Japan has far fewer unicorns than one expects – or than venture capitalists desire.

That fact, however, hides a fascinating story.

Today James Riney, founding partner of Coral Capital explains the danger of unicorn counting.

We dive deep into which startup sectors Japan is likely to lead in globally in the coming decade, how to identify unique startup value in Japan.

We also talk about how Japan has become more like Silicon Valley in the past ten years and why they are about to become very different.

It’s a great conversation, and I think you’ll enjoy it.

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Show Notes

  • Coral Capital’s portfolio strategy
  • How to find Japanese startups that can make a global impact
  • Three categories of Japanese startups with unique opportunities for growth
  • Sectors where Japan has a global advantage in startups
  • Why “niche” startups in Japan can become hugely profitable
  • What’s in Store for Carpal Capital Fund 4
  • Proof Japanese investors are long-term patent long-term investors
  • The importance of VC portfolio services is growing in Japan
  • How to get a job at a startup
  • Starting a VC fund as a foreigner in Japan
  • Japan’s “Just who does he think he is?! “ problem
  • The error in the government’s plan to attract foreign investors
  • Why foreign VC struggle in Japan
  • This biggest misconceptions foreign VCs have about the Japanese market
  • Japan’s hidden unicorns

Links from our Guest

Transcript

Welcome to Disrupting Japan, Straight Talk from Japan’s most innovative startups and VCs.

I’m Tim Romero, and thanks for joining me.

Venture capital in Japan is changing, but not in the way that most people think it is.

Today, we sit down and talk with longtime friend of the show and founding partner of Coral Capital, James Riney. Now, James first came on the show about eight years ago, back when he was at 500 startups and before he even started Coral Capital.

Over those eight years, James and Coral has probably done more than anyone to bring Silicon Valley style VC investment and VC founder support to Japan. And we’re going to talk about some of those successes and failures.

James also shares exactly what he and the team at Coral Capital are looking for in the startups they invest in and how they identify unique startup value in Japan. We also dive into the recent push to attract more foreign VC investment into Japan, what foreigners misunderstand about investing in Japanese startups, the challenges of establishing a VC fund here in Japan, and what Japanese and Silicon Valley VCs still need to learn from each other.

But you know, James tells that story much better than I can. So, let’s get right to the interview.

Interview

Tim: So, I’m sitting here with longtime friend of the show. James Rainey, who’s CEO, founder of Coral Capital. So, thanks for sitting down with us again.

James: Thank you. I guess it’s my third time.

Tim: Third time in almost 10 years.

James: It’s crazy. Time flies.

Tim: It does. Man, so much has changed. It’s just incredible. But we will go down memory lane some other time. And today let’s talk  Coral. So, tell me about your fund. Who are you investing in and why?

James: Yeah, so we are basically looking for what we call Power Law companies in Japan. So, as you know, venture capital is very much driven by Power Law, which means that there’s only a handful of companies in the industry or at a firm level that are really going to drive most of the returns. And so we’re just laser focused on finding those companies in Japan. The way that we like to frame it these days is we’re looking for the next Toyotas or the Sonys in Japan. And we’ve been doing this since 2016. And one of our big early investments was Smart HR. A lot of people might know Smart HR if you’re living in Japan, but for those that are not in Japan, basically Smart HR is an all in one HR SaaS solution for the Japan market. So, in other markets, you might know Rippling, for example, Smart HR was I believe around before rippling even existed, we bet on that company quite early. And then we also went really, really heavy into that company. So, at this point we’ve invested about 20 million and we’re the largest outage shareholder in that company.

Tim: Well, actually, let me ask you about that. Because looking at the portfolio you were mentioning, you’re looking for the next Sonys, the next Toyotas, but a lot of your portfolio has been kind of Power Law in Japan. I think HR, Smart HR is a great example of that.

James: We can get into that. Yeah, yeah.

Tim: Let’s get into that.

James: Yeah. We can get into it. So, as I was saying, Smart HR is one of our big hits in our first fund. And in our second fund it looks like it’s Kyoto Fusioneering. And so that’s a fusion company. And that’s kind of like way the opposite side of the spectrum from what you compare to like Smart HR. Smart HR is HR SaaS only focused on Japan. And then you look at Kyoto Fusioneering, which is obviously a fusion company. And so that’s a deep tech startup that is focused on the global market. So, completely different. And so what Kyoto Fusioneering does is they are basically providing their components that go into building a fusion reactor.

Tim: It’s a brilliant strategy. We had them on the show two months ago.

