Equity Finance 2024 Comparisons

In Japan, early-stage and venture capital financing typically uses preferred shares, which have a liquidation preference that is equal to (ie, 1x) or is a multiple of (eg, 1.5x or 2x) the amount of the investment. Accordingly, if a start-up enjoyed constant growth during its life up to the IPO and its valuation increased during such time, there would be investors holding different classes of preferred shares that have different liquidation preferences (eg, Series A, B, C and D) and possibly different levels of seniority. However, as such preferred shares must be converted into common shares before the common shares are listed, the articles of incorporation of the issuer typically include a provision for the mandatory conversion of such preferred shares upon a resolution by the board of directors. It is uncommon for the “Qualified IPO” concept to be provided in the mandatory conversion provisions, but a defined set of investors (preferred shareholders) often holds a consent right over the IPO.

Convertible loans (bonds) and convertible equity (an instrument called J-KISS) are popular financing instruments for start-ups. Such instruments are typically used by early-stage start-ups but are also used as a convenient bridging tool between priced financing rounds by late-stage start-ups (where such loans and equity would be typically converted into preferred shares in later financing rounds and into common shares before the IPO).

Private equity firms historically utilised leveraged buyouts in their investments in Japan, which are less complex on the equity side. Usually, they use only common shares but there are cases in which mezzanine investors invest through preferred shares (structured similarly to debt instruments). Such difference in venture capital financing and private equity financing is very natural, given the nature of their respective targets (start-ups versus mature companies or businesses), but private equity firms are starting to invest in late-stage start-ups through preferred shares alongside venture capital firms. As it takes longer for start-ups to become listed (mainly because of their desire to grow in size before the IPO), private equity firms are becoming an important source of capital for late-stage start-ups in Japan as well as in other markets.

In order for Japanese companies to list their shares on Japanese stock exchange (eg, the Tokyo Stock Exchange), they are required to undergo listing examinations by the relevant stock exchanges; these begin upon the submission of an application for listing (a “listing application”), which usually takes about three months to be approved. Before submitting the listing application, companies need to retain lead underwriters, who mainly arrange for the listing procedures (including those for making an IPO), and to have gone through the underwriting examinations by such underwriters. In practice, it takes one year to 18 months from the kick-off until the completion of the underwriting examinations. In addition, as the companies who seek to make IPOs are required to prepare audited financial statements for the most recent two financial years, it is necessary to retain an independent auditor for auditing past financial statements while the companies deal with the above-mentioned underwriting examinations.

As regards the listing criteria, in the Tokyo Stock Exchange there are the following three market segments. Each of these market segments has its own listing criteria – both quantitative and qualitative – reflecting its characteristics and concept, as follows.

• Prime market – the market for companies with a level of market capitalisation (liquidity) sufficient enough for multiple institutional investors to invest in them, and that meet a higher standard of corporate governance and commit to sustainable growth and improvement of medium- to long-term corporate value, prioritising constructive dialogue with investors.
• Standard market – the market for companies with a level of liquidity sufficient to make them investment targets in the open market, and that maintain the basic standard of corporate governance that listed companies are expected to have and commit to sustainable growth and improvement of medium- to long-term corporate value.
• Growth market – the market for companies that (to some extent) the market evaluates positively, owing to their disclosed business plans for realising high growth potential and their progress towards achieving these plans appropriately and in a timely manner, but at the same time involve a relatively high investment risk from the perspective of their business track records.

All of the above-mentioned market segments provide the listing criteria related to the liquidity of the shares of the listed companies. The criteria as to liquidity are designed to be indicators of the number and monetary value of shares traded on the market and, as such, it is common in practice that IPOs are conducted with the support of underwriters in the case of listings.

In addition, the Prime Market and the Standard Market require companies to meet certain criteria as to their recent operating results and financial positions. On the other hand, the Growth Market does not have any criteria related to financial information, but instead requests companies to prepare business plans that demonstrate the possibility of their future growth. In practice, it is common that venture companies seek to list their shares on the Growth Market.

