Private equity in Japan: market and regulatory overview

A Q&A guide to private equity law in Japan.

This Q&A is part of the PLC multi-jurisdictional guide to private equity. It gives a structured overview of the key practical issues including, the level of activity and recent trends in the market; investment incentives for institutional and private investors; the mechanics involved in establishing a private equity fund; equity and debt finance issues in a private equity transaction; issues surrounding buyouts and the relationship between the portfolio company's managers and the private equity funds; management incentives; and exit routes from investments. Details on national private equity and venture capital associations are also included.

To compare answers across multiple jurisdictions, visit the Private Equity Country Q&A tool.  For a full list of jurisdictional Q&As visit

Chris Hodgens, Norihiro Sekiguchi, Gavin Raftery, Ryutaro Oka and Yusaku Ono, Baker & McKenzie GJBJ Tokyo Aoyama Aoki Koma Law Office (Gaikokuho Joint Enterprise

Market overview

1. How do private equity funds typically obtain their funding?

Private equity (PE) funds in Japan obtain funding from a variety of sources, including:

  • Individuals.

  • Corporations.

  • Pension funds.

  • Life and non-life insurance companies.

  • Banks.

  • Trust banks.

  • Overseas investors.

Institutional investors continue to be the biggest source of funding for PE transactions in Japan.

Domestic pension funds do not typically commit large sums to PE transactions. Their investments tend to be in fund of funds, through portfolio funds. Individuals investing in PE funds are generally strategic investors who have a business relationship with the target portfolio. Domestic bank investments also tend to be of a strategic rather than a pure investment nature.

2. What are the current major trends in the private equity market?

Before the global financial meltdown, Japan's PE market was reputed to be the largest in Asia, although it only started in 1998. The growth of PE in Japan is usually seen as synonymous with the growth of the buyout industry, which started around that time. The buyout market grew rapidly in the early 2000s and now accounts for around 10% of the mergers and acquisitions deal flow in Japan. However, there is speculation that this figure may be overstated in that it may include minority-stake investments.

Distressed deals were the main driver in the early stages of the development of the buyout market, with two of Japan's long-term credit banks, the Long-Term Credit Bank and Nippon Credit Bank, being sold to foreign PE funds or consortiums with foreign involvement.

Over the years, the market has expanded to encompass corporate restructuring and turnaround deals, and also deals driven by succession issues in family-owned companies.

Buyout deals, including public to private transactions, dominated the market in 2006, a prime example being the investment in Skylark by CVC Asia Pacific and Nomura. However, the number of large-scale PE transactions shrank significantly in 2007, even before the global financial crisis, bringing into question the market's ability to sustain such deals. Statistics published by the Japan Buy-Out Research Institute (JBORI) indicate that buyout deal volume has fallen steadily from a peak volume of 90 deals in 2007 to around 46 deals in 2010. Deal size has also remained for the most part in the small to medium range. JBORI reports 27 deals for the first half of calendar 2011 with a total deal value of JPY350 billion (as at 1 November 2011, US$1 was about JPY78) already exceeding total buyout deal value for 2010. Deal value for the full calendar year 2011 will receive a further boost if Bain Capital's recently announced acquisition of Skylark from its current owner Nomura Principal Finance closes later this year.

Historically, domestic funds, comprising independent funds and financial funds (that is, domestic funds affiliated with major Japanese financial institutions), have dominated the industry. However, over the years several major foreign funds have entered the market, Carlyle being the leader, with firms such as Permira, KKR, Texas Pacific Group and Bain Capital following. Funds such as Carlyle and Bain Capital have been particularly active in recent years. Major foreign investment banks are also active in the market.

Venture capital funds and corporate funds are also significant players but tend to be focused on early stage, minority stake investments.

Hedge funds have typically operated as a source of mezzanine finance, for example, through preferred stock. As Japanese banks typically provide senior loans at preferential interest rates, PE funds have not turned to hedge funds to provide senior debt. Currently, therefore, there is little competition between PE funds, banks and hedge funds.

