Financial support for startups
The Japanese government has positioned 2022 as the beginning of the new promotion of business startups (Note 1). As noted in the Basic Policy on Economic and Fiscal Management and Reform 2022, startups are supporters of the new form of capitalism because they produce innovations as a driving force for economic growth and can contribute to resolving societal challenges, including environmental and child-raising problems. The FY2022 White Paper on Small and Medium Enterprises in Japan defines startups as “privately held companies in Japan (including Japanese companies founded by non-Japanese people and overseas companies founded by Japanese people),” “companies with unique technologies, products, services or business models, which invest in and try to expand business growth,” and “companies that change current lifestyles, society, economic models, technologies, etc. and take on the challenge of creating a new and better world.”
According to the White Paper, investment in Japanese startups increased 6.4-fold from 177.9 billion yen in 2014 to 1,143 billion yen in 2021. Financial support for startups has definitely expanded.
This scale of investment, though exceeding 1 trillion yen, is still insufficient as investment in an economic growth engine. The size of U.S. investment in startups is 33 times that of its Japanese counterpart (Note 2). Investment by venture capital firms as major investors in startups is limited to 0.03% of gross domestic product in Japan, far less than 0.40% in the United States and the second lowest after Italy among the Group of Seven industrial democracies. A frequently cited reason for the low venture capital investment level in Japan is that investment by Japanese asset owners such as pension funds in venture capital firms has been limited (Note 3).
While Japan is required to continue efforts to increase the flow of funds into venture capital firms, I ask if there are any other promising routes for providing funds to startups. In respect to the question, a breakdown of startup investment at 1,143 billion yen in 2021 indicates that financial institutions account for only 36 billion yen or 3% of such investment, against 389.9 billion yen or 34% for domestic venture capital firms, 331.1 billion yen or 29% for overseas corporations and 179.3 billion yen or 16% for Japanese corporations.
Hopes on regional financial institutions’ enhancement of financial intermediation
Given my field of specialization, here I would like to consider if private financial institutions’ activity in fund provision to startups can be increased. It is understandable that private financial institutions that collect funds through deposits are cautious about undertaking risky investments in startups. Meanwhile, it is assumed that private financial institutions have great potential to transform household behavior in Japan, where cash and deposits accounted for 1,102 trillion yen or 54.9% of household financial assets in June 2022 (Note 4).
According to the FY2022 White Paper on Small and Medium Enterprises in Japan, the reason that is most frequently cited by entrepreneurs for the smaller number of startups in Japan is concerns about failing (e.g., failing makes second chances difficult) (cited by 39.2%). Indicating the significance of this problem, the Basic Policy on Economic and Fiscal Management and Reform 2022 calls for improving "the environment for procuring growth funds by expanding loans that do not depend on personal guarantees or real estate collateral, and by creating a mechanism that enables the procurement of growth funds by providing guarantees covering whole businesses." In this respect, a breakaway from financial institutions’ lending practices that depend on personal repayment guarantees provided by business owners may improve the situation.
According to the Financial Service Agency, the share of new loans that are not dependent on business owners’ guarantees has increased steadily from 16.5% in FY2017, but had still only reached 29.9% as of FY2021 (Note 5). Also, as of FY2021, only two banks had a less than 20% share of such loans, down from 23 in the second half of 2019. Meanwhile, the number of banks with over 66.7% of their loans in this category increased slightly from three to four.
Due to this situation, the Financial Service Agency has decided to revise its supervisory guidelines to make it difficult for banks to require guarantees from business owners without a specific explanation of why such a guarantee is necessary (Note 6). The Small and Medium Enterprise Agency has promoted various measures, such as enhancing the profitability and governance of small and medium enterprises and revising the credit guarantee system to develop lending practices that are not dependent on business owners’ guarantees.
These revisions can be expected to facilitate financial institutions’ loans to startups, promoting their growth. However, it may still be difficult for financial institutions to manage risks regarding the lending of deposited funds to startups. A flow of funds that allow people to take risks is required. This means that a system for providing personal funds to venture capital funds must be enhanced.
