Editorial: CVCs and governments step up

“Japan has spent nearly three decades looking for people, [such as pre- and post-war entrepreneurs Akio Morita, founder of Sony, and Soichiro Honda, founder of the eponymous car maker,] bringing strategic coordination and visionary leadership. Maybe, as in the Meiji era, we need to invite foreigners in with these attributes.

“In the nature/nurture discussion about risk aversion in Japan, it is worth noting that 3% of Japanese people have the serotonin receptors, [which receive the endorphin or so-called happiness chemical,] versus 32% in the US. Maybe most of us we are natural worries and well-trained humans rather than the next Mr Honda?

“If so, perhaps not using competition as a basic condition for economic society but revising the Japanese concept of tenure for life is reasonable.”

These insights from a government official at roundtable on Organising for Innovation hosted by professor Toshiyuki Kono and visiting professor Erik Vermeulen at Kyushu University, Japan, caught the sense of realism brought about from trying to encourage growth and societal change in the country since the late 1980s property bubble burst.

This might be seen as pessimism to some innovation globalisation champions, such as Alec Ross judging by a review of his book, The Industries of the Future.

Marc Andreessen, however, a few years ago said (his emphasis): “Policymakers shouldn’t be trying to copy Silicon Valley. Instead, they should be figuring out what domain is (or could be) specific to their region — and then removing the regulatory hurdles for that particular domain. Because we don’t want 50 Silicon Valleys; we want 50 different variations of Silicon Valley, all unique from each other and all focusing on different domains.”

To potentially help build these domains, Michael Fox, Global Corporate Venturing (GCV) emissary in Silicon Valley, at the roundtable noted that the Valley’s success had been built on its location, critical thinking and agility to ride successive waves of technology change, which were factors that others could use for “effective localisation of value”.

Fukuoka, under its youthful mayor Soichiro Takashima (he was elected in 2010 aged 36), is one region in Japan continuing to explore its options to be a growth centre.

Professor Kono in his excellent and insightful presentation at the roundtable discussed the theoretical models applied in developing the innovation special economic zone (SEZ) in Fukuoka, a region noted for its design skills, particularly at Kyushu University, and high quality of life. He said the SEZ allowed for easier requirements for companies to make staff redundant. However, he noted that the issue of changing conduct, structures and performance was “complex” and few companies had taken up the lighter-touch approach.

This lack of take-up of US-style employee (in)security could be seen as part of a wider concern about whether economic growth is an absolute goal in itself or whether quality of life supported by lower costs could be a more appropriate policy target. In the latest Foreign Affairs issue, Zachary Karabell, head of global strategy at Envestnet, looked at Japan’s experience of slow- to no-growth over the past few decades and argued the country was “learning to love stagnation” given it still has a high quality of life.

But Karabell correctly said: “The world’s financial and political infrastructure remains dependent on the old model, in which GDP [gross domestic product] growth was all-important, and so lower costs, deflation, and slower economic expansion will continue to concern policymakers and central bankers.”

Others go further. Evgeny Morozov, who wrote the above critique of Ross’s book in the Baffler, said: “What is most interesting about Ross’s geopolitical unconscious is his treatment of the future itself. Apparently, there’s just one future, with America and Silicon Valley at the helm. All that other countries can do is either adapt to it by reshaping their industries and expectations to favour more ‘openness,’ or risk being labelled ‘control freaks’ and ‘closed societies’ by the likes of Ross and his army of think tanks, NGOs [non-government organisation], and fake grassroots activists.

“It’s pointless to imitate Silicon Valley, Ross warns. Instead, other countries should accept that American companies will operate the network and communications infrastructure on which the global economy functions. These countries, Ross tells us, should find ways to foster industries of the future and make money with additional services—like, say, data analytics—built on top of that infrastructure.

“This is, of course, very bad advice for any country that would like to preserve strong domestic industry and maintain a modicum of sovereignty.”