An equity listing involving an IPO is often positioned as a method of exit by investors of venture companies. For companies to be listed, the main purposes of listing their shares are usually to have access to capital markets for fundraising, improve their credibility and brand recognition, boost employees’ morale, and strengthen corporate governance.

As a method for equity restructuring by Japanese listed companies, share buybacks are quite common and are sometimes conducted concurrently with an offering of convertible bonds in order to increase Return on Equity (ROE). Listed companies facing financial difficulties sometimes seek debt-to-equity swaps or capital increases that dilute existing shareholders – although having a lender agree to a debt-to-equity swap debt or finding appropriate investors who can provide sufficient funds to such companies presents various practical challenges. For non-listed companies who are seeking IPOs in the future, additional financing by way of a “down round” can also be an option to raise necessary funds for continuing to grow their businesses.

Under the Companies Act of Japan, a joint stock company (kabushiki kaisha), which is the most common form of Japanese corporation, may select its corporate governance structure subject to certain rules. In practice, listed companies and non-listed companies that intend to go public in the future need to adopt any one of the following corporate structures:

• company with a board of corporate auditors;
• company with an audit and supervisory committee; and
• company with three statutory committees – a nomination committee, an audit committee and a compensation committee.

Each of the above-mentioned corporate structures requires the relevant company to have a board of directors. Among the above-mentioned structures, a “company with a board of corporate auditors” is a traditional structure, under which a board of directors has the authority to decide on the management and important decisions.

Even in a “company with an audit and supervisory committee”, a board of directors has ultimate responsibility for the administration of the affairs of the company. However, in order to facilitate prompt decision-making, the board of directors – by its resolution – may delegate to individual directors its authority to make a decision on important business and affairs, except for certain matters prescribed in the Companies Act.

In a “company with three statutory committees”, executive officers (shikko yaku) are required to be appointed and the role of monitoring and supervision of management is separated from the role of business execution. A board of directors is responsible for the supervision of management. A board of directors is required to establish a basic management policy of the company and may – by its resolution – delegate to executive officers its authority to make decisions on important business and affairs, except for certain matters prescribed in the Companies Act. Executive officers are responsible for conducting all business operations of the company within the scope of the authority delegated to them by the board of directors.

In Japan, as a matter of market practice, it is uncommon for one investor to provide both equity and debt to the same company. Although there is no specific legal restriction on doing so, investors usually have their own investment strategies that focus on particular types of instruments. In addition, Japanese companies usually have strong, established relationships with banks that serve as their “main bank” and their debt financing needs are typically met by borrowing from such banks. As such, companies usually expect external investors to provide only equity financing.

In Japan, the term equity finance by listed companies usually refers to offerings of common stock to the public that involve underwriting by securities firms. In Japan, there are several stock exchanges (including the Tokyo Stock Exchange), and the Japanese capital market – where companies can reach out to many investors with the involvement of securities firms – is well-developed, thanks to the support of various related laws and regulations (including the internal regulations of the relevant stock exchanges). In addition, Japanese listed companies sometimes decide to issue common stock directly to particular business partners by way of private placement in order to establish capital and business alliances for business purposes. Hybrid forms of financing (such as issuances of preferred stock to certain financial investors) are also an option, especially when the financial condition of issuer companies is deteriorating and it is difficult to find investors who can provide capital through an issuance of common stock.

On the other hand, a market where non-listed companies can raise funds by way of equity finance has not yet been established in Japan. As such, equity finance by non-listed companies (such as venture capital financing and private equity financing) may be conducted following bilateral negotiations between issuer companies and investors.

In cases of equity finance by non-listed companies, investors who provide funding are usually venture capital and private equity. Generally, there are no quantitative or qualitative restrictions on providing equity financing to Japanese companies.

On the other hand, in the capital market in Japan, retail investors play a significant role and thus the main funding source in the public offering of common stock is retail investors. In public offerings involving underwriters, the underwriters are required to distribute offered shares widely to the public and thus investors are not necessarily allocated the number of shares that they wish to purchase.

