Entrepreneur Association of Tokyo
Seminar Summary - EA-Tokyo's 2nd Anniversary

"Venture Funding for Small Businesses"
EA-Tokyo's 2nd Anniversary June 7, 2005
June 2005

Before any start-up venture can set sail, it must first find a way to raise money. To find out how, more than 60 businesspeople packed EA-Tokyo's 2nd anniversary seminar, held on June 7 at the City Club of Tokyo, to hear the advice of investors Hitoshi Suga and Mike Alfant, venture capitalists who have helped finance numerous Japanese start-up companies. In a panel discussion moderated by Michael Korver, a former business consultant, Suga and Alfant took turns sharing their start-up experiences and counseled audience members on how to keep afloat in Japan's turbulent entrepreneurial waters.

Banks vs. ‘Bootstrapping'
In Japan, financing a new venture is a particularly daunting task: most banks will not lend money to start-ups unless they already have substantial capital to begin with. “For non-equity financing, entrepreneurs should not expect to get much help from banks in Japan,” says Suga, who is currently Vice Chairman of FoodX Globe Co., Ltd (Tully's Coffee Japan Co. Ltd). Instead, he advises, entrepreneurs should rely on alternative forms of financing such as:
•  Their own money
•  Money borrowed from friends or relatives
•  Government loans
•  "Angel" investors
•  Corporate partners

“Bootstrapping is basically the way to go in Japan at an early stage,” says Alfant, President of Building2, a technology investment company located in Tokyo and Boston.“ Japanese banks aren't interested in small ventures, especially those run by foreigners.” In the early 1990s, Alfant says he financed his first venture in Japan using cash advanced from his credit card — at a whopping 29 percent interest rate. “It wasn't the most intelligent thing to do, but there really wasn't any other option.”  

Alfant encouraged audience members who are interested in starting their own companies to first incorporate their ventures as KKs (Kabushiki Kaisha). This requires an initial ¥10,000,000 capitalization. If someone has not gone to the trouble of setting up a KK, he says, “the odds are I'm not going be interested in dealing with you.” He adds, “What it comes down to is, you need the wherewithal to at least get enough capital yourself. It's a test. It's not meant to be easy.”

Suga noted that starting in 2006, a change in the Japanese commercial code will allow any business owner to establish their KK for just one yen. After that there will be no YK (Yugen Gaisha) limited liability companies. “This is a substantial change,” Suga says. “Any entrepreneur who wants to start a business in this country should really take advantage of that.”

Quality of investors is important
One yen, however, isn't enough to launch a business. Although both Suga and Alfant agree that bootstrapping is a preferable method of raising equity in Japan, they have reservations about each.

› Friends/family: Alfant says he has seen internal strife that can often result from family shareholdings.

›‘Angel' investors: The quality of such investors may not be equivalent to those found in the U.S., says Suga. “Some people don't distinguish the difference between debt and equity. Others might try to swoop in and take over the business after they've made a big investment.”

“Even though the color of the money may be the same, you've really got to be careful of the quality of the people you get money from,” warns Alfant. “Someone you think is an angel may actually be a devil, so you need to be a little bit careful about that. There is a very high maintenance aspect with angel investors.” He says that one good source of angel investors are people who have recently become rich. “They often do dumb things with their money.” When asked by the moderator if smart money is better than dumb money, Alfant replied, “Dumb money outchases smart money in almost any market.”

› Corporate partners: It is almost impossible for any small start-up to get direct financing from Japan's major corporations in the beginning, says Suga, who has worked for Japanese corporate Mitsui for 25 years. Typically, it takes three to six months for such players to investigate unknown ventures—lots of meetings and paperwork—but the reward is long-term stability and loyalty. “Once they're in, they'll really stick with you.”  

Venture capital sources in Japan
Suga says that although there are more than 150 so-called venture capitals in Japan, 95 percent of them are backed by big commercial banks and insurance companies such as Mitsui and Sumitomo. The presidents of these companies are typically salaried bank managers with little decision-making authority. Mostly, they are interested in much bigger ventures; small fry with sales of less than one million USD usually get a pass.

