Recommendations for Creating New Businesses:
Building an Economy and Society that Nurtures the Entrepreneurial Spirit

Chapter III : Creation of Venture Businesses

Stimulating The Start-Up of Independent Businesses And Economic Growth:

Importance of supporting start-up of businesses:

The emergence of new industries and businesses is not limited to specific fields and it is possible to create new opportunities in every field by going beyond conventional markets or by exploiting every niche market. Innovative ideas and technologies can be the spark for starting up new businesses not only in high-tech but also in conventional fields, such as distribution, business logistics, consumer services and entertainment.
In starting new businesses in conventional fields, the key players will be the individual entrepreneurs of the small to medium marginal-scale firms that carry the burden of developing the economy and play a major role in job creation.

High-tech venture businesses will lead in technological innovation:

In the fields of information, communication, computer hardware/software and biotechnology, high-tech venture businesses will lead the way in creative new technologies and are expected to carry the burden of developing new high-tech industries and businesses. These should be positioned as the leading industries of the future and the regulatory environment to nurture them must be established as national policy, which supersedes the jurisdictional framework of the government bureaucracy.

Improvement of The Fundraising Climate:

Problems related to procuring funds for start-up businesses:

A system under which start-up funding can be easily procured is essential for fostering the growth of independent venture businesses. Japan can learn much from the US in this regard, where venture businesses are sustained at each stage of their development by a variety of supporters, ranging from individual investors (known as "angels") to venture capitalists and institutional investors such as pension funds, partnership firms and government affiliated funds.

The Stock Market:

In order to stimulate the creation of venture capital funds for the support of independent venture businesses, it is essential that a system be established under which fund providers can expect quick returns commensurate with the risks they have assumed. To accomplish this, Japan must have a vigorous and open stock market in which a venture business can list its stock within a short time after start-up.
From this standpoint, it would be difficult to say that the over-the-counter market in Japan is fulfilling its responsibility at present. The stock market should be governed by the principles of thorough disclosure and individual investor responsibility. It is absolutely essential that the government bureaucrats involved in stock market administration radically change their perspective and throw-out their regulatory mind-set, if we are to create a vigorous stock market that will also foster independent venture businesses.
The key problems of Japan's over-the-counter stock market and the reforms necessary to address them are as follows:
1. Observance of formal standards of registration:
   There are no major differences between the announced standards governing the public listing of stock on Japan's over-the-counter market and the US NASDAQ market, including standards for the net worth and number of shareholders. However, in actual practice the firms that have succeeded in gaining over-the- counter registration in Japan are consistently of a higher level than required by law. We can surmise that the number of new firms going-public is being artificially restricted by inequitable application of the regulations. Firms that can be expected to attain high growth should not be prevented from registration, simply because government authorities are applying standards that are higher than required by law.
   The government has already decided that for R&D firms, certain exceptions will be made, such as not requiring them to meet the profit standard. Broadening the scope of firms that qualify for exceptions should be seriously considered. Additionally, firms applying for registration should not be required to continue to make a profit during the time they are being screened. It should be policy that during screening, a drop in earnings attributable to rational reasons, should not hinder registration.

2. Excessive demands concerning internal organization should be stopped:
   At present, authorities demand that any firm being screened adopt a uniform and formalized organizational structure. This requirement should be removed and it should be considered sufficient that a firm has instituted an self-auditing organization.

3. Reform of the method of determining initial public offering price:
   In Japan the determination of price for an initial public offering of shares is based on the auction system, but we believe that price should not be set in this uniform fashion. In order to establish a price that reflects the market demand, such methods as computation of stock price based on the demand forecast of analysts or the road-show method, which creates real demand through corporate presentations, should be considered.
   The number of shares to be sold at an initial public offering is decided on the basis of the number of issued shares coupled with market trends, without consideration of the initial public offering price. We must adopt a system that allows a flexible determination of the volume of shares offered at the initial public offering. In addition, restrictions on allocation of shares, currently set at 5,000 shares, four times a year per customer, should be abolished.

4. Improvement of the secondary market after going public:
   Regarding the stock price after going-public, NASDAQ firms engage in a proactive market making approach in which they quote selling and buying prices and must sell/buy the minimum fixed number of shares when an investor places an order. This procedure, which promotes smooth trading, should be adopted by Japan, since it would greatly improve the secondary market.
   The long period of lead-time required to prepare for listing, normally more than two years, compared to six months in the US, along with huge preparation costs hinder firms from going public in the over-the-counter market shortly after start-up.

