How the Silicon Valley Financing Model Works in Japan - Limitations and Alternatives - (AIS) John Y. Sasaki December 15, 2016 American Chamber of ...
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How the Silicon Valley Financing
Model Works in Japan –
Limitations and Alternatives
John Y. Sasaki
December 15, 2016
American Chamber of Commerce
Alternative Investment Subcommittee
(AIS)John Y. Sasaki
1991 J.D., Boalt Hall, U.C. Berkeley
1994 - 1997 Komatsu & Koma, Anderson Mōri (Tokyo)
1997 - 2002 Wilson Sonsini Goodrich & Rosati (Palo Alto)
v start-up representation
v venture capital financing
v public offerings
v M&A
v U.S. - Japan transactions
2002 - 2006 Partner, Morgan Lewis & Bockius (Tokyo)
2006 – present
üPrincipal, JSV Foreign Law Office
Gaikokuho Jimu Bengoshi (California)
ü
üAdjunct Lecturer, Keio University
üMentor, Founder Institute, Tokyo
2DISCLAIMER
This presentation is for informational purposes only, and any and
all information contained herein is not intended to constitute legal
advice. Accordingly, you should consult with your own attorneys
on all legal matters. In particular, JSV Foreign Law Office is not
licensed to advise on Japanese law, so you should consult with
your Japanese lawyers on matters of Japanese law. You should
not take, or refrain from taking action based on the content in this
presentation. We do not guarantee the accuracy of the
information in this presentation, and further assume no liability in
connection therewith.
3Today’s Agenda
u Basic Financing Model Review
v Silicon Valley vs. Japan
u Top 10 Legal Issues in Japan
v Limitations and Alternatives
4Some Basic Concepts
u Common Stock vs. Preferred Stock
v Common Stock (= “sweat equity”)
u Founders
u Employees (stock options)
v Preferred Stock
u Outside Investors
5Some Basic Concepts
u Private Financing vs. Public Financing
v Private Financing
u Venture Capital
v Public Financing
u Stock Markets
6Initial Capitalization
(or Founders Capitalization)
u Common Stock = “sweat equity”
u Issuance of Stock to Founders
v Issue High Number of Shares
v Nominal Price
7Capital Requirements
(United States)
u No Minimum Par Value
v e.g., Price Per Share = $0.001
u No Minimum Capital
v e.g., 3,000,000 Shares = $3,000
8Founders Capitalization
(United States)
u Founders – 3,000,000 Common Shares
v Price Per Share - $0.001
v Total - $3,000
No. of Stock Price Per Total
Shares Type Share Investment
Founders 3,000,000 Common $0.001 $3,000
Total: 3,000,000
9Capital Requirements
(Japan)
u No “Par” or “Non-Par” Value Stock
u No Minimum Price Per Share
v Price Per Share Can Be ¥1
u No Minimum Capital Requirement
v Initial Capital Can Be ¥1
10Founders Capitalization
(Japan)
u Founders – 500,000 Common Shares
v Price Per Share - ¥1
v Total - ¥500,000
No. of Stock Price Per Total
Shares Type Share Investment
Founders 500,000 Common ¥1 ¥500,000
Total: 500,000
11Founders Capitalization
(U.S. vs. Japan)
U.S.