In the case of offerings of listed shares to investors by way of third-party allotment, which may be authorised by a board resolution of an issuer company, if the ratio of dilution caused by such offering is 25% or more, an approval by a shareholders’ meeting or an option from independent third parties (such as independent directors) as to the rationality of such offering needs to be obtained pursuant to the listing rules of the stock exchanges. In addition, if the ratio of dilution caused by the offering is 300% or more, it is considered to be a delisting event. As such, listed companies may not – in practice – conduct an equity finance with dilution ratio of 300% or more by way of third-party allotment.

In Japan, there is no particular tendency with regard to companies who seek capital. Equity finance and detailed structures thereof are usually discussed depending on the circumstances surrounding individual companies.

As stated in 2.1 Types of Equity Finance, in Japan, the equity capital market has been well-developed and supported by the stock exchanges and securities firms who realise public offerings. According to the reports published by the Japan Securities Dealers Association (a self-regulatory body of Japanese securities firms), the number of equity financing deals conducted by Japanese listed companies by way of public offerings – including offerings of common stock or convertible bonds in overseas markets and secondary offerings by major shareholders – that have happened between January and June 2024 is 184 and the total deal size is approximately JPY1.6 trillion. While it is quite difficult to present any outlook on future market trends, the high stock prices of Japanese listed companies has been contributing to the relatively active market conditions in 2024 to date and should continue to be a key driver for generation of equity deals in 2025.

Recently, supported by high stock prices of Japanese stocks, the Japanese IPO markets have been relatively active. However, the size of the IPOs conducted by Japanese venture companies – which are the main players in this field – and their market caps are often so small that it is sometimes difficult to achieve further growth after their listing. In response to this, the Japanese government published the “Start-Up Development Five-Year Plan”, which provides various initiatives to enable Japanese start-ups to raise more funds while they are unlisted companies and to diversify their exit strategies.

In cases of public offerings by listed companies, securities firms who will underwrite offered shares and sell them to investors typically originate deals by proposing them to potential issuers. Securities firms can provide their view about potential market demands and other related information that enable issuer companies to examine the appropriate size and condition of a contemplated equity offering and make a “go” or “non-go” decision.

On the other hand, private deals may occur, owing to various circumstances such as a personnel connect between management of the issuer and officials of potential investors, introduction by external advisers of potential investors, and a bid process arranged by external advisers to seek investors.

It is very common for investors who invest in private equity to seek IPOs to realise the value of their equity investments. Recently, there have been more cases where investors and issuers seek opportunities to contemplate M&A transactions as a means for exiting investments, but IPOs are still the main exit path for investors in non-listed companies such as venture companies.

With regard to investments in the common stock of listed companies, investors usually sell their shares in the markets to realise profits. However, for example, if the amount of shares to be sold is large and it is practically difficult to sell all of such shares in the market for a reasonable price over a certain period, off-market transactions such as secondary offerings or block trading conducted with the support of securities firms can be an option as well.

As stated in 1.6 Mix of Debt and Equity Financing, historically, the main financing sources for Japanese companies are borrowings from these banks. Notably, non-listed companies who do not seek IPOs usually do not conduct equity finance from external investors. On the other hand, for non-listed companies seeking IPOs, the equity finance – which is typically provided by venture capital funds and private equity funds – is quite important to increase their corporate value so that they can make successful IPOs.

As regards Japanese listed companies, they usually meet their daily financial needs by way of bank loans, even though they can access the capital markets. As there has been a recent trend that Return On Assets (ROA) is more emphasised, many Japanese listed companies put more priority on shareholder return (including share buyback) instead of equity finance by offerings of its shares, which could cause dilutions.

