Barriers to entrepreneurship in Japan

Barriers to entrepreneurship in Japan

There are a number of cultural norms, regulations and corporate policies in Japan that either increase the risk to entrepreneurs or inhibit their ability to create wealth, which are creating real barriers to entrepreneurship.

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As my previous blog mentioned, Japan does not have an innovation challenge – rather, it has a challenge with scaling innovation through entrepreneurship and intrapreneurship.

A definition of entrepreneurship is to ‘undertake a business venture or initiative that involves the assumption of some risk in order to create wealth.’ In Japan, however, there are a number of cultural norms, regulations and corporate policies that either increase the risk to entrepreneurs or inhibit their ability to create wealth – creating real barriers to entrepreneurship, whether inside or outside an organization.

Barriers that increase risk

  • Legal environment.  Japan’s legal environment emphasises both personal liability and director’s liability. If you are a representative director of a Japanese company – and as a founder you would be – it can be difficult to shield your personal assets in the case of corporate insolvency. For example, bank loans to small companies may require personal guarantees from key shareholders. Many individuals are hesitant to start new businesses knowing that failure could have significant personal consequences.
  • Corporate hiring practices. In Japan, there is not a strong culture of mid-career hires. Instead, most large companies have a fixed structure for graduate recruitment – one that oft penalizes people who choose alternative career paths. An entrepreneur who leaves a stable corporate job or who decides to start a new venture after graduation, may find it almost impossible to get back onto the corporate track should their entrepreneurial endeavour fail.
  • Limited venture funding availability. Japan does not have an active angel funding environment similar to the US, and Japan’s growing but comparatively small VC industry means that many entrepreneurs struggle to find financing. And even if they do, the average round size in Japan is less than $1 million, which is significantly smaller than in Silicon Valley.
  • Lack of acquihire exit route. The concept of “acquihires” (i.e., a corporate acquisition for the primary purpose of acquiring target company employees, usually engineering or product management talent) has not caught on in Japan. As a result, whereas “failure” in the U.S. may mean a small 7-figure acquisition, in Japan it is much less likely to achieve a soft landing.
  • Seniority-based promotions and compensation. In many traditional Japanese organizations, career success has depended mainly on risk avoidance and longevity. Whereas a failure may cause one to be moved off a key project or management track, achieving success may not vault one into a higher job category or pay grade. Accordingly, the potential upside of success on a risky but important project in an organization does not offset the potential downside of failure. As a result, intrapreneurship has not flourished in some of the corporations that have traditionally attracted top engineering and business talent.

Barriers that inhibit wealth creation

  • Limited culture of employee equity ownership. In Japan, original founders can do spectacularly well, but employees outside of the core founding team are rarely given equity ownership. As a result, while wildly successful Japanese technology companies have richly rewarded the founding entrepreneur and created strong family office venture funds, they have not resulted in a distributed angel network in the same manner that companies like Google and Facebook did in the US. It’s very important to note that this is not due to any ill-intent on the part of founders; rather, it has simply not involved as a cultural norm in the establishment of ventures here as strongly as it has in the U.S.
  • Restrictive tax regimes. Japan’s top individual tax brackets are above 50 percent including the various tax categories and a high inheritance tax makes it difficult to pass on wealth. This provides some degree of disincentive to create wealth and also limits the amount of after-tax funds in the hands of successful entrepreneurs which may be recycled through the ecosystem in the form of angel investments.
  • Lower social cache. At least on the surface in Japan, wealth on its own is not considered as important as is being part of a respected organization which contributes to society. This has roots in Japanese culture back to the 1600s when a rigid social structure evolved under the Tokugawa shogunate which placed mercantilism in the lowest rung of social order, below government, agriculture and tradecraft. Even as rigid social boundaries have dissolved, elite status has been conferred primarily on graduates of top schools who assumed positions in the government or very large Japanese corporate institutions such as banks, trading houses and industrial groups. The founder of a wildly successful Japanese mobile gaming company once told an anecdote of the day shortly after starting the company when a new employee’s mother showed up at the office and tearfully begged the CEO to not hire her son so that he could instead find a job at a more reputable company! (Fortunately the CEO didn’t listen, and the son went on to achieve great success as a top executive in that same venture which became a well-regarded publicly listed technology company.)
  • Lack of M&A exit route. In the U.S., the proportion of exits have trended more towards M&A exits rather than IPOs; in Japan, however, exits of venture-backed technology companies are heavily weighted towards IPOs. And these are generally not billion dollar IPOs – more commonly, they are IPOs on Japan’s “Mothers Market” which is a small scale public market where market cap may be in the low tens of millions. In such case, the entrepreneurs will find themselves CEOs of public companies – with the pressure and scrutiny that entails – with social status their primary reward rather than great wealth that can flow back through the ecosystem to support the next generation of entrepreneurs.

 

Given the significant risks involved and lack of outsized returns (whether economic or social), the above factors have conspired to create an almost pervasive “fear of failure” among potential entrepreneurs. To change this mindset, there needs to be a concerted effort to break down the barriers outlined above. In the next blog, I’ll outline a number of activities that can drive increased entrepreneurship in the country, many of which have already taken root.

 

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About the author

Paul Ford works in KPMG’s Transaction Services at the Tokyo office. His operations experience as a senior finance, legal and HR executive in the technology industry provides him with unique insights during the transaction process, particularly in viewing and addressing issues from a client perspective. In 2014, Paul launched KPMG FAS’ Internet Deal Advisory due diligence practice and has personally led the due diligence of over 25 internet / software business M&A transactions since 2012, both in-bound into Japan for foreign clients and overseas on behalf of Japanese clients.

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