James: You did, right? Yeah, I saw that. Thank you for that. So, it’s a picks and shovels play. And what we like about it is we are bullish on fusion. We think fusion will come, but we’re not really sure what TAM horizon. And I don’t think anyone really knows what TAM horizon, including Kyoto Fusioneering. However, we do think that there’s going to be billions invested in fusion as an industry. And so selling to that industry is enough. The turn is big enough, at least in the short term. And then in the long term, once fusion is cracked, obviously that opens up the market completely. So, one thing when we think about investments in Japan, we also think about why Japan, like why this company would come out of Japan and why this is an interesting opportunity within the Japan context. If you think about Kyoto Fusioneering, okay, so why would a global fusion giant come out of Japan? Well, Japan historically has been very energy dependent. And so because of that, they’ve invested a lot into nuclear fission. And some of the most important companies within the nuclear fission space, you know Hitachi, Toshiba, Mitsubishi are actually Japanese. And so you have some of the best nuclear engineers in the world are Japanese. And then you think about what Kyoto Fusioneering is doing, they’re providing the components that go into the reactor. And so you need advanced manufacturing capabilities, which Japan is also good at.

Tim: I thought that was a brilliant play from them. They’re staying right on that edge. Right, where research crosses over into engineering and productizing, it’s brilliant.

James: Exactly. So, they’re combining both of those things in order to sell to a global market. And so Japan is good at both of those things. They can leverage those things and all of the sort of language and culture barriers, which we can kind of go into maybe later are not relevant from our perspective when it comes to like deep tech.

Tim: So, do you think the change in focus from a lot of Japanese focused businesses to a global market, is that something that you’ve changed your own perspective on? Or do you think that’s a result of just kind of maturation of the Japanese startup ecosystem over the last six, seven years?

James: I think it’s more of a maturation of us as a firm and understanding our sort of swim lanes and what we like and what we’re looking for, and also articulating it better. I would say probably 80 to 90% of the investments that we make kind of fall into this overarching why Japan theme. And there are basically three sort of subcategories here. There’s one, or we call it Japan category leader. And that’s where Smart HR plays in. Basically what this is, is looking at concepts that seem to be working in other markets and then trying to understand why that might work in Japan. And then if the answer is yes, then we also want to understand why the local player would capture the value in Japan. So, for example, in neighboring China, the local startups are basically protected by the government, and so they don’t really have to think about global competition. But Japan, for better or for worse, it’s a global market. And so when we’re looking at investments here, we have to consider the possibility that a global player might come into the Japan market. In the case of Smart HR, we like that there are sort of inherent entry barriers there. So, employment law is different, the insurance system is different, the government APIs are different. And so it’s not as easy as just translating the website.

Tim: There’s a subset of business SaaS around HR, accounting, legal, that that really fits into that.

James: Accounting’s great. So, there’s JGAAP, like there’s other accounting factors that you have to consider, right? Integrations, the legal framework, that kind of stuff. And so we look for like regulatory or like structural barriers that would make it hard for the global player to come into Japan. And obviously the other sort of bullet point would be that it has to be big enough to create multi-billion dollar company. So, Smart HR very neatly kind of fits that bill where HR SaaS is ubiquitous as a pain point. So, it’s large enough in Japan clearly. And at the same time, it’s hard for global payers to come into the market. So, the Salesforce of Japan is Salesforce because the entry buyers, I mean, sales processes are kind of ubiquitous. There’s not that many localizations, you can argue maybe there’s some integrations, but for the most part it’s pretty simple. Whereas accounting and HR, that’s like pretty local. But it goes both ways. Like Smart HR would have a trouble expanding into some other markets.

Tim: You say there’s three pillars?

James: Yes. Okay. So, you want to hear the second one?

Tim: I do.

James: So, the second one is where Kyoto Fusion fits in. And what this is, is what we call the Japan Advantage. These are companies that are using Japan’s fundamental strengths in order to compete globally. So, I mentioned that fusion, there’s a reason that Japan would be a leader because they’re already a leader in fusion and they’re a leader in advanced manufacturing. When we talk about SaaS, SaaS is very marketing and sales oriented. Therefore, like the language and culture barriers that tend to sort of hold back Japanese starters from going global are particularly pronounced when it comes to SaaS. But when it comes to like deep tech or biotech or maybe content IP, like things where Japan is just already good at and the product kind of sells itself, it kind of transcends those barriers. We think those are just less relevant. And so that’s where I think there’s probably going to be opportunities to build like a Sony or a Toyota.

Tim: Let’s dig into that. So, you were talking about like the global strengths. What are some of those areas where you think Japan has those global strengths? Something unique to Japan where Japanese startups would have an edge?

James: Obviously bullish on fusion. We’ve also done semiconductors like diamond semiconductors. So, anything like manufacturing related would be also interesting. We’ve done some biotech as well. We’re pretty open-minded, but we’re always looking for like, what’s the unique reason why this company exists in Japan and how can they compete globally? The town is global, we have to consider that there’s going to be global competition. And so what edge does this company have just by being based in Japan?

Tim: I mean, that makes a lot of sense because they’re going to be less capitalized than their competition coming out of the US for certain, but from coming out of other markets as well. So, they’ll need some kind of clearly defined advantage to compete globally.

