Japan’s start-up scene is on the cusp of something big

Sozo Ventures managing directors Phil Wickham and Koichiro Nakamura discuss that the stage is set in Japan for VCs and their LPs for an explosion of investment opportunities. Can Tokyo’s old guard get out of the way fast enough?

Ask anyone to name US start-ups that made it big and they will trot out global giants Amazon, Facebook and Apple. Ask the same person to name a start-up that went on to great things from Japan and you are likely to get a blank stare.

Venture firms from outside Japan can, and do, invest in Japanese companies, but many have been hesitant. Still, the nation boasts world-beating industrial companies, a highly educated, imaginative tech-savvy workforce, a large domestic market and excellent infrastructure.

Tokyo has never been able to break into the global big leagues of start-up ecosystems and it even still lags the ranks of such exciting second-tier cities as Stockholm, Singapore and Berlin. Only four of the world’s 500 unicorns are in Japan, according to analytics platform CB Insights.

That is changing.

The elements needed to attract more serious venture capital players are falling into place in the world’s largest city. And VCs are stepping up. Tokyo-based Playco raised $100 million in a Series A round, led by Sequoia Capital, with participation from our firm, Sozo Ventures.

Another example, online flea market app Mercari went public in 2018 and has swelled to a $7 billion-plus valuation as it expands from Japan into the US.

Phil Wickham Sozo Ventures
Phil Wickham, Sozo Ventures

It may be too soon to say we are at the dawn of a golden age of start-ups in Japan, but there are rays of light that suggest it could be coming.

Until fairly recently, the country’s conservative culture has prevented customers willing to try out new products and approaches, hobbling entrepreneurs. Early-stage companies have tended to be Japan-centered, lacking an international mindset and global vision. The result is a stunted start-up ecosystem, reliant on inexperienced venture investors who tend to suffocate young businesses by imposing overbearing controls and unfair valuations.

Exits are thus far less valuable than they are in the US, deterring the entry of more professional venture funds and perpetuating the cycle. Between 2017 and 2019, the median IPO for start-ups listed on Mothers was just $13 million. Direct comparisons are hard to come by, but the median US IPO in 2019 was $108 million, according to Statista.

Palpable change

But signs of change are palpable.

A walk down Tokyo’s busiest streets will confirm it is a more international place than it was a decade or two ago. It has become a place where young entrepreneurs from around the world want to live and pursue their ambitions.

We are seeing more start-ups like Playco formed by blended teams of international and Japanese founders, giving them a global ambition and perspective that’s been missing.

Flipped on its head

At the same time, Japanese companies have woken up to the fact that they need to innovate or die. Entrepreneurs used to struggle to get anyone to take their calls. Now many of the Japanese corporations have their own venture arms – such as SoftBank – and are willing to take risks on new products and ideas.

Infectious successes

Although Tokyo is not quite there yet, it has produced some recent successes, such as Mercari and Playco, that are likely to have a powerful ripple effect in the Japanese ecosystem. The bigger challenge has become filtering out the genuine opportunities from all the noise.

Koichiro Nakamura Sozo Ventures
Koichiro Nakamura, Sozo Ventures

The success of cities outside Silicon Valley has also grabbed the attention of Japanese business. Hubs like Berlin, Stockholm and Singapore have shown how tech can start up in different environments and grow to massive valuations. Spotify being a prime example in the Nordic region.

When a start-up draws in a big US firm like Sequoia, it opens eyes to what is possible and shifts behavior, helping to erode a staid ecosystem.

Supportive policy measures at the national and local level have also helped drive the shift. Tokyo’s trendy Shibuya district, for example, has started a concierge program to support start-ups, including aiding foreign entrepreneurs obtain business visas.

To complete its transition to global startup player, Tokyo needs to get to the stage where more VCs are being drawn in to identify and support the best deals and fill the gap between angel investors and giants like Sequoia.

These are the kind of funds that can write big checks and take companies to the next level with an ambitious, global outlook and start feeding those deals up the chain. The entry of this kind of player can result in a Darwinian process in which the old breed of venture funds get pushed out and replaced with more forward-thinking firms.

Five years from now, we may look back at this time as the start of a Japanese golden age for venture funds and entrepreneurs. A similar stew of factors that has created vibrant start-up scenes elsewhere seems to be coming together.

There is no question that the potential for innovation in Japan is huge; it is really now just a case of widening the openings for entrepreneurs and getting out of their way.

Phil Wickham and Koichiro Nakamura are managing directors at Sozo Ventures.