Regional financial institutions have the potential to play some roles in that respect. One of the problems that regional financial institutions face at present is that their collected deposits massively outweigh their investment opportunities. They have focused on investment trust sales both for the purposes of earning sales fees and managing their asset liabilities structure. However, investment trusts are not designed to direct funds into local startups. While investment trusts are not prohibited from covering privately held equity shares under Japanese law, it is pointed out that a framework is required for securing the sound management of investment trusts (Note 7). Such a framework would include how to respond to liquidity risks and how to assess privately held equity shares. The framework should be improved to enhance a mechanism to allow household money to flow into startups.
Hopes on support beyond financing
It is my hope that regional financial institutions will not only allow more money to flow into startups, but also provide a wide range of support options toward establishing and growing startups. For instance, they could develop local entrepreneurial infrastructure that would not only motivate people to establish new businesses, but also provide startups with higher initial evaluations. They could also provide startups with business administration know-how and help them to form partnerships with other companies.
The Banking Act was revised in May 2021 to substantially ease business scope regulations regarding banks and banking groups. It is hoped that financial institutions will take advantage of the business opportunities provided through such deregulation to enhance support for startups. In fact, some financial institutions have already launched relevant initiatives as described below.
Shizuoka Bank created a startup support initiative which gives priority to investment in startups in the Tokyo metropolitan region, accepting the fact that there are more startups there than in other regions. Through such investment, the bank is developing a cross-industrial network that is used to create new businesses to innovate banking and to support local enterprises in their revitalization efforts and expansion into new business ventures. In an attempt to innovate their business, the bank has launched a new housing loan business that adopts the “Tatepita Shizuoka” project by iYell Co., which consults with would-be home buyers and introduces them to the most suitable housing developers or builders for their needs (Note 8). The company is an investment target for Shizugin Investment Fund.
The bank also runs the TECH BEAT Shizuoka platform to invigorate local enterprises. The platform links enterprises in Shizuoka Prefecture to startups in the Tokyo metropolitan region to provide sophisticated, tailored services to the enterprises in Shizuoka. A trade fair under the platform was held in July 2022, with the participation of 56 AI startups with strengths in artificial intelligence, digital transformation and other technologies. The two-day trade fair reportedly attracted 3,300 people and produced a total of 328 official business talks (Note 9).
In order to increase customer numbers, Shizuoka Bank also sponsors first and second-attempt startup establishment workshop programs (including a September 2022 program that the bank co-sponsored along with its business partner Yamanashi Chuo Bank) and an annual Shizugin entrepreneur Grand-Prix award (FY2022 was the 9th such event). Furthermore, it became the first regional bank to be certified to guarantee private loans to “DeepTech” ventures under a system created by the Ministry of Economy, Trade and Industry in August 2021. The system allows startups with business plans certified by the ministry to use a debt guarantee program from the Organization for Small & Medium Enterprises and Regional Innovation, Japan, when borrowing loans from private financial institutions that are certified by the Minister of Economy, Trade and Industry.
I would like to introduce another case in which a local enterprise was linked to a startup. Under the Hiroshima Open Accelerator program that Hiroshima Bank runs in cooperation with the Hiroshima Prefectural government, a company called DAIKURE, based in Hiroshima Prefecture, adopted a proposal by a startup named KANBAI, Inc. for using water-resistant products as an advertising medium and developed digital signage systems using flood prevention sheets (Note 10). The regional bank served as a catalyst to link a local enterprise’s strengths to a startup’s new technology.
Making startup support a main business
In the United States, where high-growth startups reportedly create half the new jobs, startups have driven U.S. economic growth through innovation (Note 11). The U.S. experience indicates that while support for the sustainable growth of existing enterprises is important, such support alone cannot fully revitalize stagnant, non-metropolitan economies.
Meanwhile, the 139 companies which completed successful IPOs in Japan in 2021 were limited to 21 prefectures. In the remaining 26 prefectures, no companies conducted IPOs. Of the IPO companies, 88 firms or 63.3% are based in Tokyo and 10 in Kanagawa, Chiba, and Saitama, which are the prefectures neighboring Tokyo. Those based in the Tokyo metropolitan region, which includes these four prefectures, account for more than 70% of the total (Note 12), indicating that only a few startups were founded outside the region. A sense of crisis regarding this situation is prompting many regional financial institutions to focus on startup support.
Fortunately, positive changes are occurring as evident in the regional financial institutions’ business initiatives that are reviewed in this paper. It is my hope that in the future, regional financial institutions that take advantage of their regional networks will be able to boast that support for startups that invigorate regional economies is their main business.