No. of Stock Price Per Total
Shares Type Share Investment
Founders 3,000,000 Common $0.001 $3,000
Japan
No. of Stock Price Per Total
Shares Type Share Investment
Founders 500,000 Common ¥1 ¥500,000
12Issue #1 – Contributions in Kind
(United States)
uGenerally permitted – no third party valuation
required
BUT
u Services – must be past, not future, services
u In Practice
v Founders pay cash ($0.001/share), plus all IP
13Issue #1 – Contributions in Kind
(Japan)
u Third party valuation required
BUT
u Exception - if value of in-kind contribution is not
more than 5,000,000 JPY
BUT
u Valuation cannot be 0
u In Practice
v Founders pay cash (¥1/share), IP transferred
separately 14Issue #2 – Vesting/Repurchase Option
(United States)
u Vesting is standard
v 4 years, 1-year “cliff”
u Repurchase price is original purchase price
BUT
u Legal restrictions on repurchases (state-by-state)
u In Practice
v Legal restrictions are not an obstacle
v Delaware – No impairment of capital
15Issue #2 – Vesting/Repurchase Option
(Japan)
u No vesting is typical, but changing
u Repurchases are restricted – “surplus” is required
u Statutory participation rights for other shareholders
u In Practice
v Other founders have repurchase right
u 1 founder, no vesting
v Purchase at original purchase price may raise tax
issues if below fair market value
16Stock Options
(United States)
u Approvals Required
v Stockholders Approve Pool
v Board Approves Individual Grants
u Size of Pool
v No Restriction (Generally)
u Grants
v No Restrictions on Grantees
v Incentive Stock Options (ISOs) vs.
Non-Incentive Stock Options (NSOs) vs. Warrants
17Option Plan Capitalization
(United States)
u Option Plan – 1,000,000 Common Shares
v Initial Exercise Price Per Share = $0.01
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 3,000,000 Common $0.01 $30,000
Option Plan 1,000,000 Common $0.01 $10,000
Total: 4,000,000 (fully diluted)
18Stock Options
(Japan)
u Issuing Options Is Generally Permitted
v Creation of “Shinkabu Yoyakuken”
u No Limitation on Number of Options
u No Limitation on Grantees
u Shareholder Meeting Is Required
v Can Create Pool of Options Allocable by the Board over a
One-Year Period
19Option Plan Capitalization
(Japan)
u Option Plan – 100,000 Common Shares
v Initial Exercise Price Per Share = ¥10
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 500,000 Common ¥10 ¥5,000,000
Option Plan 100,000 Common ¥10 ¥1,000,000
Total: 600,000 (fully diluted)
20Option Plan Capitalization
(U.S. vs. Japan)
U.S.
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 3,000,000 Common $0.01 $30,000
Option Plan 1,000,000 Common $0.01 $10,000
Total: 4,000,000 (fully diluted)
Japan
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 500,000 Common ¥10 ¥5,000,000
Option Plan 100,000 Common ¥10 ¥1,000,000
Total: 600,000 (fully diluted)
21Issue #3 – Tax-Qualified Options
(United States)
u Main ISO Requirements
v Stock Option Plan
v Employees
v Holding Periods
u 2 years from grant to exercise
u 1 year from exercise to sale
v Stockholder Approval
u In Practice
v ISOs are converted into NSOs 22Issue #3 – Tax-Qualified Options
(Japan)
u Main Tax-Qualified Option Requirements
v Employee or director, not statutory auditor
v Exercise Period – only after 2 years from approval of
grant
u In Practice
v No conversion of ISO into NSO
v Additional Requirements
u No exercise until IPO
u No exercise after termination of employment 23Venture Capital Financing
(or Private Financing)
u Equity vs. Debt
v Banks - Short-Term Capital
u Common Stock vs. Preferred Stock
v 1 to 10 Valuation Ratio
v Preferences (in Articles/Certificate)
v Contractual Rights
u Convertible Debt or Equity
24Issue #4 – Convertible Debt
(United States)
u Securities (under U.S. securities laws)
v Compliance with federal and state securities laws
AND
u Contract
v Terms negotiated between company and investor
u In Practice
v Simple Forms – Note Purchase Agreement,
Convertible Promissory Note
v Not heavily negotiated 25Issue #4 – Convertible Debt
(Japan)
u Contract (U.S.-style Convertible Promissory Note)
v No automatic conversion
v Lender law compliance required
OR
u Convertible Bond (CB) with Warrant
v Corporate law-based – warrant terms are registered
v Warrant exercise is at investor’s option
u In Practice
v CB w/Warrant is becoming more common 26Issue #5 – Convertible Equity
(United States)
u Securities (under U.S. Securities Laws)
AND
u Contract