Alfant says that as a venture capitalist he mostly looks at high tech companies, spending anywhere between 100-200 hours evaluating each.

He looks at four things to determine if he will invest or not:
1. Quality and composition of the management team.
2. Ability of management team to generate and manage cash flow.
3. Production release of the product and service in question.
4. Relationships within the company environment between employees, business partners, suppliers, vendors, landlords, etc.

“I tend to focus on the background of the principals involved. Normally, I tend to look for some record of achievement, any number of things where an individual set out to do something and did it, impresses me.”

A lot of interesting startups are profitable until they go out of business
Suga: “People are by far the most important element in any investment decision. In Japan, investors often have to be fortune tellers as to whether a person is going to be successful. If you're an entrepreneur looking for funding outside, you really have to develop a personal chemistry or synergy between yourself and the investor. This is more important than business plans and business models.”

Alfant: “If you need capital and you can get it, you should take it. But understand that there's always strings attached—a dilution of control, shareholding, and authority. For early stage companies, get enough money to see yourself through to a cash flow positive situation. At the end of the day, it's all about cash flow. A lot of interesting startups are profitable until they go out of business because they didn't manage their cash flow. Figure out what it is going to take to get you from where you are to where you're generating your own cash. Once you're cash flow positive, then the horizon is very broad; you can influence events. When you're cash flow negative, you lose control of the ship—you're just day-to-day.”

Alfant believes it is very difficult to go back to investors and ask for money again before you turn cash flow positive.

Suga says that if you desperately need capital to start your business, then you may have no choice but to find external financing, ie: from angel investors.” But beware—if you invest ¥10 million and you find the same amount from outside investors, you immediately end up with only 50 percent of the company while at the same time contributing 100 percent of the sweat and tears which is not considered to be very fair, therefore in this country, it is allowed at the very beginning of the company right after you invest your ¥10 million, you can make a stock split, say 1:10, then right after doing that, you can get another ¥10 million which will effectively dilute the third party's contribution.”

Q & A
KK or YK?
Alfant: “I don't think you need to have a KK to get started, I think you need to have a KK if you want to get some money from somebody. Many people start with no corporate structure and no corporate entity which is sort of questionable, but it's understandable. It all depends on the kind of company.”

Suga: “In terms of a YK, there is a peculiar phenomenon happening in Japan this year. From next year, business owners will not be allowed to form a YK. There is a substantial increase in the number of YK being incorporated this year to take advantage of the minimum capital requirement of ¥3 million. After setting up a YK this year, you can convert it very easily into a KK from next year. So some people like to form a YK this year.”

What criteria takes the company out of the early stages?
Alfant: “It all depends on the type of company. When they have 5-6 employees, when their revenue is exceeding ¥100 million annually, when they have more than 1-2 customers. It's really case by case, there are no hard and fast guidelines.”

Suga agrees with Alfant in that it depends on the industry and the nature of the business.
He looks at ¥100 million yen or one million USD as a benchmark.

What do you look at in that very early stage of an idea turning into a business?
Alfant: “For me, ideas are a dime a dozen. It is all about operations and the ability to execute. I normally look at the management and a diversity of skill sets, so I don't want to see three programmers or three marketers who decide to start a company.” He tends to look for situations where there is a diversity of skill sets and some depth in each one of the individuals, and where there is a complimentary fit where the sum of the parts is greater than the individuals would be on their own. Alfant says he would much rather have a very solid operational team in place generating some sort of value from day one, than “a bunch of people sitting around exchanging ideas.”

Suga prefers down-to-earth types. “Just having a [business] concept is very easy but you've got to substantiate that concept with your experience and track record.” He agrees with Alfant that looking at the management team rather than the individuals is important.

Text: William Steele, Jonathon Walsh
Steele and Walsh are writers and editors at Business Grow , an innovative company specializing in providing a wide range of top quality Editorial and Advertising services to Japanese and foreign organizations.

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