New rules to attract overseas investor money to startups are taking effect. The Ministry of Economy, Trade and Industry (METI) revised guidelines for contracts between investors and emerging companies in September. These changes seek to change Japan's unique practice of imposing a de facto obligation to pursue an IPO, and expand to include M&As as an option for investment recovery. The rules will align with international standards, improving the investment environment for securing risk capital.

The ministry's push to revise the rules stems from a sense of urgency that Japan's unique investment practices could deter foreign investors from backing domestic startups. While Japan has startups with excellent technology, one US VC executive stated, “Investment contracts containing clauses that differ from global standards pose too high a risk for us to invest.”

While the US has over 600 unlisted companies valued at $1 billion or more, Japan has only a handful. Cultivating unicorns has become an urgent priority to boost Japan’s flagging economy.

IPO Effort Obligations Unseen in the US

Domestically, VC investment agreements often require startups to make maximum efforts toward an IPO. VC fund lifespans typically span about 10 years, and as maturity approaches, VCs frequently pressure for an early IPO.

Data compiled from the Venture Enterprise Center's White Paper shows that, in Japan, stock listings accounted for about 70% of VC investment recoveries on average from 2019 to 2023. This has contributed to the phenomenon of “small-scale listings,” where companies remain relatively small and struggle to grow significantly after going public.

In the United States, such an obligation to pursue an IPO does not exist. Companies can more easily compare both IPO and M&A options to choose the most desirable path. Acquisitions of startups by large corporations are also active, with M&A accounting for the majority of investment recoveries.

METI's new guidelines state that “M&A and secondary trading (secondary market) of unlisted shares among shareholders are also reasonable options and may be preferable for issuers.”

Japan has a unique commercial practice where VCs can demand repayment exceeding their invested amount if a startup breaches contractual obligations. When VCs exercised this right, entrepreneurs were forced to repurchase shares using their personal assets, creating a barrier to recovery for founders after business failures.

This right is not common practice in the US and has been criticized by overseas investors. Previous guidelines merely stated that such claims should be “applied restrictively,” but the new guidelines go further, explicitly stating they “should not be established.”

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