In practice, it usually takes two-to-three months from a kick-off for a listed company to launch a public offering of equity and also takes about three additional weeks to close the deal. During the preparation period until the launch, the issuer needs to deal with the due diligence procedures by the underwriters in such deal – during which, the issuer is requested to answer very a long list of queries in respect of various aspects and reflect the results thereof (including the identified risk factors) in the disclosure documents, such as the statutory prospectus. Once the deal is launched, the issuer and the underwriters conduct marketing activities for about two weeks and price the deal. The closing usually occurs one week after the pricing.

In respect of equity financing by non-listed companies, it may be legally possible to close the deal within one day if all of the existing shareholders of the companies agree. The lead time for these cases is determined based on the time necessary for the negotiations between the issuer and the investors.

In Japan, investment by foreign investors into the equity of Japanese companies is generally not restricted. However, certain regulations/restrictions may apply, as follows.

Regulated Industries

Investments by foreign investors into some regulated companies – such as aviation companies, designated holding companies having licensed broadcasting stations as subsidiaries, and NTT (the Japanese leading telecommunications business operator) – are subject to certain foreign investment regulations. By way of example, the Civil Aeronautics Act of Japan effectively limits ownership by foreign investors of shares of Japanese aviation companies to the number of shares representing less than one-third of total voting rights. Under the Civil Aeronautics Act, Japanese aviation companies may refuse to register the shares held by foreign investors in their register of shareholders in cases where the total voting rights held by foreign investors would account for one-third or more of total voting rights if they accept such registration. In such case, the foreign investors whose shares are note registered would be unable to exercise certain shareholder rights, including voting rights with regard to such shares.

Foreign Exchange Regulations

The Foreign Exchange and Foreign Trade Act (FEFTA) of Japan and its related regulations may also put restrictions on the acquisition and holding of shares and voting rights of Japanese companies by foreign investors. By way of example, under the FEFTA, if a foreign investor intends to consummate an acquisition of shares of a Japanese listed corporation that would constitute an “inward direct investment”, in certain circumstances – such as where the foreign investor is a resident in a country that is not listed on an exemption schedule therein (eg, North Korea) or where that Japanese corporation is engaged in certain businesses designated by the FEFTA in terms of national security of Japan, and other factors – a prior notification of the relevant “inward direct investment” must be filed with the Minister of Finance and any other competent Ministers in advance of such inward direct investment, except where certain conditions for exemptions are met. The definition of “inward direct investment” is broad and complicated; however, if a foreign investor desires to acquire shares of a Japanese listed corporation and – as a result of such acquisition – the foreign investor, in combination with any of its existing holdings, would directly or indirectly hold 1% or more of the total number of issued shares or the total number of voting rights of the relevant Japanese corporation, such acquisition constitutes an “inward direct investment”.

If such prior notification is filed, the proposed inward direct investment may not be consummated until 30 days after the date of filing, during which time the Ministers will review the proposed inward direct investment – although this screening period may be shortened by such Ministers if they no longer deem it necessary to review the proposed inward direct investment, or may be shortened to five business days if the proposed inward direct investment is determined not to raise concerns from the perspective of national security or certain other factors. The Ministers may also extend the screening period up to five months and may recommend any modification or discontinuation of the proposed inward direct investment and, if the foreign investor does not accept such recommendation, the Ministers may order the modification or discontinuation of such inward direct investment. In addition, the Ministers may order the foreign investor to divest of all or part of the shares acquired or to take other measures if:

• the Ministers consider the proposed inward direct investment to be an inward direct investment that is likely to cause damage to the national security of Japan; and
• the foreign investor:
1. consummates such inward direct investment without filing the aforementioned prior notification;
2. consummates such inward direct investment before the expiration of the above-mentioned screening period;
3. in connection with such inward direct investment, makes false statements in the aforementioned prior notification; or
4. does not follow the recommendation or order issued by the Ministers to modify or discontinue such inward direct investment.

In cases of acquisitions by a foreign investor of shares of a Japanese unlisted company engaged in the designated businesses, a similar prior notification requirement will apply.