James: Robotics would be another one. And these are all areas, by the way, that the Japanese government wants to exist in Japan. And so there are tailwinds where you mentioned funding. Maybe they won’t be as highly capitalized as players you’d see in the US, but there is capital available. And it’s not only equity based fundraising options, but also there’s grants. There’s very cheap debt lots of options available. So, those are things like whenever we talk about deep check, the number one question I get from investors is, oh, like, isn’t that very capital intensive? And yeah, sure, but you don’t necessarily have to dilute yourself to oblivion in order to get it off the ground. Like there’s other ways to, to fund the company. And I think a lot of people don’t understand that context when it comes to Japan.

Tim: Yeah, that makes a lot of sense. Now I was about to go on this long digression about deep tech investing, but that’s best done over a beer, I think.

James: Okay, sure.

Tim: We’re here to talk about your investing strategy, not mine. Third pillar.

James: Okay, so the third one is what we call uniquely Japan. This is a much harder one to explain. So, I talked about Japan category leader, and what that is basically like this is the X for Japan. And that pretty much gets you like 80% of the explanation. Like Smart HR is not the Rippling of Japan per se. I mean, there’s lots of intricacies there, but yeah, like that’s probably 80% of like what they do. Whereas uniquely Japan, I have to start with, okay, in Japan there’s this particular dynamic in this particular industry, which is why there’s a need for this particular solution. One example is we’re a big investors in Kakashi, and what they do is they’re a SaaS solution for the pharmacy market. In Japan, of course, I don’t know exhaustively every country’s pharmacy market, but for example, in the US most of the markets basically dominated by like CVS or Walgreens the big guys. And when you’re that big, you can kind of build out your own digital solutions. But in Japan, the major players don’t really own much of the market. It’s like 1-2%. And so it’s very fragmented. And so because it’s fragmented, there’s an opportunity to sell an all-in-one SaaS solution to that market, which is what they do. So, they do inventory management, patient management, et cetera, et cetera. And what’s really interesting about them is that, let’s say that you order medicine online and your local pharmacy is also using Kakashi, they would know already that their local pharmacy has that particular medicine in stock and they could do last mile delivery to send it to you. So, there’s the SaaS part, but then there’s also the pharmaceutical delivery part as well as procurement and other expansion areas. But it’s a unique thing to Japan, right? It’s uniquely Japan uniquely solving some pain point that’s local here.

Tim: And so sort of the differentiation between the Japan category leaders and the uniquely Japan would be that the category leaders are sort of, they’re using existing business models that are pretty much relatively standard around the world, where the uniquely Japan is, they’re building something new here that probably can’t be exported because of the business model itself couldn’t be exported.

James: Right. It’s unique to Japan and we’ve done another company that is doing a SaaS solution for the agricultural industry. Basically it’s a way for farmers to exchange goods with each other. And that’s a very analog process at the moment. I don’t know if you know JA, but I mean even JA people don’t quite understand what JA is because it’s like this monstrosity of like local collectives and things like that. So, I won’t get into it on this podcast, but that’s a very sort of Japan specific industry.

Tim: Do you ever run into problems just — it would seem that a lot of the opportunities there just aren’t big enough to be profitable?

James: Oh, I mean, they’re huge. I mean so in Japan there’s more pharmacies than there are convenience stores.

Tim: Really?

James: Yes, yes. There are a lot of pharmacies in Japan. So, it is a big market. And of course the pharmacy industry is here in Japan. I don’t know the exact number off the top of my head, but certainly big enough to build at least a hundred million in revenue and probably a billion in revenue.

Tim: Before we get too deep into this, Coral had a really huge announcement this morning.

James: Yes, we did.

Tim: Let’s talk about that.

James: Yeah, so we just announced Fund IV, so it’s a ¥25 billion vehicle focused on finding the next Smart HRs and next Kyoto Fusioneering. The next Toyotas and Sonys of Japan. And there are a few things that are different about this fund. We have historically done series B’s and series C’s, but for the most part we’re getting at as early as possible to these companies. But now with the larger fund size, if for whatever reason we miss it at the C or the A, we can pick it up at the B or the C and then into any one company we can do about 30 billion, or sorry, 3 billion Japanese Yen. Now what is that in dollars with current rates? The Yen’s so cheap, it makes me feel like all this, you know? So in buying terms, it’s more like 250 million, but with the Yen so cheap, it’s like 160 million. But anyway, it’s relatively large for the Japan market. So, we have capital to fund much more ambitious projects. And the other two sort of interesting features of this fund is that LPs give us a blessing to have a fund extension up to 14 years.

Tim: That I was really surprised at. That’s extremely long duration.

James: It’s long duration. Yeah.

Tim: What was the logic and what was the negotiations behind that?

