How Venture Capital Is Propelling Innovation in Japan

Domestic start-ups are flourishing with the help of government support, particularly those focused on digitalization and sustainability

Despite having the third-largest economy in the world and a plethora of global technology companies, Japan has a relatively small venture capital (VC) industry. Preqin data shows VC deal value in 2020 accounted for just 1% of global venture investment of $377bn, against 50% in North America, 33% in Asia (including Japan), and 13% in Europe. However, in just three years VC investment in Japan doubled, from a total of $1.7bn in 2017 to a record $3.6bn in 2020 (Fig. 1). Meanwhile, the number of deals also almost doubled from 548 in 2017 to 1,064 in 2020. 

VC investments are propelling innovation in two key verticals in Japan: sustainability and digitalization. For instance, the largest deal this year to date is a $122m investment by South Korea conglomerate SK Group in TBM Co. Ltd, a firm specializing in making Limex, an alternative to single-use plastics. Made from abundantly available limestone, Limex is fully biodegradable and recyclable. The funds will be used for expansion and setting up a joint venture with SK Chemicals to continue developing Limex. 

The second-largest deal this year involved payment platform Paidy Inc, which raised $120mn in a Series D round of funding in March. Investors in the fintech start-up include JS Capital Management, Tybourne Capital Management, and Wellington Management (Fig. 2). Paidy allows consumers to pay conveniently with just a name and email address at e-commerce stores like Amazon and Rakuten, removing the need for pre-registration or credit card details. It's also one of the first in Japan that offers a ‘buy now, pay later’ feature with zero-interest installments. The investment raised Paidy’s valuation to $1.3bn, elevating it to unicorn status. 

SmartHR, a SaaS company that digitalizes human resource paperwork such as employment contracts, raised $115mn in a Series D round led by Light Street Capital Management and Sequoia Capital. Founded in 2015, SmartHR achieved a post-money valuation of $1.6bn. The company’s services helped Japanese businesses improve productivity by reducing reliance on paperwork and physical processes like the use of 'hanko’ seals – a printing stamp for use in lieu of a signature. The company’s growth only accelerated during the pandemic as businesses increasingly adopt hybrid ways of working and embrace digitalization. 

Government Support Provides a Boost
One reason why Japan remains underserved by VC is the relatively few start-ups compared to other developed countries. This is partly attributed to the persistent social norms of conformity and lifetime employment that discourage individuals from starting out on their own. Of the 804 unicorns globally, only seven are based in Japan. However, things may be changing as Japan’s youth become more entrepreneurial.

Second, Japan’s conglomerates have always taken technological innovations in house. In addition, traditionally banks have been more willing to loan money to corporates than invest in start-ups. But the landscape is changing – with more VC funds being set up – showing that Japan is now an attractive developed market for venture investors. According to Preqin Pro, in 2010, Japan had 12 funds investing in start-ups with a total commitment of $0.2bn. By 2020, this had increased to 51 venture funds with a total commitment of $2.8bn. 

Recognizing the challenges posed by the stagnating economy and aging population, the Japanese Government is proactively offering support for the industry. This has been their agenda for a while: the Angel Tax System, for instance, was introduced in 1997. This was aimed at early-stage ventures, offering tax incentives for angel investors who purchase shares through VC funds. More recently in 2018, Japan’s Ministry of Economy, Trade, and Industry (METI) set up the J-Startup Program to provide services such as mentorship, marketing services, and networking opportunities. It also helps Japanese start-ups expand in the international market.

Additionally, government-owned Japan Investment Corp (JIC) is an active investor in the venture market. JIC created a $1.2bn VC fund this year, which is the country’s largest to date. The Japanese Government has further plans to direct public money to high-growth areas to push analog businesses online and vitalize the venture market. 

In terms of exit routes, Japanese start-ups are at an advantage. They can either file for an IPO via the supportive Tokyo Stock Exchange’s Mothers Board or aim for acquisition by cash-rich corporates that are seeking a faster pace of innovation. Tokyo’s venture ecosystem has already established crucial components, such as world-class technological innovation and R&D, as well as a stable political and economic climate. The stars are aligning for Japan’s venture capital industry to grow at an accelerated pace.

For more insights on Japan’s private capital market, read our Preqin Markets in Focus: Alternatives in Asia-Pacific 2021 Report.