Twenty-five years ago and Sony founder Morita in his book, The Japan That Can Say No, made a similar point in an encouragement to the Japanese to take a more independent role in business and foreign affairs and criticism of American business practices.

More recently, Alexander Kuleshov, president of the Skolkovo Institute of Science and Technology (Skoltech), who last month officially took over from the four-year-old research university’s founding president, US professor Edward Crawley, told Sk.ru: “Transferring the MIT model onto Russian soil may not have been the right thing to do.”

Especially after economic sanctions were imposed, Russia has been focused on a national strategy of economic development, according to this GCV analysis.

China is more ambitious as it plans to invest up to RMB1trillion ($161bn) into its domestic semiconductor industry as developing its own integrated circuit (IC) industry is of integral national strategic concern, as outlined in China’s 13^th Five Year Plan covering the years 2016-2020.

Silicon Valley itself was born out of a feeling of dissatisfaction that, in the first half of the 20^th century, the western states of the US were effectively being used as a source of raw materials. A desire by leading figures, including railroad magnate Leland Stanford, founder of the eponymous university in California, and Frederick Terman, the dean of engineering at Stanford, sought to create an industry so his students would not have to leave the valley for electronics firms in the east.

In a GCV regional analysis of Silicon Valley a few years ago, I said: “From a region that felt exploited by the east coast only half a century earlier, Silicon Valley has become an imperial centre exporting its model for other countries to follow and in return importing raw material of talent and tributes.

“The training of venture capitalists in other countries, either from working for valley-based venture firms, such as Intel, Cisco, Sequoia or Kleiner Perkins, or from studying at Stanford, means senior figures in countries as culturally diverse as the UK, Russia and China all talk the same language as US-based venture investors even if the application reflects local requirements….

“But as Terman said: ‘Industrial activity that depends on imported brains and second-hand ideas cannot hope to be more than a vassal that pays tribute to its overlords, and is permanently condemned to an inferior competitive position.’”

Despite this backdrop from international observers, many of Japan’s leading advisers are confident that economic rejuvenation is taking place within a broader context of Prime Minister Shinzō Abe’s “new realism” in foreign policy that is trying to defend the “open, liberal system,” according to Michael Auslin in Foreign Affairs.

Fukuoka’s special economic zone, therefore, is the latest in a line of proposals seen around the country. Masato Hisatake, adviser to Japan’s Ministry of Economy, Trade and Industry (METI), at the Kyushu roundtable noted that the first science and technology business law was introduced in 1995 with the first plan for the sector started a year later. The fifth such science and technology business plan will start this year.

And while there are remaining issues, the United Nations’ World Intellectual Property Organization (WIPO) puts Japan in 19^th position of its global innovation index, Hisatake rhetorically asked: “It will work?

“If not, we will do further regulatory and institutional reforms, such as limited liability corporations (LLCs), innovation patent boxes and corporate venture capital and financial resources required in specific sectors by their stages of development and vehicles used.”

Jun Saito, manager at Nikon who has helped its shift from cameras to high-specification medical imaging, gave an example in film producer Dreamworks SKG of how such vehicles as LLCs could “beget something out of nothing” by allocating profits to “talent” – in this case the SKG acronym refers to Hollywood royalty Steven Spielberg, Jeffrey Katzenberg and David Geffen – who can reap a majority of returns without having invested a majority of the $1bn set-up costs.

Entrepreneurs have concerns about bankers dressed up as venture capitalists, notably described in Y Combinator president Sam Altman’s perceptive post on late-stage preference shares last year, but the more general challenge of having VCs often receiving a one-times pref while founders or earlier angels often only have options, convertible debt or ordinary equity. Structuring “talent-first” LLC-types of structures could shift the rewards balance back to the creators of value, the roundtable discussed.

Dreamworks SKG, while hardly a typical startup in terms of the track record of its “talent” founders and main backer, Microsoft co-founder Paul Allen who contributed $700m of the initial $1bn of funding, did bring together a core constituency of what Shinto Teramoto, professor at Kyushu University, at the roundtable called people with a high “eigenvector centrality” – a method of computing approximate importance of each node in a graph.

