What Financing Mechanisms and Organizations of Business Entities Best Facilitate Innovation?

In this session, Joseph McCAHERY (University of Tilburg) gave a presentation on securitization and competing forms of finance for non-listed companies while Ronnie QUEK CHENG CHYE (Allen & Gledhill), gave a presentation on LLP and LLC systems in Singapore. SAITO Jun, (Core Technology Center, Nikon Corporation), then presented a summary report on these topics. Following this, Mr. Quek gave a supplementary explanation.

Finance comprises debt and equity. If the relationship of profit and loss (vertical axis) and time (horizontal axis) is depicted in a figure from the standpoint of the fund supplier, a successful business will yield profit and income over time (Figure 4-P.6 [PDF:748KB] ). In business entities that focus on human capital, equity plays a vital role.

As shown in the figure on the left, in the beginning there is a period during which losses continue ("death valley") and the supplier of risk capital gradually draws attention as an entity that supplies funds to an enterprise that is riskier than VC.

(Middle to right of the figure) Following the public stock offering, financing is provided by the public. As shown on the upper right, financing of a debt nature appears for the first time only when banks provide funds in the final stage. That is to say, the enterprise is maintained by financing of an equity nature. In this figure, the left side is the stage at which innovation takes place, and therefore financing in this stage is mostly of an equity nature.

Financing consists of two types: public financing supplied by the general public after IPO and private financing provided out of the pockets of family and friends prior thereto.

Financing that is supplied for innovation made by human capital is private and of an equity nature. The method of financing in the form of one vote per share may be viable in the case of public ownership. However, there are also concerns about whether this is an effective rule and how investors view the case where both public financing and private financing are supplied, as seen in a partial public company.

STMicroelectronics N.V. (ST) is a case in point of a company comprising both public and private financing. This company is funded by France Telecom and Finmeccanica of Italy. Finmeccanica is funded by the Italian Ministry of Treasury, but 34% of it is owned by a company named ST Holding II BV ("BV" means anonymous or privately held). As such, Finmeccanica is partly privately owned (Figure 5-P.11 [PDF:748KB] ). Strategic partners and closed partners are not obligated to disclose such private owners. In the case of ST, however, the name of 11 owners, such as Hewlett-Packard, Nokia, and Pioneer, have been disclosed. These companies have an arrangement in which they have ST manufacture the semiconductors they need in return for providing private financing. Such enterprises therefore entail public financing as well. For companies supplying private financing, the merit of adopting such a form of business is that technologies would be developed one after another, thus facilitating business operation. Furthermore, this form of business helps with fund procurement because of the presence of public financing, thus offering benefits in every way.

In a globalized world, capital and businesses can move to any city. Firms can simply transfer their capital and business to cities with an outstanding environment, if such cities exist. The U.S., Britain, France, and other countries design legal systems suited to capital and businesses, and they attract companies by enabling various forms of business to exist. In 2005, legal systems for LLP were established in Japan and Singapore, making it possible to introduce a new form of business.

The advantages of a partnership lie in the flexibility and privacy of the arrangement pertaining to ownership and right of management among the partners. In addition, taxes imposed on a partnership would be imposed on the marginal tax rate for individual partners. On the other hand, the disadvantage is that the partners have unlimited liability, which is probably the case in Japan as well. Thus, the new legal system created in 2005 was improved because it limited partners' liability while ensuring flexibility and pass-through taxation in the arrangement between partners.

In Japan under this new system, two forms of business, the J-LLC (limited liability company) and the J-LLP (limited liability partnership), are now possible. The J-LLC is modeled on the LLC of the U.S. However, the disadvantage of this system is that the business entity is taxed as a corporation, and at the same time, its members are also taxed according to their share of profit. As such, this system has the problem of double taxation. On the other hand, the advantage is that the members can enjoy limited liability. This is because the LLC has a corporate status that is separate from the statuses of individual members.

In the J-LLP, partners bear limited liability while enjoying pass-through tax treatment. However, since the J-LLP is not recognized as a corporation, an agreement concluded with a J-LLP is actually an agreement concluded with the partners of a J-LLP. The J-LLP has a governance structure that requires all partners to participate in the management of partnership affairs. However, it seems that the definition of management remains ambiguous and unlimited liability is imposed on all partners if some of them do not participate in the management of partnership affairs. Given the point that risk is borne under joint liability, this system is not fair to all partners.

Another characteristic of the J-LLP is that partners jointly own property but do not have ownership of real estate. Furthermore, a J-LLP can neither become a J-LLC with corporate status nor merge into a J-LLC. When its business expands and it needs to reorganize into a corporation, it becomes necessary to liquidate a J-LLP. In such a case, a J-LLP may be subject to capital gains tax. A comparison of the outline of the J-LLP system and the legal system for LLPs in Singapore is shown below (Figure 6-P.15 [PDF:748KB] ).

Unlike J-LLPs, LLPs in Singapore are granted corporate status. Although LLPs in both countries have limited liability, LLPs in Singapore are not required to compensate for losses or to bear liability as corporations because LLPs have a corporate status that is separate from the statuses of individual members. In Japan, LLPs are obligated to submit a partnership agreement. For this reason, information concerning an LLP is made public to some extent in that process. In Singapore, however, there is no such requirement and partners do not have an obligation to participate in the management of partnership affairs. Pass-through taxation exists in both countries. Whereas the consent of all partners is required in Japan for the transfer of assets, assets cannot be transferred in Singapore. Nevertheless, in Singapore the right to appoint a new partner is approved upon the retirement or resignation of a partner. Although this is a somewhat complicated system, it consequently allows the transfer of assets. Furthermore, although not shown in the figure, the point of whether or not creditors can check the accounts is included in Japan but not in Singapore.

In conclusion, it can be said that Japan's and Singapore's systems for this new vehicle have several problems from the viewpoint of both creditors and the public.