3. What has been the level of private equity activity in recent years?

The following statistics are derived from the Asia Private Equity Review.


The PE fund pool for the period from January to November 2011 was US$415 million compared to US$673 million and US$676 million in calendar years 2009 and 2010 respectively. The majority of these funds were raised locally.


US$5.5 billion was invested in the period January to November 2011, a significant increase over the US$3.2 billion and US$2.2 billion invested in calendar 2009 and 2010 respectively.


Historically, when the market was driven by distressed sales, many PE transactions were in the form of management buy-ins (MBIs). At that time, the value of MBIs was roughly equal to that of management buyouts (MBOs). However, the proportion of MBOs subsequently increased as the market moved away from distressed and turnaround situations to the acquisition of healthy targets.

There have been several take-private transactions to date, more recent examples including:

  • Nikko Principal Investment Japan's acquisition of Bellsystem24 for just over US$2 billion.

  • The Carlyle Group's acquisition of DDI Pocket, with Kyocera, for just under US$2 billion.

  • Advantage Partners' US$210 million Pokka MBO.

  • Sumitomo Mitsui Banking's financing of the World MBO.

  • Nomura Principal Finance/CVC Capital Partners' US$2.4 billion MBO of Skylark.

  • Permira's US$2.4 billion acquisition of Arysta Life Science.

  • Advantage Partners' acquisition of Tokyo Star Bank.

  • Bain Capital's acquisition of D&M Holdings.

  • The Carlyle Group's acquisition of Chimney Co.

In addition, there have been some significant leveraged buyout (LBO) transactions in recent years, including:

  • Ripplewood's acquisition of Japan Telecom from Vodafone's subsidiary, Japan Telecom Holdings, in 2003 for about US$2.2 billion.

  • Softbank's subsequent acquisition of Vodafone Japan's (formerly Japan Telecom Holdings) operations in 2006 for about US$11 billion.


Exits have steadily increased in recent years, reportedly reaching a peak of 48 deals in 2008. High profile exits include:

  • Ripplewood's listing of Shinsei Bank.

  • The sale of Japan Telecom to Softbank.

  • JAFCO's re-listing of Tocalo on the Tokyo Stock Exchange in December 2003, the first successful public-private-public deal.

  • Lone Star's listing of Tokyo Star Bank.

  • Citigroup Capital Partners Japan (formerly Nikko Principal Investments Japan)'s sale of Bellsystem24 to Bain Capital.



4. Are there any proposals for regulatory or other reforms affecting private equity in your jurisdiction?

The Japanese and Dutch governments have agreed a new tax treaty which is expected to take effect in 2012. Distributions of profit to a silent partner in a tokumei kumiai (TK) (see Question 6), which were previously not taxable in Japan, will become subject to Japanese withholding tax at the rate of 20% under the new treaty.


Tax incentive schemes

5. What tax incentive schemes exist to encourage investment in unlisted companies? At whom are the schemes directed? What conditions must be met?

Incentive schemes

The angel tax system was introduced in 1997 and generally provides favourable tax treatment to investments by individuals in small and medium-sized corporations (SMCs) and venture businesses (VBs).

At whom directed

Although the system is generally aimed at individual investors, it is also available where investments are made indirectly through investment funds such as SMCs or VBs.


An investor that is a medium to small-sized company established in the previous ten years qualifies for favourable tax treatment if it:

  • Invests a certain percentage (3% subject to the application of a complex set of factors) of its sales into research and development (R&D) aimed at developing new business, among other things.

  • At the time of investment, receives at least one-sixth of its total investment from outside the company.

  • Is not a subsidiary of a large-sized company or any affiliate company.

  • Is not publicly traded.

Qualifying investors are entitled to:

  • Offset the costs incurred on eligible investments against other capital gains derived from the sale of stock in the same fiscal year.

  • Carry forward losses for three years on sales of shares in eligible investments arising from before the venture went public.

Qualifying investors who are medium to small-sized companies established in the last three years (rather than ten) are entitled to:

  • Offset costs incurred on eligible investments less JPY2000 against the taxable income in the same fiscal year. This deduction is limited by 40% of taxable income or JPY10 million, whichever is lower.

