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Research about popularity difference of preferred stock between
Japan and US
Takeshi Kanamori
Rady School of Management Full-time 2nd year
Table of Contents:
1. What is preferred stock
2. Popularity difference of preferred stock between US and Japan
3. Comparison of venture funding market in 2 countries
4. Why preferred stock is not common in Japan compared to US
5. Conclusion and suggestion

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Preface
In Japan, Prime Minister Abe is directing national growth strategic policy called
“Abenomics”. In its “Third Arrow” stage, promotion of venture business is defined as one
of important action plans. As well as other know-hows originated in US, preferred stock
scheme, which is not common yet in Japan, is expected to contribute to Japanese venture
market growth. METI “Ministry of Economy, Technology and Industry” has started to
hosts a study group.
In this report, looking into differences of venture capital industry between
Japan and US, I tried to list up obstacles which prevent from popularization of preferred
stock in Japan. I tried to introduce a few possible suggestions at last.
1. What is preferred stock
Preferred Stock is a commonly used scheme in financing for start-ups in US, at
least for startups after Series A round. Preferred shareholders have advantage against
common shareholders, such as preferred dividend, voting right, veto power, board
representation right and so on.
In general, IPO triggers conversion of preferred into common stock. Preferred

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shareholders can enjoy the prominent advantageous characteristic “liquidation
preference” in case of liquidation of lower priced M&A. Also, these conditions can be
“tailor-made”. This is introduced as another important point in “Venture Capital and
Preferred Stock” by Korsmo” by saying,
“Preferred stock— particularly as it is used in venture capital financing—is
hardly a one-size-fits-all security. Rather, preferred stock is a bespoke security.
The needs of the circumstances are carefully measured, and the ultimate terms of
a preferred stock issue are typically finely tailored, heavily negotiated, and
“sealed with a thick stack of documents.”
Due to having these advantages, preferred stock is issued with much higher
price than common stock. Higher price issuance means less ownership by a VC. For
founders, it benefits as less dilution. Thanks to various advantages described above,
investors can enjoy effective governance to a company. In summary, preferred stock can
benefit for both investors and founders.
2. Popularity difference of preferred stock between US and Japan
In “Venture Capital and the Finance of Innovation” by Metrick and Yasuda,

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preferred stock is explained as “de-fact” finance scheme for start-ups in US.
“In public markets, the vast majority of equity investments are made with
common stock. However, for VC transactions in the United States, nearly all the
investments are made with preferred stock.”
On the other hand, in Japan, preferred stock accounts for only 10% in amount
of deals and 17% in number of deals. Over 60% of finance is done by traditional
common stock in the year 2009. In Japan, preferred stock is usually known as financing
scheme used by the government or mega banks to purchase shares of distressed but
nationally significant big listed companies such as infrastructure industry, for their
restructuring purpose. In case of financing of startups in Japan, in order to make
agreement of voting right, veto and so on, separate investment contract is usually
concluded between a VC and a startup. But, this investment contract can’t cover
liquidation preference which is possible only by preferred stock scheme.
In US, the biggest industry association, NVCA disclosed standard contract
format called “Model Legal Document” covering preferred stock issuance agreement
and term sheet. This helps a lot to founders of startups to familiarize preferred stock.
Similarly, for early stage startups before Series A, convertible note is now in common

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because the number one accelerator “Y Combinator” disclosed only a few page easy
format called “SAFE”. When I did internship in venture capital section in a tech company
in Bay Area, I found this “SAFE” is known to most entrepreneurs, especially of internet
related startups.
http://nvca.org/resources/model-legal-documents/
https://www.ycombinator.com/docs/SAFE_Primer.rtf
3. Comparison of venture funding market in 2 countries
At a glance of number of historical IPOs, Japan fights well against US in spite of
over 3 times different economic power shown by GDP.
By number of deal
By amount: Mil JPY (=百万円)

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Global GDP
If we look into number of deals, fund and amount of funds, we can see huge
difference between 2 countries’ market in both number and amount. Average amount
per investment deal is 1 MM USD in Japan while it’s 10 MM USD in US. Average amount

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per fund is 20 MM USD in Japan while it’s 100 MM USD in US.
In the long term trend of Japan, it didn’t grow enough whereas Dot Com bubble
boosted US market in 2000. And then, US experienced decline after the bubble. After
financial crisis around 2008, both market has declined once and been on pick-up trend .
In Japan

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In US
Exis is different in US and Japan. Startups in US are sold through mostly M&A

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while, in Japan, IPO is still chosen as a dominant exit as M&A.
Regarding this, we can presume various reasons. Japanese venture capitals may
prefer IPO to M&A. It seems a little strange since IPO is not so easy in Japan due to strict
criteria demanded by stock exchange. Or, in US, most investments may go bad and, as a
result, only a choice for venture capitals may be to go trade-sale by giving up IPO. Some
people explains that lack of preferred stock is one of reasons why Japanese venture
capitals don’t choose M&A. Others explain that many IPOs in Japan are “premature birth”
while US startups wants to wait IPO after they grow big enough.
Historic trend in US shows Dot Com bubble in Silicon Valley highly boosted
M&A ratio. But, if we assume Japan will follow US trend, M&A have strong potential as
an exit scheme.

