[Edaily Marketin Soyoung Park Reporter] "When domestic startups are asked where they hope to expand overseas, 'Japan' is the second most frequently mentioned destination after the U.S. However, as Japanese investors prioritize 'exits' (return on investment) above all else, expansion strategies are also evolving."

This is the recent sentiment in the local investment market, as reported by a venture capital (VC) industry insider who assists domestic startups in expanding into Japan. He added, “There is a growing trend toward a policy of allowing companies to go public but not leaving those that fail to grow properly after listing on the market for too long.”

Careful Scrutiny of ‘Exit’ Plans Amid Stricter IPO Maintenance Standards

According to the global investment banking (IB) industry on the 26th, Japanese VCs are becoming more discerning when evaluating exit possibilities—such as mergers and acquisitions (M&A) and IPOs—before investing in startups.

Japan is known as a more favorable environment for IPOs than South Korea. In April 2022, Japan reorganized its stock market into three segments: △Prime, △Standard, and △Growth. Generally, large corporations with a market capitalization of 10 billion yen (approximately 87 billion won) or more are listed on the Prime market; mid-sized companies with a market capitalization of 1 billion yen (approximately 8.7 billion won) or more are listed on the Standard market; and small and medium-sized enterprises (SMEs) and venture companies with a market capitalization of 500 million yen (approximately 4.4 billion won) or more are listed on the Growth market.

In South Korean terms, this means that even companies at the Series A and B stages can list on the Growth Market if they possess high growth potential. However, there is a growing consensus that exits have become more difficult as the criteria for maintaining a listing on the Growth Market have been tightened.

To maintain their listing in the Growth Market, companies must have a market capitalization of at least 4 billion yen (approximately 34.8 billion won). This requirement applies 10 years after listing. However, starting March 1, 2030, companies will be required to maintain a market capitalization of at least 10 billion yen (approximately 87 billion won). The effective date for this requirement has also been moved up to five years after listing.

An official from the domestic venture capital (VC) industry stated, “With exits becoming more difficult than before, investment firms are now considering exit strategies as a key factor from the very beginning when evaluating startups,” adding, “Domestic companies must also develop more detailed value-enhancement and exit plans if they are to successfully secure investment locally.”

Local VCs Creating “Secondary” Funds to Diversify Exits

Unlike in Korea, “secondary” transactions—an investment strategy in which private equity funds sell their stakes to other private equity funds to liquidate holdings—have not been common in Japan. Consequently, investment firms often rely on IPOs and M&A as their primary exit strategies.

The Japan Investment Corporation (JIC) also pointed out late last year that “there is still a shortage of secondary players and private capital,” noting that “this structure is one of the factors causing VCs to face pressure to close their funds and startups to pursue small-scale IPOs before achieving sufficient growth.”

As the exit market, which had been focused on IPOs, has become unstable, signs of change are emerging even in Japan’s secondary market, which is still in its early stages. The market appears to be gradually expanding as funds have been flowing into secondary funds one after another recently.

For example, in February of last year, Sumitomo Mitsui Banking Corporation (SMBC), together with SMBC Venture Capital Management and V Alternative Japan, established the secondary fund “Japan Boost Up No. 1.” With an initial size of 5 billion yen (approximately 43.5 billion won), the fund aims to grow to between 10 billion yen (approximately 87 billion won) and 15 billion yen (approximately 130.6 billion won) by recruiting additional external LPs.

In addition, Kepple completed the first closing of “Kepple Liquidity No. 2” last October with 6.1 billion yen (approximately 53.1 billion won). Following a second closing in April of this year, the fund’s size expanded to 9.7 billion yen (approximately 84.5 billion won).

JIC is also investing policy funds into related funds. JIC stated, “If trading of existing shares in mid- to late-stage startups becomes more active, startups will have sufficient time to achieve growth, and this will further increase the likelihood of creating unicorns.” It added, “We expect the expansion of the secondary market to foster the development of the venture ecosystem by enabling VCs to recoup their investments before an IPO, thereby creating opportunities to discover and invest in new startups.”

An industry official commented, “As local VCs are rapidly forming secondary funds and JIC is investing in them, the market sentiment is shifting, so the exit environment is expected to become more favorable,” adding, “Since various global VCs have also been eyeing secondary opportunities since last year, I believe the inflow of overseas capital will accelerate significantly as the market grows.”