James: We actually did this from fund three. I think that the common sense of making every fund 10 years is kind of ridiculous because every fund has a different strategy. And if you are coming in at seed, if you’re the first check into a company, then that’s very different from you investing at series C. So, the time to exit is obviously going to be different. If you’re trying to invest in companies and shepherd them to multi-billion dollar outcomes, it takes time. Airbnb took a long time. Stripe is still not public.

Tim: But outside of government funds and CVCs, I don’t think I’ve seen a fund of that duration in Japan.

James: We might be the only one in Japan. That has that duration.

Tim: I mean, the logic you just said is absolutely true, but that’s sort of true universally. So, what convinced the LPs to say, yeah, 14 years?

James: Yeah, we did that from fund three. We had the credibility at that point. We have done pretty well on our funds. So, we have the trust of the LPs. And then it’s also just the explaining that logic. One advantage that I think we have in Japan is that we can look at things with like a fresh eyes and just question why does this exist in the way that it does? And that was one thing that I always thought was kind of strange, that no matter what the fund strategy is, it’s 10 years and why wouldn’t it be longer than that? And so a lot of criticism from actually global LPs about Japan markets, like the VCs look for like exits very quickly. And so they try to IPO within five or seven years. And I’m sure we’re going to get into that a bit later, but it takes maybe 10 years or more to build like multi-billion dollar companies with longevity. Maybe on paper you can build like a papercorn. But that’s a different thing, right? And so we want to be able to be patient and be able to fund things on a longer time horizon.

Tim: I mean, how long will you spend deploying the capital?

James: Well, that’s going to be the same. So, typically we make our first investments within two to three years. And then normally we’re raising new funds every two to three years, but we continue to follow on into companies over probably five to six year time horizon.

Tim: Alright.

James:The other feature that I think LPs for giving us the leeway here, is that we can also do cross investment. We can invest in companies from our previous funds. Historically, we did Smart HR to fund one, and then we did an SPV to do Smart HR. And then we’ve done opportunity funds from other vehicles as well. And so we’ve done some of this sort of cross fund investment, but it was always like the flagship fund is like blasphemous. Like you can never do that. Like if we know the company really well and amongst all the opportunities that we’re looking at, like this is the one, this is the next Smart HR, we think that we should have that leeway to do it. So, within certain guidelines that we’ve agreed to with LPs, we can do cross fund investment as well. From the entrepreneur’s perspective, it’s not like you have to worry like how much money is left in this fund. We could potentially invest in the series B or series C later. And the other thing that I always thought was strange is that if you’re investing at seed, by the time that company might be ready for like a $20, 30 million check, it might be five to seven years later. Oh yeah. You know, it takes time. So, if we’ve been tracking it for that long and once it’s ripe, we want to be able to take a bite out of the apple.

Tim: I mean that really speaks to the trust that your LPs have in you to give you that flexibility.

James: Yeah. I mean we’re really grateful for that. We’ve lucked out, we’ve got some really excellent LPs.

Tim: Before we talk more about the future of Coral, I’m going to go way back to the beginning because I think one of the things that you did early on, I think you were one of the very first funds to really focus on providing value to the founders.

James: Thank you.

Tim: I mean, well, you know what I mean? Besides just writing a check from day one, you guys have been creating educational content and trying to connect founders to possible co-founders and staff. And tell me a bit about that decision. Was that something you brought with you from 500? Was that something just your own thinking?

James: Yeah, I mean it’s a combination of things. One is simply that as you know, I was also an entrepreneur, so I was just kind of making a product that I would’ve wanted as an entrepreneur. The other part is at that time there were not Silicon Valley like VCs really in Japan. Like there’s no Y Combinator of Japan, there’s no Andreessen Horowitz of Japan, no Founders Fund of Japan. Like there’s no firms that share those characteristics. And each of those are very, very different firms. But my point is that a lot of the capital was basically coming from banks that have venture arms or corporate venture capital firms that not necessarily have that sort of venture mindset. To put it lightly.

Tim: No, I agree. It was just having been on both sides of this table, most of the VCs at that time really viewed themselves more in terms of compliance. We write the check, we check in quarterly or God help the founders sometimes monthly.

James: Yes, yes.

Tim: To make sure they’re not wasting their money.

James: Monthly is in fact like considered standard in Japan which I think is crazy.

Tim: It is. So, when you were raising, when you went to your LPs, did you go to them with this story? We want to create a new type of VC?

James: Yeah, basically. I mean, we’re in our eighth year now, so we’ve had some time to build, but basically it was just an unmet need in the market. No one was really doing it. And in some ways we had the advantage of being in a time machine where we could see what others were doing in other markets. And we didn’t copy and paste it for Japan, but we did sort of pick and choose what worked for us. And so now we’ve basically come to, I wouldn’t want to say final form, but just a more formed version of ourselves.