BUT
u No repayment term
u In Practice
v Simple Forms – SAFE (Simple Agreement for
Future Equity), KISS (Keep It Simple Security)
v Not heavily negotiated 27Issue #5 – Convertible Equity
(Japan)
u Contract (U.S.-style SAFE or KISS)
v No automatic conversion
u No registered instrument per se
v But can use CB w/Warrant, with long term
u Common Stock converted into Preferred Stock
v Tax issues
u In Practice
v Not common
28Preferred Stock Financing
(United States)
u Valuation Ratio
v 10 to1 (?) – 409A Valuation
u Articles Provisions
v Dividend and Liquidation Preferences
v Anti-Dilution
v Class Voting
u Board Election
u Protective Provisions
u Contractual Rights
v Registration Rights
v Right of First Refusal/Co-Sale Rights
v Preemptive Rights
29Series A Capitalization
(United States)
u Pre-Money Valuation - $8,000,000
u Investors – 1,000,000 Preferred Shares (20% -
post-money, fully-diluted)
v Price Per Share - $2.00
v Total - $2,000,000
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 3,000,000 Common $0.20 $600,000
Option Plan 1,000,000 Common $0.20 $200,000
Investors 1,000,000 Series A Preferred $2.00 $2,000,000
Total: 5,000,000
u Post-Money Valuation - $10,000,000
30Preferred Stock Financing
(Japan)
u Valuation Ratio
v 5 to 1 (?)
u Articles
v Dividend and Liquidation Preferences
v Anti-Dilution
v Class Voting
u Protective Provisions
u Board Election
u Contractual Rights
v Right of First Refusal / Co-Sale Rights
v Preemptive Rights (plus statutory rights)
31Series A Capitalization
(Japan)
u Pre-Money Valuation - ¥600,000,000
u Investors – 100,000 Preferred Shares (14% - post-
money, fully-diluted)
v Price Per Share - ¥1,000
v Total - ¥100,000,000
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 500,000 Common ¥100 ¥50,000,000
Option Plan 100,000 Common ¥100 ¥10,000,000
Investors 100,000 Series A Preferred ¥1,000 ¥100,000,000
Total: 700,000 (fully diluted)
u Post-Money Valuation - ¥700,000,000
32Series A Capitalization
(U.S. vs. Japan)
U.S.
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 3,000,000 Common $0.20 $600,000
Option Plan 1,000,000 Common $0.20 $200,000
Investors 1,000,000 Series A Preferred $2.00 $2,000,000
Total: 5,000,000
Japan
No. of Stock Value Per Value of
Shares Type Share Investment
Founders 500,000 Common ¥100 ¥50,000,000
Option Plan 100,000 Common ¥100 ¥10,000,000
Investors 100,000 Series A Preferred ¥1,000 ¥100,000,000
Total: 700,000
33Issue #6 – Deemed Liquidation
(United States)
u Deemed Liquidation = Sale of Company
v Corporate Transaction = Merger or Asset Sale
v Critical for Silicon Valley Model
u In Practice
v Permitted provision in Articles
v Enforceable – Violation is Void
34Issue #6 – Deemed Liquidation
(Japan)
u Provision usually not registered
u Articles or Contract provision
v Enforceability issue
u In Practice
v Sometimes in Articles, sometimes in Contract
u Enforceable?
35Issue #7 – Language
(United States)
u English (of course)
u In Practice
v Stock Purchase Agreement
v Certificate/Articles of Incorporation
v Investors’ Rights Agreement
v Shareholders Agreement
v Voting Agreement
36Issue #7 – Language
(Japan)
u Terms of Preferred Stock must be registered, so
Japanese is required
u Contracts can be in English (although governed by
Japanese law), or in Japanese (of course)
u In Practice (if foreigners involved)
v Japanese – Terms of Preferred Stock
v English – Contracts (but governed by Japanese
law)
37Issue #8 – Registration Rights
(United States)
u Securities laws – registration or exemption
v Exemption for “restricted shares” (Reg. D)
u Restricted shares remain restricted after IPO
u So registration rights required for VCs to sell shares
after IPO
v Subject to exceptions, e.g., Rule 144
u In Practice
v Registration rights are not necessary for minor
investors 38Issue #8 – Registration Rights
(Japan)
u Securities laws – registration or exemption
v Exemption for private offerings
BUT
u All shares become publicly traded upon IPO
u In Practice
v Registration rights are not necessary
39Issue #9 – Valuation
(United States)
u 10-to-1 Rule
v Preferred Stock = 10 x Common Stock
v No longer applies
u 409A Compliance
v Valuation Report
u In Practice
v Still some flexibility at the early stages
v 409A valuation after VC funding
40Issue #9 – Valuation
(Japan)
u No 10-to-1 Rule
BUT
u No 409A requirement either
u Rule is uncertain, and NTA can be aggressive
v Valuation report
u In Practice
v Generally 5-to-1?