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In Japan
In US:
Number of companies in EXIT excluding liquidation etc…

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Investment stage constitution fluctuates each year. No big difference between
2 countries are clearly found. Plus, definition of each stage applied in 2 countries is not
exactly the same, which means precise comparison is difficult. For example, in US, seed
stage doesn’t include a part of angel investment.
In Japan In US: in 2013
Big difference can be found in origin of venture capitals. In Japan, most of VCs
Dot com bubble
Independent
Silicon Valley boom
Black Monday
Lehman Shock
Dot com bubble break up
No. of deals

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are founded by banks and insurance companies. Therefore, employees there are from
parent banks or insurance companies. They need to obey risk averse investment rule
charged by a parent company. On the other hand, in US, most of them are independent
VCs which can invest on their judgement.
In Japan In US
LP source in US is funded by pension fund and endowment/foundations
constituting over 40% in total. On the other hand, in Japan, despite its huge size, public
pension fund such as “GPIF” is prohibited to invest into venture capital at this moment.
The deregulation discussion just started. In Japan, historically, LP consists risk averse
organization such as nationwide “mega” banks, as well as governmental funds by “SME
Support, JAPAN” and “INCJ”. Corporations directly invest into venture capitals to aim
for strategic benefit. Recently, university funds are growing thanks to policy support.
http://www.smrj.go.jp/english/index.html
Other
Independent
Corporation Financial
Other
Independent
Corporation
Financial

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http://www.incj.co.jp/english/
In Japan: in 2015 Q3
In US
4. why preferred stock is not common in Japan compared to US
First bottleneck is its complexity derived by tailor-made feature. In Japan, VCs
and startups are reluctant to use preferred stock. Some says investment officers in
Japanese VCs are too busy. Average number of assigned startups for one officer is

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around 50 while it’s less than 10 in US. Plus, from the stand point of competition, VCs
can’t solicit “complicated” preferred stock since other VCs accept “simple” common
stock investment.
Second, lack of expert in eco-cycle is a problem. Founders and even VCs are still
at learning stage of preferred stock. Hiring professional such as international law firms
for complete research will cost too much for startups. In Japan, industry association or
industry dominant VCs hasn’t yet researched or disclosed standard format of preferred
stock whereas NVCA disclosed the format in US.
Third, Japanese VCs get used to IPO as the first choice of exit rather than M&A.
Since preferred stock is useful mainly in low priced liquidation of M&A, not in IPO,
Japanese VCs won’t get interested. Also, Japanese founders are not familiar with the idea
of selling their company to others.
More importantly, Japanese VCs tend to be less creative and less innovative.
Ruled by conservative parent companies, they tend to be risk averse to start new things.
In such environment, investment performance of partners is not measured to be
directly linked to their salary. On the other hand, in US, investment partners can earn a
big profit if successful. This is partly due to legal structure difference of VC fund set up.

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In Japan, GP is set up as corporation where individual partners can’t enjoy pass-through
tax benefit. On the other hand, in US, GP is set up as LLC and individual investment
officers, of course gaining pass-through tax benefit, can have contingent reward
dynamically linked to their performance.
Finally, let me introduce a regulation bottleneck. In Japan, official registration
is required for preferred stock issuance. Valuation related information needs to be
publicly disclosed. This may cause trouble for negotiation of future round finance.
5. Conclusion and suggestion
Preferred stock scheme has a big potential in Japan, as well as in US. But, due to
bottlenecks in the section above, it’s not common yet. Here, let me introduce my
thought about suggested actions.
First of all, I think industry organizations and the government should lead an
industry wide movement.
To solve lack of expert of preferred stock, industry organization should disclose
standard legal format quickly. And then, they should hold seminars both online and in
physical events nationwide. As such, eco-cycle players such as VCs and startups will be

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educated to have a basic knowledge. Moreover, they can designate the legal format as
mandatory for their acceleration program companies.
Second, the government should take supportive policy to promote not only
preferred stock specifically, but also the entire industry growth. The government
already started tax benefit for angel fund and VC investment. Governmental fund
activity is on the rise, including INCJ and university funds. These actions needs to be
kept and expanded further.
Finally, how to make VCs to be more creative is the most difficult question. As
for this too, we can come up with governmental support: i.e. regulation of lowering
ownership of parent companies, subsidy for GPs which is set up as LLC not as
corporation etc... But, I think the government shouldn’t take such direct actions. It’s a
kind of chicken-egg question. Creativity should be grown by healthier tool,
“competition”.
If there is regulations which works as entry barrier, they should be deregulated.
The said policy actions should be done. As a result, VC industry will become more
attractive and new entry will increase. Consequently, even if they are under a traditional
banks, VCs will become creative. In reality, nowadays, we can see increasing number of

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news articles about newly set up VCs. Some banks have started creative actions such as
acceleration programs of Fin-Tech and setting up Silicon Valley office. That way, as long
as current growing trend continues, the industry will become more competitive and
creative so that VCs will invest into preferred stock as a normal way.

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Book of reference
As books of reference, I mostly referred to industry association research
reports by NVCA, “National Venture Capital Association” in US and VEC “Venture
Enterprise Center” in Japan.
http://nvca.org/
http://www.vec2.jp/
To discuss potential obstacles against preferred stock, I referred to books
written by Japanese CPA, “Tetsuya Isozaki” who seemingly has the deepest knowledge
about preferred stock potentiality in Japan. He founded a seed venture capital “Femto
StartUp” and is a core member of the study group organized by the government.
http://femto.vc/en.html