  • Carry forward losses for three years on sales of shares in eligible investments arising from before the venture went public.


Fund structuring

6. What legal structure(s) are most commonly used as a vehicle for private equity funds in your jurisdiction?

Domestic structures

There are several forms of partnership agreement available under Japanese law. The four most commonly used as a structure for PE funds in Japan are:

  • A voluntary partnership (nin'i kumiai) (NK), established under the Civil Code.

  • An investment limited partnership (toshijigyo yugensekinin kumiai) (Investment LPS), established under the Limited Partnership Act for Investment (Law no. 90 of 1998).

  • A limited partnership (yugensekininjigyou kumiai) (LPS), established under the Limited Partnership Law for Venture Capital Investment (Law no. 40 of 2005) (LPS Law).

  • A silent partnership (tokumei kumiai) (TK), established under the Commercial Code.

The NK and the Investment LPS are probably more popular vehicles than the others. The LPS is a more recent structure created initially for the purpose of encouraging investment in early stage or VBs.

The key differences between these structures from an investor's perspective are that:

  • Investors in an LPS are liable only to the extent of their respective investments.

  • An Investment LPS consists of limited liability partners and unlimited liability partners.

  • Each investor in an NK has unlimited liability for partnership debts pro rata to his respective contribution, unless otherwise agreed between the partners.

Previously, the scope of investments that a fund adopting the LPS could make was limited. Currently, however, funds adopting any of the structures above can:

  • Invest in listed or unlisted companies.

  • Provide bridge finance, rehabilitation finance or debtor-in-possession finance.

Foreign structures

Many domestic funds also used limited partnership structures based in foreign jurisdictions such as the Cayman Islands, sometimes in conjunction with domestic structures.

Foreign funds typically use foreign law governed limited partnership structures.

7. Are these structures taxed, tax exempt or fiscally transparent for domestic and foreign investors?

Domestic structures

LPS (including Investment LPS) and NK. Both the LPS and NK are fiscally transparent entities for Japanese tax purposes for both domestic and foreign investors and domestic investors must include as income and pay tax on their share of the LPS or NK profits.

Foreign investors, generally, are regarded as having a taxable presence (a permanent establishment) in Japan through their participation in a domestic LPS or NK. They are generally taxable at full corporate rates on their share of income (that is, dividend and capital gain) attributable to their activities through the LPS or NK. Foreign limited partners of the LPS who satisfy certain conditions are deemed not to have a taxable presence in Japan.

Additionally, under Japanese tax reforms instituted in 2005, the general partner must withhold tax on any LPS or NK distributions made to a foreign LPS or NK member except for those limited partners of an LPS who satisfy certain conditions and are deemed not to have a taxable presence in Japan.

If the foreign investors do not have a permanent establishment in Japan, either by virtue of their participation in the domestic LPS or NK or otherwise, they are only subject to normal withholding tax rules on dividends and similar income received from a Japanese company through the LPS or NK. They need only pay capital gains tax (CGT) on the sale of shares in the Japanese company if the LPS or NK holds at least a 25% ownership in the Japanese company sold, regardless of the individual investor's share. CGT does not arise unless their shareholding in the Japanese company is 25% or greater for investors who are resident in a treaty country. Foreign limited partners of an LPS who satisfy certain conditions are exempt from CGT even if no tax treaty protection is available.

TK. The TK is fiscally transparent for both domestic and foreign investors and:

  • Domestic investors must pay corporation tax at standard domestic rates on their share of TK profits.

  • Foreign investors are generally subject to withholding tax at the rate of 20% on all TK distributions. Investors with a permanent establishment in Japan are taxable at full Japanese corporate rates. Under domestic principles, the Japanese tax authorities do not usually assert that a foreign investor has a taxable presence in Japan simply by virtue of participation in a TK arrangement alone. However, the risk of the authorities asserting that the foreign investor has a permanent establishment in Japan in any particular case must be considered on a case-by-case basis.