In Japan, there no statutory restrictions on Japanese companies making dividend payments to shareholders located outside Japan. Under the FEFTA, dividends paid on shares of Japanese corporations held by foreign investors may generally be converted into any foreign currency and repatriated abroad.

In Japan, Japanese financial institutions (including securities companies) who serve as underwriters in public offerings of shares will be subject the AML and KYC rules – pursuant to which, they must conduct a KYC process when they open securities accounts for new clients to invest in Japanese listed shares. In addition, Japanese securities companies have record-keeping obligations and must report suspicious activities to the supervisory authority if they identify such activities.

In Japan, it is typically agreed in a contract for a Japanese company’s equity financing transaction (eg, an investment agreement) that the governing law is Japanese law and that the jurisdiction is the Tokyo District Court – whereas the laws of and the courts in other jurisdictions may be agreed upon depending on, among other things, locations of investors. It is widely recognised that the courts in Japan (including the Tokyo District Court) are reliable and fair, regardless of whether equity investors are from abroad. On the other hand, it is not very common for an issuer company and equity investors to agree in an investment agreement upon arbitration or mediation in an international forum or body.

In 2020, the FEFTA was amended to tighten the regulations applicable to acquisitions by foreign investors of shares of Japanese companies, taking into consideration the global trends following Foreign Direct Investment (FDI) regulations. For further details, please see 3.1 Investment Restrictions.

Withholding Tax

Generally, individual non-residents of Japan or non-Japanese corporations without a permanent establishment in Japan – collectively, “non-resident holders” of shares of common stock of Japanese corporations – are subject to Japanese income tax collected by way of withholding on dividends paid by such Japanese corporations. Such tax will be withheld prior to the payment of the dividends.

In the absence of any applicable tax treaty, convention or agreement reducing the maximum rate of the Japanese withholding tax or granting an exemption from the Japanese withholding tax, the rate of the Japanese withholding tax applicable to dividends paid by Japanese corporations on their shares to non-resident holders is generally 20.42% (or 20% on or after 1 January 2038) under Japanese tax law.

However, with regard to dividends paid on listed shares issued by a Japanese corporation to non-resident holders (except for any non-resident holder who is an individual holding 3% or more of the total number of shares issued by the Japanese corporation), the 20.42% (or 20% on or after 1 January 2038) withholding tax rate is reduced to:

• 15.315% for dividends to be paid on or before 31 December 2037; and
• 15% for dividends to be paid thereafter.

Due to the imposition of a special additional withholding tax (2.1% of the original withholding tax amount) to secure funds for reconstruction from the Great East Japan Earthquake, the original withholding tax rates of 15% and 20% (as applicable) had been effectively increased to 15.315% and 20.42%, respectively, during the period beginning on 1 January 2013 and ending on 31 December 2037.

Capital Gains Tax

Regarding the sale or other disposition of shares of Japanese corporations outside Japan by a non-resident holder who is a portfolio investor, the gains derived therefrom are not – in general – subject to Japanese income tax or corporation tax.

The withholding tax rate applicable to dividends paid by Japanese corporations on their shares to non-resident holders may be reduced by the income tax treaties that Japan has with other countries, but the reduced tax rates vary depending on the terms of such income tax treaties. In addition, under the income tax treaty between the USA and Japan, dividends paid to pension funds that are qualified US residents and eligible to enjoy treaty benefits are exempt from Japanese income taxation by way of withholding or otherwise – unless such dividends are derived from the carrying on of a business, directly or indirectly, by such pension funds. Similar treatment will be applied to the dividends paid to pension funds under the income tax treaties with certain other countries, including the UK.

Under Japanese tax law, any reduced maximum rate applicable under a tax treaty shall be available when such maximum rate is below the rate otherwise applicable under the above-mentioned Japanese tax law with regard to the dividends to be paid by Japanese corporations on their shares.