Tim: Yeah. I think now, I mean, you can point to successes, you can point to not only the returns, but the ecosystem you’ve built and say, look, this is delivering value. The LPs can see that. But when you were raising the first fund, this was a new idea in Japan. And so is it something that you pitched as a feature to the LPs or was it something you just kind of kept to yourself and figured you were going to execute this way once you got the funds raised?

James: You know, just like a startup, you kind of figure out your stepping stones, and so you can’t boil the ocean. You can’t do everything at once. But the first fund was okay we did it with 500 startups. And so it was, okay, we’re going to be a Silicon Valley style firm in Japan and we’re going to leverage the brand and we’re going to do things like a Silicon Valley capitalist would. And that was a story and that was enough, actually. But on that first fund, we built a track record, and then from our second fund and third fund, we were starting to build the sort of architecture of what we have now. And so now we call ourselves, we’re the ecosystem VC, we invested over a hundred companies at this point. And everyone has their sort of like, own challenges, but the commonalities are, they need access to more capital, usually a lot more capital in some cases, they need access to great talent. And then they also need insights like, best practices on how to build their companies, how to scale their companies. And so fundamentally, we just don’t believe that VCs are going to really like, we can’t give you success. But what I do think VCs can do is what increase the speed and the scale of that success. And so that’s basically what we focus on by figuring out, okay, these are the common issues that they face. And so we’ve built a platform and a demo day for fundraising that makes it much, much faster to meet all the key players all at once. And then there’s also, we tell you the secrets in some cases it’s to our detriment because we’ve invested in a company and we want to get into that company at a cheaper price at the next round. But once we’re on the cap table, we’re getting those companies in tip top shape in order to convince other investors to invest. And then we also have the hiring part. And the hiring part is actually, I would say it’s probably what we’re best at. And so we’re hiring almost 200 people for portfolio companies per year.

The reason that we’re able to do this is because early on we went really, really big on content. And so we run the largest sort of media outlet amongst startups and VCs in Japan. And that has over a hundred thousand people reading our stuff every month. And we’ve been able to channel that traffic into something called Coral Careers, which is basically like a portal for like a career in startups. And so you can apply there and basically what happens on the backend is you go into a database and then anyone from our portfolio companies that’s working on recruiting can access that and contact you directly. So, just through this we’re hiring about 10 people per month, and that database has 15,000 people now. I mean, it’s huge.

Tim: In the US certainly part of the VC’s job is helping their portfolio raise the next round, that’s just almost definitionally. Japanese VCs don’t tend to think that way, or at least they haven’t in the past. Is that something you see changing?

James: Depends on the VC, I mean, so normally the way that it works is that VCs are, they’re frenemies. And so in some cases they compete, in some cases they’re friends and they will introduce deals to like the drinking buddies. And the way that we’ve approached, not just fundraising, but also hiring, is that we systematize it, we make it a platform. And so we run a program, we have everyone make sure that they’re running a tight process. We get them to meet all the partners, the key decision makers at the investment groups, whether that be VCs or corporate investors all at once. And then we also like follow up to see how that fundraising is going. And so we just make it a more structured process, which sounds very simple, but the other VCs in Japan are not doing that.

Tim: So, you mentioned the two of the key things are raising the next round, finding the teams. These are incredibly important for any founder of a growing startup. What’s missing? What needs to be added?

James: The other final piece is, okay, so once you’ve raised the money, and a lot of times that money is raised to hire people, but now what, like, how do you scale the company? And there are all kinds of things that are just like from the banal, like, okay, what HR SaaS we should use? Of course, my HR to like, hey, I’m thinking about setting up a stock option plan, and how do I communicate?

Tim: So, shades of Y Combinator here.

James: Yeah, exactly. That’s what it is. And so basically we’ve built like a Y Combinator like community in Japan without the accelerator. So I mean, that’s what we’re trying to do. We have built an ecosystem here. We have this co-working space where founders and employees can come in. And so we want the CFOs to talk to each other. We want the marketers to talk to each other. We want them to exchange information. We might have high level information, but we don’t have the real time information. So, they’re the practitioners. Like they know what’s the most relevant at this moment in time. And so getting that across our portfolio as quickly as possible is important for us.

Tim: So, when you were raising fund one, this was a new concept in Japan, is it becoming more common? Do you see more and more VCs trying to add value to the portfolios in this way?

James: Yes. There’s many folks that have copied us or at least tried. But I mean, structurally it can be very hard. So for example, if you are a VC that takes a very traditional model, and when you invest, you’re a lead investor and you sit on boards, then their calendar does not have time to basically like hacking together like a talent database and like in figuring out how to increase like applications to that database.

Tim: Even taking a step back from the actual execution of doing something like this, do you get a sense that the VC’s perception of what a VC should be is changing? Do you think Japanese VCs are coming around to the idea that hey, VCs should be playing this role?

