The Case for Search Funds in Japan

It is not often that we hear about M&A activity in Japan, despite it being home to the world’s (!) oldest (!) company. Kongo Gumi, headquartered in Osaka, is a construction company that was founded in 578 AD and its first project was building the Shitenno-ji Buddhist temple. The company is operational until today, handling the design, construction, restoration, and repair of shrines, temples, castles, and cultural heritage buildings. So when it says that it boasts more than 1,400 years of corporate history, it is definitely not lying, despite how unbelievable the number may sound.?

And although the country’s “corporate” history goes back centuries, Japanese CEOs are the most pessimistic globally about their company’s future, mainly due to concerns about the viability of their current business model, according to PwC’s 26th Annual Global CEO Survey.

Can we hear the search fund bells?

We may be biased, but we believe that these are excellent conditions for search funds to thrive in the country. Think about it: Companies that have been going steady for years and decades, that need some fresh blood to help adapt their business models to today’s conditions and the future’s challenges.?

However, according to the International Search Funds 2022 report conducted by IESE Business School, Japan has witnessed the formation of only 1 search fund to date. Yoshiaki Kurosawa paved the way by launching Japan's first traditional search fund in 2019, culminating in a significant acquisition in 2021.?

But there is more than meets the eye

Japan boasts two search fund accelerators, with JaSFA taking the lead since its establishment in 2018, according to insights from SMEVentures ’ Jake Nicholson . Led by Noriko and Hajime Shimazu , JaSFA has provided essential support to active search funds, resulting in successful acquisitions by searchers such as Kenji Watanabe, Yuki Mizoguchi, Keita Ito, and Shota Maruyama. Another accelerator, Search Fund Japan, was founded by Kimitake Ito in 2020 and supports multiple searchers on their entrepreneurial journeys.

This movement signifies a tipping point similar to Australia, fueling expectations of increased activity in the coming years.?

It isn’t all rainbows and butterflies

Asian cultures, known for their conservatism, present unique dynamics for search fund entrepreneurs. Asian investors typically exhibit a more risk-averse appetite compared to their American counterparts, favoring traditional asset classes like property over venture capital and private equity. Building relationships takes precedence in conservative Asian markets, making it challenging for unknown entrepreneurs to secure investments.?

Additionally, M&A activity seems to have taken a hit. Only a few Japanese companies engaged in large cross-border deals aimed at transforming their business portfolios in 2022, according to a report from Bain. Deal value of M&As dropped by 20% in the first nine months of 2022, but deal volume remained at the same level as 2021, indicating a rise in small deals.?

The nature of those deals were small, as opposed to transformative ones, such as Nippon Steel's acquisition of Thai steelmakers.

But there’s good news

Japanese companies are expected to resume deals as they clarify their growth strategies and shed nonstrategic assets. Financial investors, including private equity, remain interested in buying carved-out assets in Japan. Moreover, interest rates in Japan are comparatively low, making it affordable to borrow for deals.

Let’s hear it from the real, on-ground, searching warriors

Based out of the world’s most populated city, Tokyo, Mitsuya Shimura , the founder and managing partner of search fund M-Capital GK , raised USD 420,000, and started his search phase for a Japanese company to acquire in August 2022. He is looking to close a USD 10-20 million acquisition by July 2024.

Sneak peek at Mitsuya’s origin story: Mitsuya spent eight years in a sales and marketing function at Toray, a Japanese Chemical Company and got an MBA from IE Business School in 2021. He also holds a Master of Civil and Environmental Engineering from @Waseda University, and interned pre-MBA at the first Japanese traditional search fund JBS Partners .

We talked to Mitsuya about why he became a searcher, what is significant about Japanese business culture and how he’s manoeuvring the local conditions.?

Moonbase Capital: Why did you decide to become a searcher in the first place?

Mitsuya Shimura: My grandfather and my father were entrepreneurs, and they inspired me to be one. But I never had a specific idea around which I could launch my own company. Somebody introduced me to the concept of entrepreneurship through acquisition. Also, in 2021, when I was doing fundraising, there was only one traditional search fund in Japan, and it seemed very cool to me at the time to be one of the pioneers of the search fund community in the country. During my MBA program in Madrid, I met 50-60 search fund entrepreneurs and 70-80 search fund investors from around the world and learned from them how to start a search fund.

MC: What sectors are you targeting for your acquisition??

MS: I am not targeting one particular industry but currently I am sourcing deals, mainly in software, healthcare, environment-related industries, because they’re growing sectors in Japan. The country’s economy itself is shrinking because the population is shrinking. This may be hard on a lot of people but those three industries specifically can have the potential to grow in those conditions.?

MC: How do you obtain your industry data?

MS: In Japan, we have a very expensive company database by several research firms, but I got access to it through one of my investors. In there, you can see basic information about companies in the country, such as sales, income, shareholders, the name of the owners, etc.?

MC: Does it also include contact information for the owners??

MS: Oh, no. That we predict. We check the company’s website domain and then try out different combinations of the owner’s first and last name with different punctuations, followed by an @ and the company’s domain. We then make a list of possible email addresses and send out an introductory email to all of them. Although there are many M&A brokers in Japan, I do not rely on them at this time, but rather approach targets on my own.?

MC: And how successful is that? How high is the response rate?

MS: About 3% respond and in 1% of the cases, I get a meeting with the owner. In Japan, company owners are very conservative or shy, compared to, for example, the US or the EU. It’s part of our culture. Hence, it is very difficult to track them down, find their contact information and get a meeting. However, thanks to my interns, I can meet one new owner every week.

Ibrahim Abdel Rahim san from Moonbase Capital and I hold monthly strategy meetings to determine our search strategy for the Japanese market.

MC: What else is significant about the way Japanese company owners do business?

MS: We have a very solid seniority system. Most elderly people do not believe in the search fund model, because searchers, to them, are too young to head a company. And due to the seniority system, the majority of companies in Japan are owned and run by people in their 60s or 70s. That is why I am currently targeting companies whose owners are aged between 40 and 60. This younger generation of owners have a more flexible mindset to accept new concepts, like that of a search fund. That’s a loss because it automatically rules out a large number of companies. However, I am in the process of testing the hypothesis to see if it is correct.

MC: Tell us about the Japanese M&A market.

MS: There are 4 million companies in Japan and the average age of owners is 60 years. About 50-60% of them don't have a successor. They then either decide to pass on the company to the next generation of executives in the business who are 0-10 years younger than them, in compliance with the seniority system, or they sell to an M&A boutique or small-cap private equity firm. According to my calculations, about 3,000? local boutiques and firms have been popping up in Japan, mainly because they know that business succession is a serious problem in the country. This makes the market very competitive, especially for young searchers, and causes a spike in prices. So, it's tricky.

MC: What do you look for in a potential acquisition??

MS: Of course, typical search fund criteria such as recurring revenue, growing industry, and EBITDA are very important. But on the other hand, I think the most important question is whether I would have enough motivation to handle this company by myself. I need to be passionate about the service or product it provides. This is my 11th month of sourcing activities, and one of the most enjoyable moments in the search process is to hear the stories of how the owners have established their businesses with passion and how they are contributing to society.