Japanese Corporate Venture Capital Investments in US Startups: Part 1 – Publications

The number and investment amount of Japanese CVC (Corporate Venture Capital) funds that directly invest corporate funds in external startups have increased significantly in recent years. This is especially true in the areas of digital transformation (DX) and climate change.

The membership of the Japan Venture Capital Association has more than quadrupled in the last ten years. Recent reports attribute this growth to various structural developments. For one thing, independent VCs are on the rise in Japan, and have become “a mark of a mature startup ecosystem.”

The virtuous cycle required for this expansion is clear. More VC investment spurs startup success, leading to improved VC revenues that attract more capital and talent. result? VC is gaining ground as an asset class, accelerating the positive feedback loop.

investment structure

There are three important investment structures to consider for CVC funds, each offering a different type of risk mitigation.

• Direct investment from Japan: There is no need to bear the burden of fund formation, but there is a risk that Japanese investors will be directly involved in disputes in the United States (particularly startup-related disputes). There are also blocker entities that insulate Japanese investors from US tax and audit risks.
• Investments by US Corporate Funds: Investing through a US corporate fund reduces the risk of Japanese investors becoming directly involved in US disputes, but the fund is treated as a corporation for US tax purposes. In addition, dividends received by US corporate funds from investee companies are subject to federal income tax.
• Investments by US LP Funds: The Limited Partnership (LP) fund structure allows Japanese investors to enjoy the tax benefits of pass-through taxation while reducing the risk of direct involvement in disputes in the United States. LP funds are treated as partnerships for U.S. tax purposes and are not subject to federal income tax on dividends received from investee companies.

Fund formation procedure

In Japan, there are steps required to set up a fund. The first step is the establishment of a blocker entity that will isolate Japanese investors from US tax and audit risks and further reduce the liability risks associated with investing in the US. U.S. tax-exempt individuals and some foreign investors use such avenues when participating in private his equity or investing in hedge funds.

Next, prior to the conclusion of a business limited partnership agreement and investment agreement by a Japanese investor, a notification of qualified institutional investors and a notification of special business for qualified institutional investors, etc. will be made in Japan.

On the US side, Delaware is the preferred jurisdiction for fund formation. Delaware’s corporate law reflects the latest developments in business in the United States and includes provisions that limit the personal liability and extend the indemnification of directors and officers, making it easier to attract qualified personnel. increase. The Chancery Court of Delaware specializes in corporate practice, with professional judge dispute resolution and numerous precedents for high business predictability.

Note that this venue also shows prestige, as the majority of US public companies and over 60% of Fortune 500 companies are incorporated in the state. On a practical level, Delaware offers faster processing by authorities compared to other states. Regarding privacy issues, Delaware filings require less personally-identifying information, which reduces the risk of disclosure liability.

Important points regarding fund formation

• Before an investor in Japan concludes an investment business limited partnership agreement and an investment contract, it is necessary to submit a notification of a qualified institutional investor and a notification of special business for qualified institutional investors, etc. in Japan.
• Delaware is suitable for forming fund managers and LP funds in the United States.
• In addition to the company’s filings related to fund formation, the filings with the Department of Commerce’s Bureau of Economic Analysis (BEA) and filings under the US securities laws must also be considered.

learn more

For more information on CVC investment fund issues, see the full presentation, Corporate Venture Capital Investment in US Startups (Part 1): Fund Formation and Investment Structure (conducted in Japanese). The event is part of his 2023 series designed for Japanese companies and funds developing new business models through investment in US start-ups.

For details, please contact Ayumi Yokoyama.