The second meeting of the “Expert Panel on Venture Capital (VC) Funds”

In response to the “Policy Plan for Promoting Japan as a Leading Asset Management Center” (published by the “Council of New Form of Capitalism Realization” of the Japanese government on December 13, 2023), the Financial Services Agency (FSA) and the Ministry of Economy, Trade and Industry (METI) jointly held the second meeting of the “Expert Panel on Venture Capital (VC) Funds” on May 28, 2024.

The following provides an English summary of the secretariat’s briefing material. In addition, the FinTech Association of Japan provided comments as well as sample legal documents for startup investment in the form of equity as well as convertible bonds (also only available in Japanese).

The secretariat’s document acknowledges the rapid growth of the VC market in recent years and its crucial role in the startup ecosystem. However, it also recognizes the comparatively smaller size of Japanese VC funds compared to those in the US and other countries. The FSA seeks to encourage more investment from domestic and international institutional investors in Japanese VC funds through the publications of principles, hoping to expand the size and influence of the industry, ultimately strengthening the overall startup ecosystem.

Key Takeaways

Purpose

The document establishes principles to encourage investment in Japanese VC funds by both domestic and international institutional investors. These principles are not legally binding regulations but rather recommendations and expectations that can be used as a framework for fund operations and investor relations.

Scope

The principles are aimed at VCs seeking to attract capital from a wide range of institutional investors. However, the document acknowledges the unique characteristics of certain types of VC, including Corporate Venture Capital (CVC), financial-sector-related VCs, and university-affiliated VCs, as well as early-stage VC funds, and encourages them to consider the principles as appropriate to their specific circumstances.

Approach

The document utilizes a principles-based approach, meaning it doesn’t prescribe specific rules but rather provides general guidelines for best practices. This approach is intended to encourage flexibility and adaptation to individual VC fund characteristics.

Two Categories of Principles

The document categorizes the principles into two groups:

• Recommended Practices: These are considered fundamental elements for VCs to consider when operating as a legitimate investment vehicle. They include topics like fiduciary duty, governance, conflict of interest management, and information disclosure.
• Expected Practices: These practices, while not mandatory, are encouraged to enhance the VC’s appeal to investors and contribute to the overall growth of the startup ecosystem. They focus on value creation for investee companies, including investment strategy, support services, and post-IPO involvement.

Recommended Practices

Fiduciary Duty

• General Partner (GP) should operate the VC fund with the goal of maximizing LP’s share value.
• Key personnel should be dedicated to fund operations.
• Adequate measures should be in place to manage conflicts of interest.
• LPs should have a clear understanding of their rights, particularly when it comes to receiving information about the fund’s performance.

Sustainable Management Structure

• VCs should have a sustainable structure with multiple professionals, ensuring continuity in case of key personnel departures.

Compliance Management

• VCs should implement robust compliance systems to ensure adherence to relevant laws and regulations.

Transparency of LP Rights

• Ensure equal rights for all LPs, preventing any individual LP from having an unfair advantage.

Conflict of Interest Management

• VCs should clearly identify and manage any potential conflicts of interest between the GP and LPs, especially when the GP has other business ventures or manages multiple funds.

Alignment of Interests between GP and LP

• Encourage GP’s to align their interests with the LPs by adopting fair profit-sharing structures.
• VCs should prioritize the maximization of LP’s returns on their investment.

Fair Valuation of Fund Assets

• VCs should provide LPs with transparent information about the valuation of fund assets, including methodologies used.

Regular Information Provision

• VCs are encouraged to provide LPs with quarterly reports on fund financials and annual reports that detail the fund’s strategy and future plans.

Expected Practices

Investment Contracts with Startups

• VCs should design investment contracts that allow startups to achieve their growth potential without undue restrictions. The contracts should ensure fair upside sharing for all stakeholders.

Support for Investee Companies

• VCs are expected to provide value beyond capital, actively supporting investee companies with mentorship, talent acquisition, business matchmaking, and other resources.
• VCs are expected to fulfill their duties as board members in investee companies, upholding corporate governance and maximizing shareholder value.

Capital Policy Support for Investee Companies

• VCs should assist investee companies with future fundraising rounds, including follow-on investments and potential contract modifications.
• VCs should be flexible in extending the fund duration if necessary, considering the long-term interests of both investee companies and LPs.

Post-IPO Engagement with Investee Companies

• VCs should maximize the value of investments during potential sale or exit events, considering all options, including both IPO and M&A.
• VCs should consider maintaining a stake in investee companies even after an IPO, particularly those focused on later-stage investments, to support the company’s continued growth.

ESG and Diversity Consideration

• VCs are expected to align their fund operations with ESG principles and diversity considerations, reflecting the increasing awareness of these factors among stakeholders.

Overall Impact

The principles outlined in the document are expected to raise the standards for Japanese VC funds, making them more attractive to institutional investors, both domestically and internationally. This could lead to increased investment in the sector, ultimately supporting the development and growth of Japanese startups and the overall startup ecosystem. The document encourages a culture of transparency, accountability, and value creation for all stakeholders in the VC landscape.

Further Development

The document suggests that the FSA will monitor the adoption and impact of these principles. Regular updates and revisions might occur to ensure the document remains relevant to the evolving VC landscape in Japan.