[PODCAST] The hidden danger of unicorn counting in Japan — Interview with James Riney at Coral Capital (Part 2)

Japan has far fewer unicorns than one expects – or than venture capitalists desire.

That fact, however, hides a fascinating story.

Today James Riney, founding partner of Coral Capital explains the danger of unicorn counting.

We dive deep into which startup sectors Japan is likely to lead in globally in the coming decade, how to identify unique startup value in Japan.

We also talk about how Japan has become more like Silicon Valley in the past ten years and why they are about to become very different.

It’s a great conversation, and I think you’ll enjoy it.

(The second of four parts. Continuation from Part 1.)

Tim: You say there’s three pillars?

James: Yes. Okay. So, you want to hear the second one?

Tim: I do.

James: So, the second one is where Kyoto Fusion fits in. And what this is, is what we call the Japan Advantage. These are companies that are using Japan’s fundamental strengths in order to compete globally. So, I mentioned that fusion, there’s a reason that Japan would be a leader because they’re already a leader in fusion and they’re a leader in advanced manufacturing. When we talk about SaaS, SaaS is very marketing and sales oriented. Therefore, like the language and culture barriers that tend to sort of hold back Japanese starters from going global are particularly pronounced when it comes to SaaS. But when it comes to like deep tech or biotech or maybe content IP, like things where Japan is just already good at and the product kind of sells itself, it kind of transcends those barriers. We think those are just less relevant. And so that’s where I think there’s probably going to be opportunities to build like a Sony or a Toyota.

Tim: Let’s dig into that. So, you were talking about like the global strengths. What are some of those areas where you think Japan has those global strengths? Something unique to Japan where Japanese startups would have an edge?

James: Obviously bullish on fusion. We’ve also done semiconductors like diamond semiconductors. So, anything like manufacturing related would be also interesting. We’ve done some biotech as well. We’re pretty open-minded, but we’re always looking for like, what’s the unique reason why this company exists in Japan and how can they compete globally? The town is global, we have to consider that there’s going to be global competition. And so what edge does this company have just by being based in Japan?

Tim: I mean, that makes a lot of sense because they’re going to be less capitalized than their competition coming out of the US for certain, but from coming out of other markets as well. So, they’ll need some kind of clearly defined advantage to compete globally.

James: Robotics would be another one. And these are all areas, by the way, that the Japanese government wants to exist in Japan. And so there are tailwinds where you mentioned funding. Maybe they won’t be as highly capitalized as players you’d see in the US, but there is capital available. And it’s not only equity based fundraising options, but also there’s grants. There’s very cheap debt lots of options available. So, those are things like whenever we talk about deep check, the number one question I get from investors is, oh, like, isn’t that very capital intensive? And yeah, sure, but you don’t necessarily have to dilute yourself to oblivion in order to get it off the ground. Like there’s other ways to, to fund the company. And I think a lot of people don’t understand that context when it comes to Japan.

Tim: Yeah, that makes a lot of sense. Now I was about to go on this long digression about deep tech investing, but that’s best done over a beer, I think.

James: Okay, sure.

Tim: We’re here to talk about your investing strategy, not mine. Third pillar.

James: Okay, so the third one is what we call uniquely Japan. This is a much harder one to explain. So, I talked about Japan category leader, and what that is basically like this is the X for Japan. And that pretty much gets you like 80% of the explanation. Like Smart HR is not the Rippling of Japan per se. I mean, there’s lots of intricacies there, but yeah, like that’s probably 80% of like what they do. Whereas uniquely Japan, I have to start with, okay, in Japan there’s this particular dynamic in this particular industry, which is why there’s a need for this particular solution. One example is we’re a big investors in Kakashi, and what they do is they’re a SaaS solution for the pharmacy market. In Japan, of course, I don’t know exhaustively every country’s pharmacy market, but for example, in the US most of the markets basically dominated by like CVS or Walgreens the big guys. And when you’re that big, you can kind of build out your own digital solutions. But in Japan, the major players don’t really own much of the market. It’s like 1-2%. And so it’s very fragmented. And so because it’s fragmented, there’s an opportunity to sell an all-in-one SaaS solution to that market, which is what they do. So, they do inventory management, patient management, et cetera, et cetera. And what’s really interesting about them is that, let’s say that you order medicine online and your local pharmacy is also using Kakehashi, they would know already that their local pharmacy has that particular medicine in stock and they could do last mile delivery to send it to you. So, there’s the SaaS part, but then there’s also the pharmaceutical delivery part as well as procurement and other expansion areas. But it’s a unique thing to Japan, right? It’s uniquely Japan uniquely solving some pain point that’s local here.

Tim: And so sort of the differentiation between the Japan category leaders and the uniquely Japan would be that the category leaders are sort of, they’re using existing business models that are pretty much relatively standard around the world, where the uniquely Japan is, they’re building something new here that probably can’t be exported because of the business model itself couldn’t be exported.