Some investors have taken the position that Japanese withholding tax on TK distributions to offshore investors earned by foreign TK investors can be lawfully avoided where the offshore taxpayer could apply a favourable bilateral tax treaty. A favourable tax treaty is one containing an other-income clause, that is, a treaty clause stating that income not categorised elsewhere in the treaty is taxable only in the foreign investor's country of residence. By characterising the TK distributions as other income, the offshore taxpayer can assert that TK distributions are not taxable in Japan, and therefore not subject to Japanese withholding tax. Considering recent Japanese court cases and trends, however, it is likely that using such a treaty clause to avoid withholding tax on TK distributions will trigger tax authority scrutiny. Investors should investigate carefully before investing through a TK arrangement.

Foreign structures

Generally, foreign LPSs are fiscally transparent for Japanese tax purposes, and impose tax on the investors and:

  • Domestic investors must pay tax in Japan on their share of total LPS profits.

  • Foreign limited partners in a foreign structure are subject to the same taxation as if they were limited partners in a domestic structure.

8. What (if any) structures commonly used for private equity funds in other jurisdictions are regarded in your jurisdiction as not being tax transparent (in so far as they invest in companies in your jurisdiction)? What parallel domestic structures are typically used in these circumstances?

The Japanese tax authorities usually consider the attributes of a foreign entity by analogy to a comparable Japanese domestic entity. To determine whether a particular foreign entity is tax transparent in Japan, the investor can generally look to the laws under which the foreign entity was created and the particular entity's articles of incorporation.

It is generally irrelevant whether a foreign entity is treated as tax transparent under the law of its home country. For example, the authorities generally treat US limited liability companies (LLCs) as corporations for Japanese tax purposes, regardless of whether the LLCs have elected transparency treatment for US tax purposes. However, certain income tax treaties, such as the Japan-US income tax treaty, contain a special rule where any entity that is treated as tax transparent in the home country is treated as tax transparent for the purpose of the application of the income tax treaty, regardless of any classification rule under Japanese domestic tax law.


Investment objectives

9. What are the most common investment objectives of private equity funds?

The average life of funds in Japan is eight years, although some funds have lives of ten plus two years.

The typical minimum rate of return sought in Japan is a gross internal rate of return (IRR) of 25%.


Fund regulation and licensing

10. Do a private equity fund's promoter, principals and manager require licences?

Generally, a PE fund's promoter, principals and managers must be registered with the relevant Japanese authority as an investment management business operator, if:

  • They invest the fund's assets in securities and/or derivatives as defined by the Financial Instruments and Exchange Act (Law no. 25 of 1948) (FIEA).

  • There are Japanese resident investors.

This applies whether the fund is a NK, LPS, Investment LPS or a TK.

However, there are exemptions including that:

  • No registration or notification is required to manage the offshore fund's (the offshore partnership's) assets if:

    • all Japanese resident investors of the offshore partnership are qualified institutional investors;

    • the total number of Japanese resident investors of the offshore partnership is less than ten; and

    • the total amount of contributions made by the Japanese resident investors is not more than one third of the total amount of contributions of the offshore partnership.

  • No registration is generally required to manage the partnership's assets, but a notification must be filed with the relevant Japanese authority, if:

    • at least one investor is a qualified institutional investor; and

    • the total number of investors (other than the qualified institutional investors) is less than 50.

  • No registration is required to manage the partnership's assets, but a notification must be filed by the registered investment management operator with the relevant Japanese authority if the fund's promoter, principals or managers enter into a discretionary investment management agreement with a registered investment management operator so that the registered investment manager manages the partnership's assets and certain other conditions are satisfied.

11. Are private equity funds regulated as investment companies or otherwise and, if so, what are the consequences? Are there any exemptions?


Japanese PE funds are usually structured as a partnership and not as an investment company. However, in some cases, they are structured as joint stock corporations (kabushiki kaisha) (KK), some of which are listed on the Tokyo Stock Exchange. KKs are treated similarly to normal corporations and there are no exemptions.