James: Yeah, I do. I would say there’s a handful of firms that have woken up. So, but still a handful. Still a handful. So, definitely the market has changed. I’m not going to say that it’s thank thanks to us, but I certainly think that we put a jolt to the system.

Tim: No, I think you really have had a much bigger impact on the Japanese VC ecosystem than your assets under management would imply.

James: Yeah. Well, thank you. Yeah.

Tim: Why do you think so many VCs still are focusing on check writing? Is it just inertia or they’re big enough, they don’t have to sweat it?

James: Well, most VCs in Japan or finance backgrounds, consulting backgrounds. And that’s not to say that that’s a bad thing. I mean, like there are many, many very successful VCs that have those backgrounds. But if you are more like an operator or you have like an entrepreneur background, you just kind of see the world differently. The solutions that you come up with to the same problems are different. And so we’ve always looked at venture capital as a product, and that’s why we’ve built our own tools and we’ve come up with our own sort of creative ways and to solve similar problems. Whereas if everyone has the same background, it’s likely that they’re all going to come up with similar solutions? And we just happen to be the black sheep here.

Tim: Well actually, let’s get back to that. So, founding a VC in Japan as a foreigner, did that work to your advantage? Did it work to your disadvantage? A little of each?

James: A little of each. A little of each. So, for context for the audience, I did halfway grow up in Japan. So, I was in Japan on and off until I was 12. So, I do speak Japanese quite well. Now, with that said, no matter how long I’ve lived in Japan, my face doesn’t change. So, I’m still very much a Gaijin. Yeah, I mean, there’s some ways that it benefits me in some ways that it doesn’t. So, in ways that it does even though I speak native level Japanese, there are some cultural FAPAs that I cannot worry about too much. And so I can go to the decision maker directly, or I can be a little bit more direct about like, hey, we really want to invest your company and we’re going to support you, this kind of thing. In cases where it doesn’t benefit, there are some founders that are very globally minded, and I tend to sort of connect with them much better, whereas there are others that are very much domestically minded. But we have other members on the team that connect and I think every firm is going to have that sort of different chemistry with different type of teammates. But that’s probably one. And then when we first got started, no one in the VC industry took it seriously, we were able to raise our fund. And so there were LPs clearly that believed in us. But I would say that the old guard, the VCs, which I’m very cool with now, like I’ve been accepted into the community, I think now, but at that time, yeah, I mean, it was like, who’s this guy? And then we launched the JKISS, which is basically like the SAFE of Japan and like who’s this guy coming in and creating, like what he says is the standard or should be the standard for financing documents in Japan. Like, who does he think he is?

Tim: No, I mean, that attitude, the who does this guy think he is attitude, I think holds Japan back in so many ways. Anytime someone stands up and say, hey, this would be cool, I’m going to do it. 50 people around, it’s like, well, who does this guy think he is?

James: Right. Yeah. I mean, to be fair, I was 26 at the time, like maybe that would’ve happened in Silicon Valley too. But for the record, the JKISS is very much widely used now, and literally it’s in government papers and publications like, hey, we support the JKISS and the tax benefits also, you can use the JKISS, by the way, I just want to make sure that’s in there.

Tim: I mean, obviously you found LPs who believed in you and saw the vision, but was there a lot of skepticism about, I mean, and not just skepticism, like any new fund faces skepticism.

James: Yeah, I mean, if you want to live a life in entrepreneurship or just life in general, there’s always going to be skepticism. It’s constantly, it’s like, okay, so we’ve had very fast fundraisers and I’m very grateful for that, but I don’t think people realize how many nos there actually are. It’s a grind. The nos are kind of product part of the process. And if you just think of it as like a feedback loop, then it’s like a bit easier to have that mental fortitude.

Tim: Main cabinet office. A lot of government agencies, Tokyo Metropolitan Government, are all trying to attract more foreign VCs to Japan, both in terms of investing in Japanese companies, but also individual investors to come and start funds and to bring that knowledge with them. As someone who’s gone through that, how hard a time are these people in for? If someone wants to come and set up a fund here, what should they expect?

James: So, to be honest, I think it’s totally ridiculous that the government is even pushing this. And I’ll tell you why. If there are good companies, they will get funded by global investors. So, Smart HR is funded by Sequoia. There are other companies also in a portfolio that I raise money from, Green Oaks, Light Street, et cetera. So, if you have the good companies, they will come. And the problem with what the government is doing is the VCs that are going to take money from the Japanese government in order for them to invest in Japan, like with strings attached, there’s going to be adverse selection there. Sequoia is not going to take the money with the strings attached, like, hey, you have to invest in Japan. Like, they’re not going to do that. And the other thing is that as much knowledge and success that those firms have, they don’t have like the local connections and the local sort of understanding in order to help those companies at the earliest stages. It might sound like I’m talking in my book, but it is true. I mean, they don’t. There’s no one…

Tim: And you are a bit, but that’s okay. But see, this is true everywhere. American VCs, these firms have offices in London, they’re in Europe, they’re all over the world. Japan seems to be a really popular destination for funds looking for LPs. It’s a great place for funds to raise money. But there’s not a lot of investment into the country.

