization for Small & Medium Enterprises and Regional Innovation.
   — Promoting fair value evaluation of investments, as mandated by the LPS (Limited Partnership for Investment) Accounting Rules.
   — Developing guidelines and model contracts for venture investment agreements to ensure appropriate practices.
4. In March 2018, the government, in collaboration with the Japan Venture Capital Association and Mizuho Information & Research Institute, formulated the “Main Points to Consider for Sound Venture Investment Agreements in Japan” to promote appropriate venture investment.
5. In March 2022, the Fair Trade Commission and the Ministry of Economy, Trade and Industry jointly developed the “Guidelines for Business Collaboration and Investment in Startups” and revised the “Main Points to Consider for Sound Venture Investment Agreements in Japan.”
6. From February 2024, the government plans to hold a study group on “Improving the Environment for Expanding Foreign Investment in Japanese Startups.”
7. The Ministry of Economy, Trade and Industry has published the “Model Limited Partnership Agreement for Investment” and its explanatory notes to facilitate the formation of investment limited partnerships (LPS) and streamline contract negotiations.
8. The document provides an overview of the contents of the “Model Limited Partnership Agreement for Investment,” which covers various aspects such as contributions, management of partnership business, accounting, investment policies, and distribution of profits.
9. The document includes statistics on the types of funds (venture, buyout, turnaround, etc.) managed by qualified institutional investor business operators under the Financial Instruments and Exchange Act.

In summary, the document outlines the Japanese government’s efforts to create a favorable environment for venture capital investment in domestic startups by promoting fair valuation practices, developing guidelines and model contracts, and encouraging investment from institutional and foreign investors through various initiatives.

Explanation from the Japan Venture Capital Association

The JVCA is a general incorporated association established in 2002 with its office in Tokyo. It lists its board members, including the chairpersons, vice-chairpersons, executive directors, directors, and advisors from various venture capital firms and corporations.

The association has seen steady growth in membership, with 374 member companies as of April 2024, including 160 venture capital firms, 123 corporate venture capital firms, and 91 supporting members.

The JVCA’s activity policy for 2023–2024 is centered around three main goals:

1. Expanding investment funds: Providing necessary information and data to domestic and foreign institutional investors while significantly expanding the procurement and supply of investment funds to startups.
2. Promoting the circulation of funds: Diversifying funding sources for startups and exit options for investors, as well as supporting corporate venture capital activities and startup M&A to facilitate the circulation of funds for new industry creation.
3. Enhancing the startup ecosystem: Contributing to the realization of a diverse and sustainable startup ecosystem by engaging in long-term policy initiatives in collaboration with the public and private sectors and making the results of their activities visible.

The JVCA aims to have the combined market capitalization of listed and unlisted startups reach 100 trillion yen by 2027.

The association has various committees and subcommittees focused on different aspects, such as VC knowledge development, media communication, collaboration with corporations, global networking, regional startup ecosystem activation, LP relations, policy advocacy, university collaborations, compliance, and diversity, equity, and inclusion.

The presentation highlights the JVCA’s efforts to facilitate the flow of investment funds from institutional investors to domestic VC funds, including:

1. Promoting fair value evaluation of VC funds through industry-wide initiatives, including publishing practical guidelines and holding educational seminars.
2. Continuously implementing and publishing a domestic VC performance benchmark in collaboration with Preqin, covering fund performance data from 54 member firms.
3. Developing a due diligence Q&A (DDQ) and quarterly reporting (QR) template to address the information needs of institutional investors when conducting due diligence on domestic VC funds.
4. Producing a compliance handbook and providing examples of limited partnership agreements (LPAs) in collaboration with law firms and audit firms.
5. Promoting Japanese VC asset class and startup ecosystem to overseas institutional investors through participation in international conferences, media outreach, and direct meetings in Singapore, London, and planned visits to the United States.