James: Right. It’s unique to Japan and we’ve done another company that is doing a SaaS solution for the agricultural industry. Basically it’s a way for farmers to exchange goods with each other. And that’s a very analog process at the moment. I don’t know if you know JA, but I mean even JA people don’t quite understand what JA is because it’s like this monstrosity of like local collectives and things like that. So, I won’t get into it on this podcast, but that’s a very sort of Japan specific industry.

Tim: Do you ever run into problems just — it would seem that a lot of the opportunities there just aren’t big enough to be profitable?

James: Oh, I mean, they’re huge. I mean so in Japan there’s more pharmacies than there are convenience stores.

Tim: Really?

James: Yes, yes. There are a lot of pharmacies in Japan. So, it is a big market. And of course the pharmacy industry is here in Japan. I don’t know the exact number off the top of my head, but certainly big enough to build at least a hundred million in revenue and probably a billion in revenue.

Tim: Before we get too deep into this, Coral had a really huge announcement this morning.

James: Yes, we did.

Tim: Let’s talk about that.

James: Yeah, so we just announced Fund IV, so it’s a ¥25 billion vehicle focused on finding the next Smart HRs and next Kyoto Fusioneering. The next Toyotas and Sonys of Japan. And there are a few things that are different about this fund. We have historically done series B’s and series C’s, but for the most part we’re getting at as early as possible to these companies. But now with the larger fund size, if for whatever reason we miss it at the C or the A, we can pick it up at the B or the C and then into any one company we can do about 30 billion, or sorry, 3 billion Japanese Yen. Now what is that in dollars with current rates? The Yen’s so cheap, it makes me feel like all this, you know? So in buying terms, it’s more like 250 million, but with the Yen so cheap, it’s like 160 million. But anyway, it’s relatively large for the Japan market. So, we have capital to fund much more ambitious projects. And the other two sort of interesting features of this fund is that LPs give us a blessing to have a fund extension up to 14 years.

Tim: That I was really surprised at. That’s extremely long duration.

James: It’s long duration. Yeah.

Tim: What was the logic and what was the negotiations behind that?

James: We actually did this from fund three. I think that the common sense of making every fund 10 years is kind of ridiculous because every fund has a different strategy. And if you are coming in at seed, if you’re the first check into a company, then that’s very different from you investing at series C. So, the time to exit is obviously going to be different. If you’re trying to invest in companies and shepherd them to multi-billion dollar outcomes, it takes time. Airbnb took a long time. Stripe is still not public.

Tim: But outside of government funds and CVCs, I don’t think I’ve seen a fund of that duration in Japan.

James: We might be the only one in Japan. That has that duration.

Tim: I mean, the logic you just said is absolutely true, but that’s sort of true universally. So, what convinced the LPs to say, yeah, 14 years?

James: Yeah, we did that from fund three. We had the credibility at that point. We have done pretty well on our funds. So, we have the trust of the LPs. And then it’s also just the explaining that logic. One advantage that I think we have in Japan is that we can look at things with like a fresh eyes and just question why does this exist in the way that it does? And that was one thing that I always thought was kind of strange, that no matter what the fund strategy is, it’s 10 years and why wouldn’t it be longer than that? And so a lot of criticism from actually global LPs about Japan markets, like the VCs look for like exits very quickly. And so they try to IPO within five or seven years. And I’m sure we’re going to get into that a bit later, but it takes maybe 10 years or more to build like multi-billion dollar companies with longevity. Maybe on paper you can build like a papercorn. But that’s a different thing, right? And so we want to be able to be patient and be able to fund things on a longer time horizon.

Tim: I mean, how long will you spend deploying the capital?

James: Well, that’s going to be the same. So, typically we make our first investments within two to three years. And then normally we’re raising new funds every two to three years, but we continue to follow on into companies over probably five to six year time horizon.

Tim: Alright.

James:The other feature that I think LPs for giving us the leeway here, is that we can also do cross investment. We can invest in companies from our previous funds. Historically, we did Smart HR to fund one, and then we did an SPV to do Smart HR. And then we’ve done opportunity funds from other vehicles as well. And so we’ve done some of this sort of cross fund investment, but it was always like the flagship fund is like blasphemous. Like you can never do that. Like if we know the company really well and amongst all the opportunities that we’re looking at, like this is the one, this is the next Smart HR, we think that we should have that leeway to do it. So, within certain guidelines that we’ve agreed to with LPs, we can do cross fund investment as well. From the entrepreneur’s perspective, it’s not like you have to worry like how much money is left in this fund. We could potentially invest in the series B or series C later. And the other thing that I always thought was strange is that if you’re investing at seed, by the time that company might be ready for like a $20, 30 million check, it might be five to seven years later. Oh yeah. You know, it takes time. So, if we’ve been tracking it for that long and once it’s ripe, we want to be able to take a bite out of the apple.

Tim: I mean that really speaks to the trust that your LPs have in you to give you that flexibility.

James: Yeah. I mean we’re really grateful for that. We’ve lucked out, we’ve got some really excellent LPs.

In Part 3, the challenge of adapting Silicon Valley's methods to Japan and the evolution of Japan's VC industry will be discussed.

Click here for the Japanese version of the article