James: Yeah. And I’ll tell you why. In 2020 and 2021, the ZRIP era, it was go-go days, like everything was good times people were just like flying into geographies, like, okay, maybe not with Covid, but right after that. And the first markets that really saw their prices shoot up were the English speaking markets or the markets where you didn’t need to speak the local language in order to compete. UK, places in Europe, even Southeast Asia, Japan, you do really have to speak Japanese or at least try to get over that barrier. So, it’s not as easy. So, I did have those like crossover fund types pinging me about deals in Japan, but it was much harder for them to really understand what’s going on and catch those opportunities quickly. I just think it’s, there is that sort of black box element about Japan that makes it much harder to penetrate.

Tim: So, do you think even as the ecosystem grows, and let’s say that the government targets are hit, we hit the 10X in five years, which we could. Do you think that the VC scene here will remain primarily a domestically led VC industry?

James: Well, to be clear, I want more foreign VCs to come and invest in Japanese companies. And in order to get to that 10X from here OKR that the government has set, we’re going to need to do that. That’s obvious. But what I’m saying is that bringing the capital here is not going to solve the fundamental problem, which is you need startups that you need good startups.

Tim: Yeah. There’s a supply side problem as well. Yeah, that’s true.

James: Exactly. So, that first and foremost needs to be solved. And I just think that at the earlier stages, in order to build these companies to a significant enough scale for it to be interesting for foreign investors, you need to invest in a local ecosystem so that it’s self-sustaining without the global capital. And once it is, the global capital will come. There’s good investment opportunities, it’ll flood.

Tim: That makes sense. For the foreign VCs that are thinking of investing in Japan or coming to Japan, what do you think are the biggest misconceptions that exist about the Japanese market?

James: Okay, so this most recent fund, we have 30% of our capital from outside Japan. And these days, I’m typically the person that foreign institutional investors will get in touch with, or I’ll be introduced as the person to talk about Japan VC in English. So, I’ve talked about this a lot. The sort of qualifiers, or the filters that I always ask in the beginning are, do you understand the local IPO dynamics? And almost always the answer is no. For better or for worse, the barometer for startup ecosystems in recent years has been number of unicorns. And so you look at, UK has X unicorns, Europe has Y unicorns. No, but China has whatever Z unicorns, as we’ve seen like these, a lot of them are not unicorns at all. They’re actually paper coins. And so I think we’ve had this like reality check. The difference in Japan is that it’s much easier to go public. So, you can go public around series B or series C in terms of valuation and revenue. And so historically companies have gone public around that stage. The good thing about that is that you can get liquidity a bit earlier as a VC, as an early investor, that’s fine, but because those companies go public around that stage, there’s a lot of cases where actually they crossed the billion dollar mark in enterprise value after IPO just a few years after IPO.

Tim: You wrote a really good article about this a while ago, and we’ll link to it on the site. But yeah, in terms of actual value, economic value creation, exactly. It is comparable.

James: Exactly. So, actual enterprise value creation, like that’s what’s important. And these are companies that are liquid now, like they’re public companies. And so why are they not counted? So, unicorn, technically the definition is a private company. That’s valued at over a billion dollars. The thing is, in Japan, a lot of these companies have gone public early and then crossed the billion dollar threshold. I always knew that this was like a fundamental issue. Like it was like a hidden truth that made Japan very misunderstood and so on. The unicorn counts, we didn’t score very well, but we ran the analysis, the article that you’re talking about where between 2011 and 2021, we were looking at, what companies went public within 12 years of founding and then crossed over a billion dollars in enterprise value. And we call these hidden unicorns. And what we found is that actually there were over 40 companies that met this criteria. So I mean, like, this is not counting all the other like new minted unicorn, like real unicorns or I don’t know if real’s the right word, but that tells you a very different story. We’re actually like, maybe there is a lot more enterprise value creation and fund.

Tim: No, I think you’re onto something there. And in fact, I think it comes down to who’s doing the counting. If it’s the VCs doing the counting, they don’t care about enterprise value created 12 years after they exit their fund ends. But the thing is, if it’s METI, the long term is what they really care about. And I think this is relatively new even on the US side, because if you look at like Amazon or Google or certainly Apple, most of the value creation happened well after their IPO.

James: Exactly, exactly. So, it happened well after the IPO. And so this is something that’s different. And so if you are just doing a cursory review of geographies, you’re like, okay, where should I allocate to VC? And you’re like, okay, like let’s start with where there’s unicorns, it doesn’t tell you the whole story. Whereas in Japan, you have to count the hidden unicorns in order to have a holistic picture of what’s going on.