v Maybe 1-to-1 after Preferred Stock financing
41Exit Strategy
u Initial Public Offering (IPO)
v Liquidity
u Acquisition Target
v Market
42Show Me The Money! (U.S.)
u Founders’ Initial Investment
v $3,000 (for 3,000,000 Shares)
u Projected IPO Price or Acquisition Price
v $5 - $20 Per Share
u Total Value of Founders’ Shares
v $15,000,000 - $60,000,000
43Show Me The Money! (Japan)
u Founders’ Initial Investment
v ¥500,000 (for 500,000 Shares)
u Projected IPO Price or Acquisition Price
v ¥500 - ¥2,000 Per Share
u Total Value of Founders’ Shares
v ¥250,000,000 - ¥1,000,000,000
44M&A Structures
(United States)
u Stock Purchase
v Target has few stockholders
v Liabilities kept in separate entity
u Asset Purchase
v Liabilities not automatically included
v But may not be as tax efficient for seller
u Merger
v Target has a lot of stockholders
v Triangular merger to keep liabilities separate (and for
cross-border deals) 45Triangular Merger
(United States)
S S S S S S
＄ B
S S S B
T MS T or MS
u Buyer establishes a new subsidiary (“Merger Sub”)
u Merger is between Merger Sub and target.M&A Structures
(Japan)
u Share Purchase
u Business (Asset) Purchase
u Merger (including triangular mergers)
u Share Exchange (kabushiki koukan)
v Corporate transaction (for shares)
u Share Transfer (kabushiki iten)
v New company established
u Corporate Split (kaisha bunkatsu)
v Target business is spun out and then acquired 47Issue #10 – Triangular Mergers
(United States)
u Consideration can be paid directly from Buyer to
Target stockholders (from U.S. law standpoint)
u Works in cross-border situation
v Buyer establishes Merger Sub in country of Target
(U.S.)
u In Practice
v Triangular merger is commonly used if many
stockholders, even in cross-border deal (for U.S.
target)
48Issue #10 – Triangular Mergers
(Japan)
u Consideration must first be transferred to Merger Sub
v Consideration must be from merging entity
u So, share purchase or share exchange (kabushiki
koukan) is more common
BUT
u Non-Japanese buyer cannot use share exchange to
purchase Japanese target
u In Practice
v Stock purchase is most common structure, even if
many shareholders 49Summary of Issues ISSUE Problematic? Issue #1: Contributions In Kind No Issue #2: Vesting/Repurchase Option Yes Issue #3: Tax Qualified Options No Issue #4: Convertible Debt No Issue #5: Convertible Equity No Issue #6: Deemed Liquidation Yes Issue #7: Language No Issue #8: Registration Rights No Issue #9: Valuation Yes Issue #10: Triangular Mergers Yes
Other Issues in Japan
5 Lack of experienced entrepreneurs.
4 Is equity really an incentive in Japan?
3 Fear of failure.
2 Immature M&A market.
1 Lack of VCs with start-up experience.
51Conclusion
u The Japanese legal system has become
much more favorable to start-up
companies in recent years.
u However, certain legal and non-legal
issues remain in Japan for start-ups.
52Thank you.
Any Questions?
E-mail: jsasaki@jsvlaw.com
For more information on these issues, go to
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