A non-resident holder of Japanese shares who is entitled under any applicable tax treaty to a reduction in respect of the Japanese withholding tax rate or an exemption therefrom is, in principle, required to submit – in advance through a withholding agent – a statutory application form (together with any other required forms and documents) to the relevant tax authority before any payment of dividends. A standing proxy for a non-resident holder may provide such application service. In this regard, a certain simplified special filing procedure is available for non-resident holders to claim treaty benefits for an exemption from or a reduction of the Japanese withholding tax by submitting a special application form (together with any other required forms and documents).

As of August 2024, Japan has 73 tax treaties with 80 countries and regions for the purpose of elimination of double taxation and prevention of tax evasion and avoidance. These tax treaties are basically consistent with the “OECD Model Tax Convention on Income and on Capital”.

In Japan, the following four types of in-court insolvency proceedings are available:

• liquidation-type proceedings – ie, bankruptcy proceedings under the Bankruptcy Act and special liquidation proceedings under the Companies Act; and
• rehabilitation-type proceedings – ie, civil rehabilitation proceedings under the Civil Rehabilitation Act and corporate reorganisation proceedings under the Corporate Reorganisation Act.

Any of the aforementioned proceedings are available for Japanese joint stock companies whose shares may be owned by equity investors. However, as the purpose of Japanese in-court insolvency proceedings is to liquidate or restructure the debts of any debtors that become insolvent, generally – in cases where the debts of a debtor exceed its assets – the shareholders of such debtors are not expected to be involved in the proceedings and have no rights to object to such proceedings, with a limited exception in respect of the rehabilitation-type proceedings.

In respect of the liquidation-type proceedings described in 5.1 Impact of Insolvency Processes on Shareholder Rights, the assets held by a company are converted into cash and such cash is distributed to the creditors first. The shareholders are entitled to such cash only if and to the extent there is any cash remaining after the distribution to the creditors. However, in practice, the shareholders are highly unlikely to receive any cash after the liquidation-type proceedings.

Further, the purpose of the rehabilitation-type proceedings is to turn around the debtor’s business by restructuring its debts and such debts will be modified in accordance with a rehabilitation plan or a reorganisation plan – as the case may be – approved in the respective proceedings. In addition, as long as the debts of a debtor exceed its assets (ie, the economic value of the shares is zero), such rehabilitation plan or reorganisation may provide for, among other things, the acquisition of the shares of such debtor from its shareholders for no consideration with the permission of the court. In practice, such share acquisition for no consideration is almost always made so that the debtor can introduce a new sponsor who the creditors approve of, and the investments of the existing equity investors lose all of their value.

Although the required period for insolvency proceedings may vary depending on various factors (such as the amount of the debts, the number and nature of the creditors, and the residual value of the assets, including the business conducted by the debtor), according to the standard timeline published by the Tokyo District Court, civil rehabilitation proceedings – which are the common option for restructuring Japanese corporations – would usually take five months from the filing date of the petition for such proceedings until the completion of the proceedings. As regards recovery for the shareholders, as stated in 5.2 Seniority of Investors in Distributions, in practice, the shareholders are highly unlikely to receive any cash from the assets of the insolvent debtor in Japanese insolvency proceedings.

In Japan, the rehabilitation-type proceedings – especially the civil rehabilitation proceedings – are usually prioritised over the liquidation-type proceedings. However, in practice, in any insolvency proceedings in Japan, the shareholders of a debtor are highly unlikely to be in a position to collect any value in relation to their equity investments. These insolvency proceedings are usually handled by debtors, creditors, a court and new sponsor candidate(s), if any.

The shareholders of Japanese joint stock corporations have limited liability, which means the shareholders of an issuer company will assume no liability. The shareholders just lose the value of their investments into the shares of such issuer company if such issuer company becomes insolvent. It is uncommon for equity investors to be sued by insolvency administrators for any reason.

In respect of listed shares, it should be noted that – in the listing rules of the Japanese stock exchanges – any commencement of bankruptcy procedures is considered to be a delisting event. Therefore, if a listed company publicly announces its commencement of bankruptcy procedures, the share price of such company is highly likely to fall and it will become difficult to sell such shares in any markets.