[PODCAST] The hidden danger of unicorn counting in Japan — Interview with James Riney at Coral Capital (Part 4)

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.

James: Yeah, I mean, if you want to live a life in entrepreneurship or just life in general, there’s always going to be skepticism. It’s constantly, it’s like, okay, so we’ve had very fast fundraisers and I’m very grateful for that, but I don’t think people realize how many nos there actually are. It’s a grind. The nos are kind of product part of the process. And if you just think of it as like a feedback loop, then it’s like a bit easier to have that mental fortitude.

Tim: Main cabinet office. A lot of government agencies, Tokyo Metropolitan Government, are all trying to attract more foreign VCs to Japan, both in terms of investing in Japanese companies, but also individual investors to come and start funds and to bring that knowledge with them. As someone who’s gone through that, how hard a time are these people in for? If someone wants to come and set up a fund here, what should they expect?

James: So, to be honest, I think it’s totally ridiculous that the government is even pushing this. And I’ll tell you why. If there are good companies, they will get funded by global investors. So, Smart HR is funded by Sequoia. There are other companies also in a portfolio that I raise money from, Green Oaks, Light Street, et cetera. So, if you have the good companies, they will come. And the problem with what the government is doing is the VCs that are going to take money from the Japanese government in order for them to invest in Japan, like with strings attached, there’s going to be adverse selection there. Sequoia is not going to take the money with the strings attached, like, hey, you have to invest in Japan. Like, they’re not going to do that. And the other thing is that as much knowledge and success that those firms have, they don’t have like the local connections and the local sort of understanding in order to help those companies at the earliest stages. It might sound like I’m talking in my book, but it is true. I mean, they don’t. There’s no one…

Tim: And you are a bit, but that’s okay. But see, this is true everywhere. American VCs, these firms have offices in London, they’re in Europe, they’re all over the world. Japan seems to be a really popular destination for funds looking for LPs. It’s a great place for funds to raise money. But there’s not a lot of investment into the country.

James: Yeah. And I’ll tell you why. In 2020 and 2021, the ZRIP era, it was go-go days, like everything was good times people were just like flying into geographies, like, okay, maybe not with Covid, but right after that. And the first markets that really saw their prices shoot up were the English speaking markets or the markets where you didn’t need to speak the local language in order to compete. UK, places in Europe, even Southeast Asia, Japan, you do really have to speak Japanese or at least try to get over that barrier. So, it’s not as easy. So, I did have those like crossover fund types pinging me about deals in Japan, but it was much harder for them to really understand what’s going on and catch those opportunities quickly. I just think it’s, there is that sort of black box element about Japan that makes it much harder to penetrate.

Tim: So, do you think even as the ecosystem grows, and let’s say that the government targets are hit, we hit the 10X in five years, which we could. Do you think that the VC scene here will remain primarily a domestically led VC industry?

James: Well, to be clear, I want more foreign VCs to come and invest in Japanese companies. And in order to get to that 10X from here OKR that the government has set, we’re going to need to do that. That’s obvious. But what I’m saying is that bringing the capital here is not going to solve the fundamental problem, which is you need startups that you need good startups.

Tim: Yeah. There’s a supply side problem as well. Yeah, that’s true.

James: Exactly. So, that first and foremost needs to be solved. And I just think that at the earlier stages, in order to build these companies to a significant enough scale for it to be interesting for foreign investors, you need to invest in a local ecosystem so that it’s self-sustaining without the global capital. And once it is, the global capital will come. There’s good investment opportunities, it’ll flood.

Tim: That makes sense. For the foreign VCs that are thinking of investing in Japan or coming to Japan, what do you think are the biggest misconceptions that exist about the Japanese market?

James: Okay, so this most recent fund, we have 30% of our capital from outside Japan. And these days, I’m typically the person that foreign institutional investors will get in touch with, or I’ll be introduced as the person to talk about Japan VC in English. So, I’ve talked about this a lot. The sort of qualifiers, or the filters that I always ask in the beginning are, do you understand the local IPO dynamics? And almost always the answer is no. For better or for worse, the barometer for startup ecosystems in recent years has been number of unicorns. And so you look at, UK has X unicorns, Europe has Y unicorns. No, but China has whatever Z unicorns, as we’ve seen like these, a lot of them are not unicorns at all. They’re actually paper coins. And so I think we’ve had this like reality check. The difference in Japan is that it’s much easier to go public. So, you can go public around series B or series C in terms of valuation and revenue. And so historically companies have gone public around that stage. The good thing about that is that you can get liquidity a bit earlier as a VC, as an early investor, that’s fine, but because those companies go public around that stage, there’s a lot of cases where actually they crossed the billion dollar mark in enterprise value after IPO just a few years after IPO.

Tim: You wrote a really good article about this a while ago, and we’ll link to it on the site. But yeah, in terms of actual value, economic value creation, exactly. It is comparable.

James: Exactly. So, actual enterprise value creation, like that’s what’s important. And these are companies that are liquid now, like they’re public companies. And so why are they not counted? So, unicorn, technically the definition is a private company. That’s valued at over a billion dollars. The thing is, in Japan, a lot of these companies have gone public early and then crossed the billion dollar threshold. I always knew that this was like a fundamental issue. Like it was like a hidden truth that made Japan very misunderstood and so on. The unicorn counts, we didn’t score very well, but we ran the analysis, the article that you’re talking about where between 2011 and 2021, we were looking at, what companies went public within 12 years of founding and then crossed over a billion dollars in enterprise value. And we call these hidden unicorns. And what we found is that actually there were over 40 companies that met this criteria. So I mean, like, this is not counting all the other like new minted unicorn, like real unicorns or I don’t know if real’s the right word, but that tells you a very different story. We’re actually like, maybe there is a lot more enterprise value creation and fund.