Tim: Of course, you have to have a longer fund 14 year fund. There you go.

James: Right. Exactly. And by the way, I mean VCs in the US also, like ultimately they’re like 15 year funds. Even if it says 10 years, like there’s extension, extension, extension. And as long as you have like an Airbnb in there or a stripe in there, you get some leeway.

Tim: You get the extension. Yeah.

James: You get some leeways.

Tim: Alright. Do you think that’s going to change? Because not only more and more capital is being raised, but bigger and bigger funds are being raised and to deploy that capital, it’s got to be deployed into later and later stage companies. So, do you think this dynamic’s going to change in Japan?

James: It is changing, it already is changing. I would say that the Japan market is what Silicon Valley looked like maybe in like the early two thousands.

Tim: Hopefully not too early in the 2000 I was over there. It was pretty bleak.

James: Yeah, yeah, yeah. Maybe, maybe 2005 onwards.

Tim: Okay. There we go.

James: Alright. My point is that the labels on these rounds have really like shifted. What was a series A in the US at that time is really a seed round now, right? Raising three to 5 million might’ve been a series A at that time. And that’s kind of the case in Japan where a series A, it could be anywhere from three to 10 million or something. And of course there’s outliers, but that’s generally the range. And then seed rounds are maybe like 500k to 3 million or something like that. And so the labels are very different in Japan.

Tim: Alright, well listen James, before I let you go, I’m going to ask you to peer into this crystal ball and tell me what does Japan’s startup ecosystem look like in 10 years? What does Coral Capital look like in 10 years?

James: What we’re doing at Coral, the dream that we’re building is basically we want to be of course the top firm in Japan and I think we’re getting there. But we are building a firm that is based in Tokyo, investing in hopefully the Power Law companies, the next Toyotas and Sonys in Japan. But eventually we do have global aspirations, but we’ll always keep this sort of Japan angle. So, we’d love to be able to invest in companies that we see outside Japan. We also think might have potential coming into Japan. So, going back to the Japan category leader topic, when we’ve come to inclusion that that category is probably going to be dominated by a global player, then we’ve already done the work and we’ve thought about that area, why not invest in a global player and help them come to Japan? And so this is still very early stages, but who knows how it’s going to play out. But maybe the open AI of Japan is open AI. They set up shop here, maybe not of course like getting in early and like competition in the US is really fierce. Like I understand all those challenges, but what we’re building here is we want to be the number one firm known for Japan. And so we’re building a team that is able to do that. On that note, we’re also hiring, so let me just plug that in. Please apply at our website. Looking forward to seeing your application.

Tim: Excellent. Alright James. But thanks so much. Let’s not wait so long before the next one.

James: No worries. Thanks for sitting down. Yeah, yeah, yeah, yeah. Thanks

Outtro

And we are back.

James’ point about the dangers of unicorn counting is an important one and one I’ve talked about myself in past episodes. We’ll put links to both James’ article and the past podcast episodes at the site. You see, US startups are staying private much longer and can raise levels of capital that used to require access to public markets.

So yeah, markets where that’s true will have a lot more unicorns because there is much less incentive to go public in such markets.

In fact, WeWorks fall from a $47 billion super unicorn status was actually triggered by their decision to go public because that opened them up to much greater financial scrutiny than raising VC funding ever did. And you know, come to think of it, WeWork might be the only startup in history whose bankruptcy was caused by their IPO filing.

Startups are valuable because they drive innovation that leads to long-term enterprise value and quality job creation. And unicorn counting is not necessarily the best measure of that.

So, could patient venture capital provide Japan with a systemic edge?

Maybe.

A more patient mindset and the influence of corporate venture capital in Japan is certainly causing VC culture to develop differently here. Add to that, some very impressive innovations in deep tech manufacturing and robotics and that would be something that plays to Japan’s strengths, is unique in the world and could create tremendous value rather than pushing for riskier growth, faster exits and more liquid secondary markets. Perhaps Japan can continue to expand while maintaining a focus on long-term value creation.

Maybe. We’ll see, won’t we?

In any event, I strongly agree with James’s assessment that a lot about Tokyo today feels like Silicon Valley back in the old days. There’s a lot of genuine innovation at creating real value and we have a lot of passionate founders solving problems using small budgets and big dreams.

 

 

If you want to talk more about how to raise a fund in Japan, James and I would love to hear from you. So, come by disruptingjapan.com/show220 and let’s talk about it. And hey, if you enjoy disrupting Japan, share a link online or just tell people about it. Disrupting Japan is free forever and letting people know about it is the absolute best way you can support the podcast.

But most of all, thanks for listening and thank you for letting people interested in Japanese startups and VC know about the show.

I’m Tim Romero and thanks for listening to Disrupting Japan.