Generally, an interest in a PE fund (partnership) falls within the scope of securities as defined under the FIEA and the distribution and marketing of PE funds (including off-shore funds) is subject to the FIEA's regulations and disclosure requirements.

To encourage Japanese investors in the Japanese primary market to subscribe for interests in the partnership, the partnership must comply with the regulations under the FIEA concerning both:

  • Securities brokerage businesses.

  • Disclosure.

Under the disclosure regulations, the subscription and sale of interests in the partnership by more than 500 persons constitutes a public offering (that is, the acquisition of newly issued interests in a PE fund by 500 or more persons (FIEA)).

To make a public offering:

  • A Securities Registration Statement (SRS), written in Japanese, must be filed with the director of the Kanto Local Finance Bureau. An SRS is similar to a US registration statement.

  • A prospectus (which is, in substance, a copy of a part of the SRS), written in Japanese, must be prepared and delivered at the same time or before the subscription of interests in a PE fund.

Marketing for prospective Japanese investors to subscribe for, or to purchase, specific interests in the partnership in the Japanese primary market is generally regarded as securities brokerage business, as FIEA defines partnership interests as securities.

Individuals cannot generally engage in a securities brokerage business unless they have been registered with the Financial Services Agency as a Type I Financial Instruments and Exchange Business Operator or as a Type II Financial Instruments and Exchange Business Operator under the FIEA. In this context, securities brokerage business includes the marketing for subscription of securities (including a public offering of securities). An exemption to registration (Exempted Businesses Conducted by Qualified Institutional Investors) is available.


An investment company is not subject to tax, if the PE fund is structured as an investment company (a corporate type investment fund) under the Act on Investment Trusts and Investment Corporations (Law no. 198 of 1951) for the main purpose of investing in specified assets (including securities, derivatives, real estate and loans), provided substantially all of its profits are distributed to the investors (shareholders).

The fund's promoter, principals or managers can directly solicit investors without registration, although a notification must be filed with the relevant authority, if:

  • At least one qualified institutional investor subscribes for or purchases interests in the partnership.

  • The total number of investors (other than the qualified institutional investors) is less than 50.

  • Certain other conditions are met.

An SRS is not required if interests in a foreign PE fund are offered for purchase or sale to less than 500 persons in the Japanese secondary market.

12. Are there any restrictions on investors in private equity funds?

There are no restrictions on investors in PE funds except that:

  • Investors resident in Japan must report remittances of more than JPY100 million into or out of Japan to the Ministry of Finance (the Japanese bank involved in the transaction usually prepares and files the necessary report on its customer's behalf).

  • If an investor is under 20 years of age, his investment can be cancelled, unless he has obtained his representative's consent for the investment.

For FIEA's marketing restrictions, see Question 11).

13. Are there any statutory or other limits on maximum or minimum investment periods, amounts or transfers of investments in private equity funds?

There are no limits on maximum or minimum investment periods or amounts of investments in PE funds (see Question 11).


Investor protection

14. How is the relationship between the investor and the fund governed? What protections do investors in the fund typically seek?


The relationship is governed by a limited partnership agreement. The investors (that is, the limited partners) are liable only to the extent of their respective investments (LPS Law).

Investment LPS

In investment LPSs, the relationship is governed by a limited partnership agreement. General partners have unlimited liability and are jointly and severally liable for the investment LPS's debt, and limited partners are liable to the extent of their respective investments, under the Limited Partnership Act for Investment.


The relationship is governed by a partnership agreement. However, each investor has unlimited liability for partnership debts pro rata to his respective contribution, unless otherwise agreed between the partners (Civil Code).


The relationship is governed by a bilateral agreement between each investor (silent partner) and the proprietor (eigyosha). The investors are liable only to the extent of their respective investments under the Commercial Code. Each investor can examine the proprietor's balance sheet under the Commercial Code.


Interests in portfolio companies

15. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio company? What are the relative advantages and disadvantages of each? Are there any restrictions on the issue or transfer of shares by law?

Funds focused on buyouts usually only take equity in a portfolio company because it enables them to control and participate in the company's management.