The presentation also includes a section expressing the JVCA’s expectations and recommendations regarding the proposed “VC Principles” being discussed by the Financial Services Agency’s Working Group on Asset Management. The JVCA argues that the VC industry’s practices should be shaped by private professionals based on the agreed-upon LPAs between limited partners (LPs) and general partners (GPs), rather than being regulated by government-imposed principles that could hinder the diverse and healthy development of LPs, GPs, and the startup ecosystem.

The document concludes with an appendix listing the JVCA’s member companies, including venture capital firms, corporate venture capital firms, and supporting members from various industries and professional service providers.

Explanation from the Japan Investment Corporation

This document is a presentation by the Japan Investment Corporation (JIC) titled “Challenges for Domestic Venture Capital Firms — Toward Accepting Funds from Domestic and Overseas Institutional Investors.” It discusses the current state of the domestic startup (SU) and venture capital (VC) ecosystem in Japan, and the challenges faced by domestic VCs in attracting funds from institutional investors, both domestic and overseas.

The presentation highlights the following key points:

1. Current State of Funding for Domestic Startups and Venture Capital:
   - Institutional investors, both domestic and overseas, are not investing significantly in domestic startups and VCs.
   - Domestic VCs receive limited funding from domestic institutional investors such as pension funds and insurance companies.
   - In contrast, the European market has seen an increase in funding from overseas investors as the startup ecosystem matures and generates attractive returns.
2. Challenges for Domestic VCs in Attracting Institutional Investors:
   - Domestic VCs lack the track record, operational structure, and governance standards required to attract institutional investors.
   - Only a few domestic VCs (around 20 as of 2024) have successfully attracted funds from domestic and overseas institutional investors.
3. Key Factors for Attracting Institutional Investors:
   - Returns: Institutional investors seek VCs with the potential to generate top-quartile global returns (net 3x or higher).
   - Qualitative GP (General Partner/VC firm) Evaluation Criteria:
   — Attractive and sustainable strategy
   — Strong and dedicated investment team
   — Conflict-of-interest management
   — Alignment of interests between GP and LPs (Limited Partners/Investors)
   — Global-standard fund agreements
   — Transparency and accountability to LPs
   — Integrity and ethical conduct
4. JIC’s Role and Approach:
   - JIC aims to expand the pool of domestic VCs capable of attracting institutional investor funds.
   - JIC conducts due diligence on potential VC investments, focusing on factors such as conflict-of-interest management, team alignment, fund governance, and fund agreements.
   - JIC engages with VC firms before and after investment, providing guidance and feedback to help them meet institutional investor standards.

The presentation also includes examples of JIC’s negotiations with VC firms before investing, such as restructuring ownership and compensation structures, ensuring dedicated investment teams, and improving fund agreements and governance.

Additionally, the document provides insights into JIC’s post-investment engagement with VC firms, including providing feedback on reporting, communication with LPs, middle-office functions, and best practices.

The presentation concludes by emphasizing the importance of developing a pool of domestic VCs capable of attracting institutional investor funds, which can contribute to the growth and development of the domestic startup ecosystem, drawing parallels with the European market’s evolution.

Overall, the document highlights the challenges faced by domestic VCs in Japan and JIC’s efforts to bridge the gap between these VCs and institutional investors, with the aim of fostering a more robust and sustainable startup and venture capital ecosystem in the country.

Explanation from the Secretariat on the Principles

This document outlines key considerations for developing principles for venture capital funds (VCs) in Japan that aim to attract institutional investors’ funds from both domestic and international sources. The primary objectives are to promote the establishment of trustee responsibilities and fund management practices among VCs aligned with international standards, enhance the appeal of VCs as a long-term investment asset class, and support the growth of the VC industry.

The document is structured into two main sections: I. Basic Concept of the Principles, and II. Proposed Points to be Included in the Principles.