Tim: No, I think you’re onto something there. And in fact, I think it comes down to who’s doing the counting. If it’s the VCs doing the counting, they don’t care about enterprise value created 12 years after they exit their fund ends. But the thing is, if it’s METI, the long term is what they really care about. And I think this is relatively new even on the US side, because if you look at like Amazon or Google or certainly Apple, most of the value creation happened well after their IPO.

James: Exactly, exactly. So, it happened well after the IPO. And so this is something that’s different. And so if you are just doing a cursory review of geographies, you’re like, okay, where should I allocate to VC? And you’re like, okay, like let’s start with where there’s unicorns, it doesn’t tell you the whole story. Whereas in Japan, you have to count the hidden unicorns in order to have a holistic picture of what’s going on.

Tim: Of course, you have to have a longer fund 14 year fund. There you go.

James: Right. Exactly. And by the way, I mean VCs in the US also, like ultimately they’re like 15 year funds. Even if it says 10 years, like there’s extension, extension, extension. And as long as you have like an Airbnb in there or a stripe in there, you get some leeway.

Tim: You get the extension. Yeah.

James: You get some leeways.

Tim: Alright. Do you think that’s going to change? Because not only more and more capital is being raised, but bigger and bigger funds are being raised and to deploy that capital, it’s got to be deployed into later and later stage companies. So, do you think this dynamic’s going to change in Japan?

James: It is changing, it already is changing. I would say that the Japan market is what Silicon Valley looked like maybe in like the early two thousands.

Tim: Hopefully not too early in the 2000 I was over there. It was pretty bleak.

James: Yeah, yeah, yeah. Maybe, maybe 2005 onwards.

Tim: Okay. There we go.

James: Alright. My point is that the labels on these rounds have really like shifted. What was a series A in the US at that time is really a seed round now, right? Raising three to 5 million might’ve been a series A at that time. And that’s kind of the case in Japan where a series A, it could be anywhere from three to 10 million or something. And of course there’s outliers, but that’s generally the range. And then seed rounds are maybe like 500k to 3 million or something like that. And so the labels are very different in Japan.

Tim: Alright, well listen James, before I let you go, I’m going to ask you to peer into this crystal ball and tell me what does Japan’s startup ecosystem look like in 10 years? What does Coral Capital look like in 10 years?

James: What we’re doing at Coral, the dream that we’re building is basically we want to be of course the top firm in Japan and I think we’re getting there. But we are building a firm that is based in Tokyo, investing in hopefully the Power Law companies, the next Toyotas and Sonys in Japan. But eventually we do have global aspirations, but we’ll always keep this sort of Japan angle. So, we’d love to be able to invest in companies that we see outside Japan. We also think might have potential coming into Japan. So, going back to the Japan category leader topic, when we’ve come to inclusion that that category is probably going to be dominated by a global player, then we’ve already done the work and we’ve thought about that area, why not invest in a global player and help them come to Japan? And so this is still very early stages, but who knows how it’s going to play out. But maybe the open AI of Japan is open AI. They set up shop here, maybe not of course like getting in early and like competition in the US is really fierce. Like I understand all those challenges, but what we’re building here is we want to be the number one firm known for Japan. And so we’re building a team that is able to do that. On that note, we’re also hiring, so let me just plug that in. Please apply at our website. Looking forward to seeing your application.

Tim: Excellent. Alright James. But thanks so much. Let’s not wait so long before the next one.

James: No worries. Thanks for sitting down. Yeah, yeah, yeah, yeah. Thanks

And we are back.

James’ point about the dangers of unicorn counting is an important one and one I’ve talked about myself in past episodes. We’ll put links to both James’ article and the past podcast episodes at the site. You see, US startups are staying private much longer and can raise levels of capital that used to require access to public markets.

So yeah, markets where that’s true will have a lot more unicorns because there is much less incentive to go public in such markets.

In fact, WeWorks fall from a $47 billion super unicorn status was actually triggered by their decision to go public because that opened them up to much greater financial scrutiny than raising VC funding ever did. And you know, come to think of it, WeWork might be the only startup in history whose bankruptcy was caused by their IPO filing.

Startups are valuable because they drive innovation that leads to long-term enterprise value and quality job creation. And unicorn counting is not necessarily the best measure of that.

So, could patient venture capital provide Japan with a systemic edge?

Maybe.

A more patient mindset and the influence of corporate venture capital in Japan is certainly causing VC culture to develop differently here. Add to that, some very impressive innovations in deep tech manufacturing and robotics and that would be something that plays to Japan’s strengths, is unique in the world and could create tremendous value rather than pushing for riskier growth, faster exits and more liquid secondary markets. Perhaps Japan can continue to expand while maintaining a focus on long-term value creation.

Maybe. We’ll see, won’t we?

In any event, I strongly agree with James’s assessment that a lot about Tokyo today feels like Silicon Valley back in the old days. There’s a lot of genuine innovation at creating real value and we have a lot of passionate founders solving problems using small budgets and big dreams.

If you want to talk more about how to raise a fund in Japan, James and I would love to hear from you. So, come by disruptingjapan.com/show220 and let’s talk about it. And hey, if you enjoy disrupting Japan, share a link online or just tell people about it. Disrupting Japan is free forever and letting people know about it is the absolute best way you can support the podcast.

But most of all, thanks for listening and thank you for letting people interested in Japanese startups and VC know about the show.

I’m Tim Romero and thanks for listening to Disrupting Japan.

Click here for the Japanese version of the article