Evolution of Japanese Venture Capital April 24, 2008 Michael Korver Managing Partner Global Venture Capital Some Observations • Both “high-growth expectation” entrepreneurial activity and VC funding levels in Japan are much lower than in the US (even when adjusted for population and size of economy). Also lower than in Europe. • According to the Global Entrepreneurship Monitor (GEM), Japan ranked second from last among high-income countries surveyed in terms of the prevalence rate of high- growth expectation early-stage entrepreneurship during 2000 – 2006. • Venture capital is available in Japan, but much of it comes from organizations affiliated with large financial institutions. • Most VC-backed companies in Japan target domestic market exclusively. According to GEM, Japan ranks last among high-income countries surveyed in terms of the prevalence rate of the international orientation of its entrepreneurial ventures. • According to GEM, Japanese have the lowest perceptions of the positive attributes about entrepreneurship activity in the world. • Japanese VC’s depend heavily on a handful of Japanese stock exchanges for exits (and performance) of their domestic portfolio companies. • Japan is a technologically sophisticated country with large domestic early-adopter markets and global companies generating significant amounts of technology innovation. What is the role of entrepreneurship and venture capital in driving this innovation? International Comparisons • U.S. venture capitalists invested $29.4B in 3,813 deals in 2007 – marking the highest yearly investment since 2001 (MoneyTree Report) • According to preliminary figures released by the EVCA, European venture capitalists invested €11.5B in 2007 • Japanese VCs invested ¥2,800 hundred million in 2,773 companies in the year ended Mar. 31, 2007 • Primary exit vehicle for venture-backed companies in U.S. and Europe is the trade sale; in Japan it is the IPO (although many more IPOs in U.S. than in Europe for venture-backed companies) Most Active Japanese VCs Amount Invested (100 Mil. Yen) SBI Holdings 1,170 Chuo Mitsui Capital 769 JAFCO 603 NIF SMBC Ventures 370 Nikko antfactory 239 JAIC 227 Mizuho Capital 90 Tokyo Marine Capital 81 ORIX Capital 80 Mitsubishi UFJ Capital 79 Source: Nihon Keizai Shimbun How Attractive? Availability of Venture Capital U.S. x Japan x Size of opportunity Global Venture Capital • Tokyo-based independent venture capital firm investing since 1997 • Five partners • Invested in over 35 ventures in Japan, Hawaii, California, U.K. • Investment thesis: “source globally, invest locally” • www.gvc.jp “Source Globally, Invest Locally” Investments in early-stage ventures located around the globe that have “meaningful contacts” with Japan and/or other East Asian economies . “Meaningful contacts” include one or more of the following attributes: ① Large market potential in Japan and/or other East Asian countries and a strong commitment on the part of management to consider these markets to be of significant importance. ② Technology, product or service amenable to due diligence by applying internal resources or by tapping resources in Japanese and/or other Asia- based corporations or academic/research institutions. ③ Strong potential for partnering with Japanese or other Asia-based corporations. ④ Potential to undertake an IPO on Japanese capital markets. Our Investment Strategy • “One size doesn’t fit all” – innovation not bounded by geography; markets are global • Silicon Valley doesn’t need more VC money or “bridging organizations” • U.S. not the appropriate first market for all innovations – Too competitive – Early adopters may be elsewhere – Infrastructure to support growth of the market may not exist in the US – Larger potential markets may exist outside of the U.S. • Powerful potential competitors or partners may lurk in Asia What we look for • Market opportunity – Large and fast-growing – Compelling value proposition – Effective “go-to-market” strategy • Management team – All bases covered – Experienced • Technology or other sustainable “barriers to entry” Case Studies • Hoku Scientific (Nasdaq: HOKU) – Alternative energy (Hawaii): achieved IPO on the strength of commercial relationships with two large Japanese companies • SpectraGenics – Medical equipment (California): Launched product in Japan pending FDA approval in the U.S. • ReallyEnglish.com – ITC (U.K.): English language online learning content developed in U.K. but primary customers in Japan • GeoVector – ITC (California/New Zealand): Development team in NZ and first market in Japan’s world leading mobile telephone sector A Little History • 1973 Japan Associated Finance Co., Ltd. (JAFCO) established