I. Basic Concept of the Principles:

1. Purpose: The principles aim to encourage VCs seeking funds from institutional investors to establish investment evaluation practices and trustee responsibilities based on international standards, ultimately enhancing the attractiveness of VCs as a long-term asset class and promoting the VC industry’s development.
2. Scope: The principles are intended for VCs of a certain scale seeking to raise funds broadly from domestic and international institutional investors. Specific exceptions or considerations are proposed for corporate venture capital (CVC), early-stage VCs, and financial institution or university-affiliated VCs, recognizing their unique characteristics and development stages.
3. Position: The principles are envisioned as a best practices guide for VCs seeking institutional funds, rather than a set of mandatory rules. VCs may deviate from the principles if they provide reasonable justifications and future prospects to their limited partners (LPs). The principles are intended to facilitate dialogue and mutual understanding between VCs (general partners, GPs) and LPs, without being subject to government monitoring or compliance enforcement.

II. Proposed Points to be Included in the Principles:

1. Trustee Responsibilities: VCs should recognize their trustee responsibilities to LPs and aim to maximize LPs’ equity value through maximizing the value of their portfolio companies. Establishing an LP Advisory Committee (LPAC) to facilitate communication between GPs and LPs is recommended.
2. Sustainable Management Structure: VCs should ensure key personnel are dedicated to fund management and establish a sustainable organizational structure with multiple investment professionals to ensure continuity.
3. Transparency in LP Rights: Any individual rights granted to specific LPs should be transparent to all LPs, and LPs should be able to demand rights granted to LPs with equal or smaller commitments.
4. Conflict of Interest Management: VCs should identify and manage potential conflicts of interest, particularly in cases of dual roles, multiple fund management, or advisory services to portfolio companies. Clear policies and LPAC oversight are recommended.
5. Compliance Management: VCs should establish compliance roles, policies, and procedures to ensure adherence to regulations and fund agreements, including insider information handling and anti-money laundering measures.
6. GP Commitment: VCs should make appropriate financial commitments to their funds to align interests with LPs, following practices of buyout funds and global VCs.
7. Profit Distribution Structure: VCs should prioritize maximizing returns on LPs’ committed capital over individual investment multiples and consider global standards such as those outlined in the ILPA Private Equity Principles for profit distribution, carried interest, and management fees.
8. Fair Value Evaluation: VCs should conduct fair value evaluations of their non-listed portfolio holdings and provide information on the evaluation methodologies to LPs.
9. Information Frequency and Content: VCs should provide quarterly financial reports and annual reports detailing the implementation of investment strategies and future plans to LPs.
10. Investment in Startups: VCs should structure investment contracts with startups in a manner that facilitates future funding rounds, business expansion, and incentivizes entrepreneurial drive, while considering the startup’s governance level.
11. Supporting Portfolio Companies: VCs should provide value-added support to portfolio companies through constructive dialogue, human resource introductions, business matching, know-how sharing, coaching, and M&A support. Directors appointed by VCs should act in the best interests of all shareholders.
12. Capital Policy Support: VCs should cooperate in subsequent funding rounds for portfolio companies, consider follow-on investments or contract modifications, and remain flexible regarding fund extensions to support the companies’ growth and maximize LP returns.
13. Post-IPO Approach: After a portfolio company’s IPO, VCs should carefully consider the timing and methods for divesting their holdings to maximize value. Alternatively, VCs may consider retaining stakes to support further growth and governance (cross-over investing), depending on their strategies.
14. ESG Considerations: VCs should define and implement ESG policies in their fund operations and report on their ESG practices to LPs, reflecting the increasing importance of ESG among stakeholders.

The document invites feedback on any additional points that should be included in the principles.

In summary, the document proposes a comprehensive set of principles focused on promoting trustee responsibilities, sustainable management, transparency, conflict management, compliance, fair valuation, information disclosure, and value-added support for portfolio companies among VCs seeking institutional funds. The principles aim to align VC practices with global standards, enhance the appeal of VCs as an asset class, and facilitate dialogue between VCs and their institutional investors.

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