Fortunately, initiatives are underway that may dramatically change this situation. Japan's Ministry of International Trade and Industry (MITI) has launched an effort to revise regulations affecting crucial issues such as the par value of founders' stock, stock splits accompanying capital increases, and stock option plans for employees.

But the wheels of Japanese bureaucracy don't exactly rotate at lightning speed, and as usual, it may be innovations from foreign firms that really force the issue. In pursuit of greater understanding of the possibilities in this area, we met with Mike Yoshii and Kouji Ishikawa of White & Case, who have been deeply involved in developing strategies to overcome the problems we touched on in the last issue of JIR (http://www.jir.net/jir4_00.html). Be sure to read our interview with Mike and Kouji below.

At a seminar the other day, Allen Miner of SunBridge (www.sunbridge.com) presented a telling statistic: In Japan, large bricks-and-mortar companies operate more than 75% of the top 25 Web sites, while venture firms account for less than one-quarter of the leading sites. In contrast, new venture firms in the U.S. account for 60% of the top Web sites, while large players operate only two-fifths of the leading sites.

Allen pointed out that this situation illustrates the very different natures of the Japanese and U.S. venture communities. The purpose of Allen's Venture Habitat project, launched recently in the Mark City building at Shibuya Station, is to bring the best elements of the Silicon Valley and Bit Valley venture environments together in one Tokyo location. His group is off to a good start - the office is beautiful, and SunBridge is getting a great deal of television and press coverage...

This month we enjoyed both online and offline chats with attorneys Michael Yoshii and Kouji Ishikawa of White & Case (Tokyo) / Kandabashi Law Offices, a firm active in assisting a number of Internet-related companies here in Japan. Michael and Kouji were kind enough to share their perspectives on the issues we touched on in the April 2000 edition of JIR.

- Why do new Japanese companies issue so few shares?

This is the key question, and will take some explaining. To begin with, we should expand on the problems resulting from too few shares.

First, as you mentioned last month, the high per-share price means that only large institutional investors can afford the company's shares. Individuals have no opportunity to become shareholders. Most founders of venture companies are more democratic and would prefer wider share ownership.

Second, without enough shares, liquidity is a serious problem. Without liquidity, the share price is too volatile and unreliable. U.S. NASDAQ requires a minimum public share float of 1,100,000 shares; currently Mothers only requires a 1,000 share float and Japan NASDAQ has announced it will require only 1,100 shares. Spread over the minimum 300 shareholders, this is only three to four shares per shareholder. Many shareholders probably own only one share, and won't sell it.

Third, high tech companies often merge and make alliances to grow. The main currency for this is not money, it is the company's shares. Not having enough shares is an impediment to M&A.

Fourth, enough stock options cannot be issued. When a company has only 3,000 shares, as is true for some companies listed on Mothers, its stock option pool (which is limited to 10% of issued shares unless special permission from MITI is obtained to increase the number) is only 300 shares. This makes it very difficult to issue reasonable numbers of options to more than senior executives. If the company uses a standard four year vesting schedule, the minimum options grant is four shares (one per year). But if the company's share price is $150,000 per share, the $600,000 value and exercise price of the options granted is too much for any employee except senior executives. And four options is not very attractive to the employee. As stock options become a key factor in recruiting and retaining key employees (which our clients believe will happen in Japan just as in the U.S.), companies that can issue options will attract and keep the better employees.

The venture companies listing on TSE Mothers with share prices of $100,000 or higher are the victims of a par value share capital structure. The founders did not have the money to purchase enough founders' shares at par value (for example, to issue 1,000,000 par value founders' shares would cost the founders $500 million). The founders obviously want to retain a large percentage ownership of their own company. So if the founders can only purchase a few shares, the VCs or strategic investors purchase even fewer at a very high share price. By IPO, the per-share price is extremely high.

There has been a lot of discussion of these problems, which the TSE Mothers market has highlighted. Most commentators have blamed legal restrictions. In fact, the real obstacles are lack of information and resistance to change, not legal obstacles.

Contrary to what many Japanese founders and VCs believe, it is quite possible to increase the number of founders' shares to a reasonable level. The trick is to issue no par (mugakumen) shares rather than par value (gakumen) shares. No par and par value shares are identical as far as value, shareholder rights, etc., and numerous listed companies in Japan have issued no par shares rather than par value shares. But one major difference is that whereas par value shares cannot be issued for less than 50,000 yen per share, no par shares can be issued for any price. In fact, some of our startup clients have issued their founders' shares for as low as one yen per share.

What confuses people is that the first 200 shares of a K.K. cannot be issued for less than 50,000 yen per share, even if the company issues no par shares. This is to satisfy the minimum 10,000,000 yen paid-in capital requirement. But thereafter founders' shares can be issued at any price. So even if the founders have only 11,000,000 yen in capital, the company can issue 1,000,000 no par founders' shares and have a stock option pool of 100,000 options. If the company issues par value shares, for the same paid-in capital the company would issue only 220 shares, and would have a stock option pool of only 22 options.