5. Investor's responsibility and the roles of issuers/underwriters:
   As a consequence of the over-the-counter market's relaxed listing standards, resulting from the introduction of certain exceptions, an increase in bankruptcies of high-risk firms is expected. As mentioned earlier, it is a given that these firms must be required to make a thorough disclosure and potential investors must be made aware of their individual responsibility. New regulations regarding disclosure are being planned, and they should not only emphasize figures and numbers. Rather, they should take the form of easy-to-understand information made in the form of statements concerning the economic climate in which a firm operates and the management philosophy of its leaders.
   In their role as intermediaries between stock issuers and the market, securities firms should be responsible for fair and timely distribution of disclosed information to all investors.

The Need For Practical Venture Capital:

The role of venture capital is to supply venture businesses possessing growth potential with funds and management resources, so their rapid growth will be insured and they will foster the next-generation industries.
Venture capitalists should not only respond to needs for funding when a firm is in its earliest stages, but should also fulfill a venture capitalist's wider role of generally supporting new venture businesses by: 1. assuming posts as directors or advisors to monitor and support management; 2. introducing potential key candidates to bolster the management team; 3. introducing new customers and company partners; 4. providing long-term financing using their influence to arrange equity financing, loans, new investors, etc.; and 5. developing "corporate identity" and, playing the roll of a mentor who provides introductions and connections to the corporate world.
While there are many venture capitalists in Japan, their principal activity is lending rather than investing. The firms they help to finance are chiefly those that already have good prospects for going public. Only a few are willing to fulfill the wider role of a true venture capitalist, which goes beyond merely providing capital during their start-up phase or shortly thereafter. And, there is a very limited number of venture capitalists who possess the ability to properly evaluate companies and technologies and thus be able to support the management during start-up.
In order for the government to encourage practical venture capitalists who are willing to provide risk capital, the most important change in regulations is shortening the time between a firm's founding and the time it is permitted to go public so it is possible to produce an early return on investment. In addition the following measures need to be addressed:
1. Increase the volume of funds available by relaxing the restrictions on asset management for institutional investors, such as pension funds;
2. Allow high-risk start-up firms and others recently founded to put aside a certain percentage of the invested capital in tax free reserves; and,
3. Establish a framework for government support of fund procurement by venture capitalists, similar to the US SBIC Program, which guarantees obligations when a venture capitalist provides funds.
The government should also consider establishing a new system to encourage private sector support of venture businesses by working cooperatively with public financial institutions.

The Incubation Function and Regional Revitalization:

Start-up of Regional Business and the Role of Incubators:

One of the roles that independent venture business is expected to fulfill is that of revitalizing and expanding regional economies. The new business incubator is a critical component in supporting the start-up of small and medium-size businesses. Incubators provide business in the initial start-up phase with office/R&D space at low rent, clerical support services and expert technical and management guidance.
A number of incubators are already operating in several regions under the management of local government and economic authorities. For example, the Osaka Shimaya Business Incubator, a not-for-profit arm of the Osaka Urban Industry Promotion Center, fulfills incubator role and in addition promotes cooperation between firms in different industries, supports external research organizations, including the Osaka City University. It has also formed an affiliation with the City of Osaka's collateral exempt loan system, and is producing impressive results.
The Tohoku Intelligent Cosmos Plan, under the leadership of seven prefectures in northeast Japan and the Tohoku Economic Federation, is forming a base for development of creative science and technology which will serve to coordinate development throughout the region. The successful ventures will be used to create new industrial technology that can be used regionally. This program is an innovative attempt to develop a diversified incubator which can provide advanced technology to local manufacturing, agricultural, forestry and fishery industries. The program's progress is being watched with great interest.
During the fiscal year, Okayama Prefecture launched a program titled "Operation to Support and Foster Young Edisons", which provides graduate school students and others from all over Japan, with comprehensive support to enable them to start new businesses on the condition that they conduct research in Okayama Prefecture and maintain their headquarters there for five years after establishment. The support provided ranges from that at the research and development level and extends to collateral-exempt, low interest loans for establishing a firm and supporting management training. The program is very highly regarded as an exceedingly unique experiment.
Other innovative experiments are under way in regional districts to support the growth of R&D intensive firms in which the local government is playing a central role, such as Toyama Foundation for Development of Technology and the Aichi Technology Development and Information Communication Center. Both the Japanese government and the business community must lend strong support to all of these efforts.
In addition, existing government research facilities as well should be able to play a more proactive role by making their resources available for use of local businesses and entrepreneurs and by providing them with technological guidance.