in 1973 as a JV among Nomura Securities Co., Ltd., Nippon Life Insurance Co., and Sanwa Bank, Ltd. • 1982 JAFCO established Japan’s first VC fund • 1987 JAFCO shares start trading on OTC market • 1996 Global Venture Capital established • 1998 Japanese Limited Partnership Law implemented • 1999 TSE Mothers exchange started in 1999 • 2001 NASDAQ Japan exchange started in 2001 • 2001 JAFCO listed on the first section of the TSE in 2001 • 2002 Major revision of the Commercial Code • 2002 Japan Venture Capital Association established • 2005 NIF Ventures merged with SMBC Capital to form NIF SMBC Ventures • 2006/8 NIFSMBC VC Fund 2006 Series ($600K) • 2007/7 JAFCO Super VC Series (>$1B) • 2007/9 JAFC V2 Fund Series ($1B) Venture Enterprise Center VC Fund Benchmark Report • In most recent report (for fiscal year ended March 31, 2007) 85 VC fund management organizations reporting for 451 funds • Average fund size around $40M with 10 limited partners – Japanese investors 71%, non-Japanese investors 13%, GP 14% • Data go back to vintage year 1982 Japanese Stock Markets for Emerging Growth Cos. Name Established 2006 Listed Market Avg. Amount IPO’s Cos. Cap. Raised at (¥100M) IPO (¥100M) JASDAQ Feb. 1963 59 971 133,692 44 Tokyo Stock Nov. 1999 41 185 38,776 23 Exchange “MOTHERS” Osaka Stock May 2000 22 156 23,824 25 Exchange as “HERCULES” NASDAQ Japan Note: (1) All figures as of end of December, 2006 unless otherwise indicated. (2) JASDAQ launched NEO market for emerging growth companies at end of 2007. Equity Investments by Japanese Venture Capital Funds and Companies Units: ¥100M for Amounts and number for Companies Note: Annual figures. Figures from 2001 to 2003-1 are for annual periods through September of indicated year. Figures from 2003-2 to 2006 are for annual periods through March of following year. E.g., “2006” is for the fiscal year ending March 31, 2007. Source: VEC Investment Trends • Nearly 80% are new investments (vs. follow-on) • Nearly 80% of new investments are for Japanese companies • Shift from start-up/early to later stage investing – <5 years from founding: 46% → 40% – 5 – 10 years from founding: 22% → 32% • From hi-tech to medium-tech – IT related: 35% → 30% – Life Sciences/Medical: 18% → 13% – Manufactured products/services:25% → 40% – Financial services, Real estate: 5% → 17% Source: VEC Performance? • For 402 funds for which performance data is available with vintage years from 1982 – 2007, aggregate IRR is 4.55% (vs. 3.47% for weighted avg. TOPIX) • For vintage years before 2003, three years (’89, ’90, ’01) in which aggregate IRR is negative Source: VEC What (or who) is responsible? This man….. Regulatory and Tax • 2006 National Tax Agency imposes 20% withholding on capital gains distributions to foreigners investing through Japan domiciled venture capital funds • 2007 Ministry of Finance regulates management of venture capital funds • 2007 Ministry of Finance imposes mark to market rules for audits of venture capital funds VC Investments Drying Up? Source: From Masashi Kobayashi blog (http://venturecapital.typepad.jp/blog/2008/03/post-4be3.html) Also, Japanese IPOs Source: From Masashi Kobayashi blog (http://venturecapital.typepad.jp/blog/2008/03/post-4be3.html) !"#$%&'(&)*+,-./-&0,'123&4'*56/.+% <97 <87 @ABCAD <77 EFGHIJ ;7 :7 K)L4MN)B 97 87 OPQRST 7 877= 8779 877> 877: 877? Japanese Emerging Growth Companies 2005(92 Observations) 2006(115 Observations) 2007(76 Observations) 2008［Jan. - Mar.] (17 Observations) Avg. Market Cap. At 231Hundred Mil. 172 Hundred Mil. Yen 94 Hundred Mil. Yen 79 Hundred Mil. Initial Trading Price Yen Yen Avg. Amount Raised 11 Hundred Mil. Yen 10 Hundred Mil. Yen 10 Hundred Mil. Yen 9 Hundred Mil. Yen PER at Initial Trading 149X 107X 54X 15X Price Amount Raised Prior to 13 Hundred Mil. Yen 8 Hundred Mil. Yen 9 Hundred Mil. Yen 10 Hundred Mil. IPO Yen VC Ownership at IPO 13.53% 16.23% 17.21% 16.95% CEO Ownership % at 28.04% 31.78% 29.94% 21.65% IPO Founding to IPO (Yrs.) 17 16 17 23 CEO Age at IPO 49 49 50 52 Note: 2008 excludes Seven Bank Emerging Growth Companies 2007 Web2.0 (5 Cos.) ICT (20 Cos.) Life Sciences (8 All Industries (76 Cos.) Cos.) Avg. Market Cap. at 170 Hundred Mil. 107 Hundred Mil. 61 Hundred Mil. Yen 94 Hundred Mil. Yen Initial Trading Yen Yen Price Avg. Amount Raised 10 Hundred Mill. Yen 11 Hundred Mil. Yen 7 Hundred Mil. Yen 10 Hundred Mil. Yen PER at Initial Trading 16 X 48X 44X 54X Price Amount Raised Prior to 8 Hundred Mil. Yen 7 Hundred Mil. Yen 23 Hundred Mil. Yen 9 Hundred Mil. Yen IPO VC Ownership % at IPO 13.53% 15.77% 24.49% 17.21% CEO Ownership % at 28.88% 26.81% 31.84% 29.94% IPO Founding to IPO (Yrs.) 9 15 12 18 CEO Age at IPO 39 50 49 50.