Expanding Japan’s Entrepreneurial Mindset

Prime Minister Kishida aims to boost yearly investment in startups and the number of unicorns 10-times each by 2027, under his “new capitalism” economic policy. It is an admirable goal, but one which cannot be reached alone by pumping more money into startups.

Venture capitalists invest 40 times more into startups in the USA than they do in Japan. But the reason is not lack of capital. Japan has plenty of capital. What it lacks are enough risk-taking entrepreneurs. Said another way, the number of business opportunities exceeds the supply of startup founders in Japan.

That’s mainly the result of labor market distortions introduced by policymakers during Japan’s high growth postwar period. Then, Japanese firms needed to fill large numbers of newly created manufacturing jobs. To attract committed workers, firms offered graduates lifetime jobs. After, policymakers passed laws which prevent companies from dismissing workers—laws which today gum up labor markets. Notably, they encourage the smartest and most ambitious graduates to join big and prestigious companies rather than risky startups.

Cocooned within big firms, managers easily lose their hunger to innovate. Akira Morikawa, the former CEO of Line Corporation, once described Japan’s traditional management ecosystems as zoos where well-fed managers become lazy. Yet to survive in today’s fast-moving markets, “People need to build their own road,” Morikawa advised.

What should government do to boost entrepreneurship in Japan? Akiko Naka, the CEO of Japanese startup Wantedly, offered her advice at The Economist Magazine’s Japan Summit in 2016. Paraphrasing, Naka said the best thing policymakers could do was “to stay out of the way” of entrepreneurs.

Her thoughts reflect those of critics who argue government should not try to micromanage innovation and growth. That should be left to the market: “After all, it was the business class of entrepreneurs and investors, together with the market economy that pitted them against one another, that was responsible for bringing an end to the scarcity, want, and oppression that had been human destiny theretofore,” wrote J. Bradford DeLong, in his new book encompassing the economic history of the twentieth century.

Entrepreneurial investors find novel ways to solve seemingly intractable problems, including launching new startups without founders to run them. A decade ago, there were few entrepreneurs launching Japanese startups. That did not deter Jeffrey Char, an American Tokyo-based investor, from vetting business ideas and launching startups through his investment firm, J-Seed Ventures. Char simply found and ran the businesses himself, until he was able find a suitable co-partner to take on the CEO role.

Masahiko Honma, a general partner and co-founder of Incubate Fund Co., Ltd, a leading independent Japanese VC firm, pursues a similar strategy. Incubate Fund general partners, called GPs, first decide which ideas they wish to invest in. Then they find a suitable CEO and CTO to elevate into the role of co-founders. Together, they launch the company. Other times, Incubate Fund co-invests with founders who already have their own startup ideas. The split is roughly half-and-half, he reports.

"Some Japanese founders are risk-averse by nature, so we guarantee them an initial two to three years’ salary without increased workload beyond that of a traditional job,” he says. “That makes it easy for them to step out from corporate life.” In return, Incubate Fund can take a larger percentage of the startup’s ownership.

Taking the idea one step further, Incubate Fund GPs actively search for young talent within the VC industry. When they find a candidate ready to launch their own fund, they set them up as a GP of a newly formed VC firm. Incubate Fund GPs helped to launch Kentaro Sakakibara’s venture capital career this way, for example.

Incubate Fund also recruits new university graduates who wish to follow VC careers, rather than join traditional companies. "We don't hire them for long—only for 5 to 7 years,” says Honma. “Then we set them up as a GP in their own venture capital company."

They are unable to provide a career path within their own firm, so Incubate Fund offers recruits the opportunity to develop independently. "We offer them a path similar to a sushi shop apprenticeship. They learn by doing,” he says, adding, “Before they are in their late 20s, we tell them, ‘You have to set up your own shop.’”

Independent firms like J-Seed and Incubate Fund differ from traditional VCs in that investment decisions are made by GPs who hold a financial stake in portfolio companies, while salaried managers employed by traditional VC firms do not. That helps to align independent VC interests with those of startup founders.

Successful entrepreneurs and investors invariably reinvest a portion of windfall gains back into new startups, creating a virtuous cycle of reinvestment. It’s a slow but proven market-driven way to build startup ecosystems and entrepreneurial mindsets like those found in Silicon Valley.

Since 2010, yearly amounts invested in Japan by independent VCs have outpaced those made by other VC types (e.g., government, university, corporate and so forth). Independent VCs account for about one-third of total startup investment, making it the largest source of startup capital in 2020 (source: Initial Inc). Expect this trend to continue—with or without labor reform, best introduced as soon as possible to level the nation’s startup playing field.

Big firms cannot innovate fast enough in today’s fast-moving markets to make good on promises of lifetime employment. Graduates are slowly waking up to the reality they must fend for themselves.

As Morikawa said, “People need to build their own road.” Let them do so.

Richard Solomon is an author, publisher and spokesman on contemporary Japan. He posts Beacon Reports at beaconreports.net