We caution that there are a number of fairly complex legal and tax issues involved in an issuance by a K.K. of 1,000,000 no par shares. In Delaware, the same number of shares could be issued in a couple hours with 2 pages of legal documentation. In Japan, the process is much more involved and the legal documentation is 100 pages. But it can be done, and done in as little as five to ten days. We have also confirmed the legality of this structure with the Ministry of Justice and with the Examination Division of TSE Mothers. A number of our Internet company clients have decided to use this capital structure, and we have registered capital increases with one to ten million no par founders' shares with the Legal Affairs Bureau.

We should also caution that this capital structure is new and market acceptance is still unknown. Although no par shares are common, the concept of issuing a large number of founders' shares for low prices is new. Some underwriters are currently hesitant because there is yet no precedent in Japan, and they have raised issues about whether their back office and marketing departments will be able to handle IPOs of companies which have millions of shares as opposed to thousands of shares. One underwriter recently told us that it is concerned that a share price of 50,000 yen (about $500) or less per share will be viewed as penny stock, and shunned by investors. Others have told us that they do not want the company to have individual shareholders holding small lots of shares, and therefore want to keep the number of shares down and the per share price high.

A number of our clients have decided to take these risks in order to avoid the par value share trap. They know that this capital structure is the standard model in the U.S. and other countries, and feel confident that Japan will follow. They believe that electronic trading will lower commissions and allow more individual investors to participate, and that companies with reasonable share prices will be more attractive to investors than companies with unaffordable prices. They want wider share ownership and also want to give stock options to employees. But a few clients have been more conservative and have stuck to par value shares.

As reported in your past newsletter, another potential solution would be stock splits. But as reported a stock split cannot be done unless the net assets of the company exceed 50,000 yen per share. The law may be amended someday to remedy this, but most of our clients cannot wait for the law to change.

- Why do shares of some companies not trade at all on some days?

Lack of liquidity and high per-share prices. As discussed above, this is not due to government rules, but more to lack of knowledge about the no par share alternative, and resistance to change by traditional underwriters.

- Tell us what White & Case is up to these days.

We work together as a team of Japanese and U.S. attorneys to assist high tech companies, including Internet startups. We are currently assisting 15-20 Internet startup companies in all phases of development. Most have U.S. or other foreign shareholders, but some are purely Japanese. We assist in designing the capital structure, setting up the K.K., issuing founders' shares, VC investments, stock option plans, web contracts, and an assortment of other legal matters through and including IPO. Japanese and U.S. tax attorneys also are part of the team to handle the numerous tax issues faced by high tech companies.

Our clients range from NASDAQ listed companies investing $100 million in a Japan startup to individuals with only a business plan and the 10,000,000 yen minimum capital to form a K.K. We also represent VCs in their investments both outside and inside Japan, so we have a good idea of what are typical capital structures for Internet companies outside of Japan, and what are the market standards for VC and strategic partner investments.

Many of our clients have a Silicon Valley philosophy (wide share ownership, stock options, etc.) and we have worked long and hard to find ways to implement this in Japan, with all the restrictions that apply here. Surprisingly, there are answers to most of the impediments, and it is possible to replicate a typical Silicon Valley capital structure in a Japanese K.K. We are convinced that this will become the standard in Japan for venture companies, and it is very exciting pioneering this change.

White & Case (Tokyo) / Kandabashi Law Offices
Tel 81-3-3259-0200
Fax 81-3-3259-0150
Michael J. Yoshii - myoshii@gol.com
Kouji Ishikawa - kishikawa@whitecase.com

The information technology (IT) revolution has finally hit Japan, according to television program lead-ins and headlines flaunted by nearly every newspaper and magazine in the country. For whatever reason, "IT revolution" is now the buzzword of the season here in Tokyo. Perhaps you are wondering: Why wasn't this the case ten years ago?

My take is that the buzz over the "IT revolution" is in a sense replacing recently-adjusted (and far more realistic) expectations for the "Internet revolution." Mature businesspeople here who monitor e-commerce developments in the United States have in general been extremely skeptical of high-flying U.S. Internet firms operating under business models that, from the Japanese standpoint, are transparently unsound. These businesspeople have from the beginning understood the Internet primarily as a tool for reducing costs, rather than a channel for increasing revenues. Recent stock market events support this viewpoint.

So now the IT revolution can begin in earnest, devoid of some of the star-struck baggage carried in by over-financed and under-functional Internet startups. Now that's something deserving of some buzz...

We're looking for folks to join us on our mission to become the leading e-business solutions provider in Asia, bar none. Immediate opportunities are available for:

- Developers
- Technical Solution Integration Director
- Online Marketing Director
- Strategic Practice Managers

What we'd really like to know is 1) what kind of work you want to do and 2) why. We are particularly interested in individuals with strong sector-specific experience outside of the Internet industry proper. Contact masako.nakamura@twc-jp.com.