Reconstruction following the Great Hanshin-Awaji (Kobe) Earthquake and new industry development:

On March 28, 1995 Keidanren released its "Proposal for the Revitalization of Industry Following the Kobe (Hanshin Awaji Region) Earthquake", in which Keidanren called for a number of initiatives to assist in the rebuilding. The area affected by the earthquake had a strong technology base, supported by rich human resources and the report called for priority treatment be given to establishing an incubator facility to promote creation of new high-tech industries and businesses. Naturally, regional priorities must be established by local business people in drafting a reconstruction plan, but Keidanren wishes to re- emphasize the importance of making new industry and business creation a top priority in the overall post-quake rebuilding effort.

Responsibilities of the central and municipal governments:

Government support of start-up businesses:

Although the private sector must take the initiative in the launching new industries and businesses, it must be supported fully by the government, which should make a bold change in its policy of protecting existing small and mid-size enterprises and instead lend support to the start-up of independent venture businesses, particularly R&D firms.
The Law on Temporary Measures to Facilitate Specific New Business (which sunsets on May 29, 1996) and The Law on Temporary Measures to Facilitate Business Innovation are designed to provide extensive support of new businesses and promote restructuring of existing firms. We advocate that government go a step further to lay the foundation for intergovernmental cooperation in order to provide the comprehensive support necessary for the start-up of new businesses. Furthermore, the central and municipal governments should set a fixed percentage or set-aside goods and services that would be purchased from independent venture businesses, since this "endorsement" of the businesses would increase the market's evaluation of their worth.
Municipal governments should also work with local business groups to support start-up businesses which are in keeping with the unique character of each region, beginning with the creation of incubator facilities mentioned earlier. For example, the Foundation for Osaka Research Enterprise Companies (FORECS), set-up with funds provided by the Osaka Prefectural Government and regional businesses, provides investment deposit funds to venture capital firms, known as "indirect venture capital". It is an innovative experiment that is attracting considerable attention.

The role of public financial institutions:

Public financial institutions should play a significant role in fund procurement of independent venture businesses. For instance, The Venture Enterprise Center (VEC), which has a nearly 20 year track record, provides a variety of programs to support start-up firms in addition to guaranteeing their obligations. VEC has played a major role in the start-up of R&D companies throughout Japan and is to be commended for expanding its framework for guaranteeing obligations and the scope of industries that it supports.
However, VEC's key responsibility and that of other government-sponsored venture capital institutions, is the timely provision of loans and the guarantee of obligations. They do not possess sufficient investment authority; the firms they support are limited in scope; they lack the capability to evaluate new ideas and technology. Therefore, they are unable to fully address the venture capital needs of a growing economy. As for the more conventional public financial institutions -- they are not structured to provide start-up financing -- period. In general, public financial institutions are not fulfilling the all important role of supporting the growth of the new industries and businesses that can revitalize Japan's economy.
All public financial institutions must go beyond their conventional framework and, working together with private sector-financial institutions, assume responsibility for providing venture capital and coordinating start-up business services. Specifically, in order to match innovative ideas and technologies with start-up firms, public financial institutions must be capable of evaluating technology, as well as commercial viability. They should not require short- term returns on investments but should provide long-term venture capital in the form of an investment.
At the same time, they should provide equitable management assistance, including guidance on growth strategy to firms that are novices at business management. In their initial stages of growth, venture firms must have assistance with accounting, tax and legal matters and must receive guidance in creating relationships with research institutes and with big corporations. Furthermore, we believe that the so-called "corporate venture" -- a venture business generated from within a major corporation -- will play a very significant role in Japan's economic future. Public financial institutions should also play a role in the creation of this type of venture business by providing creative funding and taking risks inherent in this kind of start-up assistance.