Teramoto said Japan’s government under Abe had refocused the so-called Impact programme of the country’s Cabinet Office from 100 programmes trying to “impulse paradigm change in technology” to 12. However, the issue of selection remains regardless of concentration or diversification as such selection remains top-down driven. In Italy, for example, there is a “shocking” level of connections between company directors and four-time former Prime Minister Silvio Berlusconi, the roundtable identified.

Still the general issue remains in Japan, as well as in most countries outside of the US, that even if there are a ready pool of entrepreneurs able to scale up into meaningful business there is often still a financing gap but the battle to help them more is worth fighting.

Joseph McCahery, professor of international economic law and professor of financial market regulation at Tilburg University, presented results at the roundtable from his co-authored study published last year showed employment was “resilient” at small and medium-sized enterprises (SMEs, those with less than 255 employees,) through a financial downturn. The countries under scrutiny (France, Germany, the Netherlands, Poland and Romania,) however, had between a three and five-times gap in loans and equity available to them versus the US. McCahery said: “The majority of SMEs do not think equity is available.”

He added that despite hopes that alternative financing platforms, such as crowdfunding, could complement VCs, “the issue is they will be [over-]regulated before they can grow to fill the gap”.

There is greater hope about corporate and other so-called “tourist” or non-traditional venture investors’ activity levels (see this editorial taking Friday’s deal activity as a snapshot).

But while some countries’ corporate venturing units had expanded quickly in the past few years and were increasingly doing deals outside their home countries, particularly from the US, China and Japan, there were relatively few foreign CVCs investing in Japan-based startups, according to GCV Analytics. Whereas China and the US last year received tens of billions of dollars from venture syndicates including both foreign and/or domestic CVCs, Japan was third for domestic CVC activity but almost off the chart for lack of foreign CVCs investing there.

Nevertheless, roundtable attendees were particularly excited by both the new wave of corporate venturers from emerging companies as well as the revitalised policies from established corporations, such as Yamaha, KDDI and NTT Docomo.

There seems to be little reason for the lack of interest by foreign CVCs. Shigeo Kagami, professor and head of office of collaborative research development at the division of university corporate relations at the University of Tokyo, said foreign corporations, such as search engine provider Google (now under the Alphabet holding company), had been acquirers of university startups, such as Tokyo’s Shaft and Phyzios.

Kagami also updated the roundtable on the country’s plan to invest more than $1bn through four of its universities’ venture funds. He said Tokyo, which receives the largest share of the four with Y50bn ($450m), had in February set up the UT Innovation Platform as a fund of funds able to commit to an expected five or six venture capital firms. Part of the money, Y8.3bn, was also expected to go to Kagami’s department to support the infrastructure translating research into innovation – often called gap funding.

This will complement existing venture capital firm UTEC, which manages more than $300m to invest in university spinouts after being set up be Tokyo university last decade.

Kagami said: “Tokyo University’s tech transfer office, which we call Technology Licensing Office, patents 600 inventions each year and can take equity in startups formed out of this research in lieu of license fees. However, two-thirds of patents are in conjunction with industry partners, 2,500 in total, but “few lead to tangible results”. So is this a good result, he asked rhetorically?

This, ultimately, is the challenge. How do you organise for successful innovation and recognise it when it comes?

In the same month that Andy Grove, co-founder of chip maker Intel Capital, died it could be that Japan as a country of “natural worriers” will find its way through this challenge. Grove had said: “Only the paranoid survive.”

The threats and opportunities around global innovation and supporting and funding entrepreneurs by corporations, governments and universities among others seem to morph and multiply but the reality in Japan seems to be one where it is already doing well.

Editor note: Flights and accommodation to Kyushu were paid by the university. I’ll be visiting Tokyo on Monday, 28 March, for a corporate venturing roundtable hosted by DLA Piper, complimentary to investors, so this post might be updated subsequently.