Funds typically prefer common stock, which enables them to easily control and exit portfolio companies. However, funds also take convertible instruments such as convertible bonds and stock subscription options. Preferred stock is often taken in corporate restructuring and turnaround deals.

Shareholder approval is required for the issue of shares if the:

  • Issuing company's articles have pre-emption rights or similar provisions.

  • Issue is to a third party (third party allotment) and the issuing company is a closed corporation.

  • Issue exceeds the limits set by the issuing company's authorised capital.

  • Issue price is particularly favourable.

Otherwise, the issue is subject to board approval.

There is no legal restriction on the transfer of shares, although this can be restricted by a company's articles.



16. Is it common for buyouts of private companies to take place by auction? If so, which legislation and rules apply?

Auctions of private companies are becoming increasingly common in Japan, especially in the case of target companies with a large enterprise value. Auctions of private companies are not governed by any legislation or rules.

17. Are buyouts of listed companies (public to private transactions) common? If so, which legislation and rules apply?

Buyouts of listed companies have become increasingly common in Japan. There have been several notable listed company buyouts since 2005. However, after the worldwide financial crisis and collapse of Lehman Brothers in 2009, the number of large-scale buyouts has diminished, while small or medium-sized transactions (especially buyouts of companies whose shares are listed on subsidiary markets such as JASDAQ) have become more common.

Public to private transactions are subject to a range of rules, in addition to the FIEA, including:

  • Substantial shareholder rules (5% rule). Under the 5% rule, a person who acquires a holding of more than 5% of the issued voting shares of a company listed on any stock exchange in Japan must file a substantial shareholding report within five business days after the acquisition.

  • Tender offer bid (TOB) rules. Under the TOB rules, a person seeking to acquire, in an off-market transaction, either more than 5% of a listed company's voting shares from more than ten shareholders within a period of 60 days, or more than one third of the company's voting shares, must submit a formal takeover or tender offer bid to all shareholders. However, more complicated rules were introduced in December 2006 as part of a sweeping reform of Japan's securities laws. In addition, the government has issued a series of guidelines for the TOB rules of 2009 and 2010 that are not necessarily consistent with the FIEA.

  • Insider trading rules. Under the insider trading rules, a person in possession of inside information commits the offence of insider trading if he buys or sells a public company's shares using material facts relating to the company's business before the company publicly discloses this information.

  • Government public to private guidelines. In November 2006, there was a public to private transaction where minority shareholders claimed that the price offered was unreasonably low (the Lex Holdings case). To address the protection of minority shareholders, the Ministry of Economy, Trade, and Industry of Japan is discussing non-binding guidelines (announced in September 2007) for public to private transactions as safe harbour rules.

  • Deregulation of squeeze-out process. Under the Japanese Companies Act, the issue of callable shares to minority shareholders, currently the most widely used squeeze-out mechanism in Japan, is subject to shareholder approval and this process takes approximately four to six months to complete following closing of a tender offer. However, under amendments to the Act on Special Measures for Industrial Revitalization which came into effect on 1 July 2011, an offeror that acquires more than 90% of the target company's issued shares can apply to the Minister of Economy, Trade and Industry (and the minister of any other government agency having jurisdiction over the company) for permission to waive the requirement for shareholder approval.

  • Court precedents. In the Lex Holdings case, the Tokyo District Court held in December 2007 that the original tender offer price was considered to be a fair price for squeeze-out even though minority shareholders claimed that the tender offer price was unreasonably low. By contrast, the same court also held in re: Kanebo case (in March 2008) that the fair squeeze-out price should be more than twice the original tender offer price. However, Kanebo was a squeeze-out after an asset transfer following a tender offer. As the acquisition structures of Lex Holdings and Kanebo were different, the Kanebo case is unlikely to be a leading case for the typical scheme for squeeze-out which Lex Holdings employed. The Lex Holdings decision was subsequently overturned by the Tokyo High Court in September 2008, where the court held that the fair price for exercising the shareholder's appraisal right in this case should be moderately higher than the tender offer price. The Supreme Court endorsed the Tokyo High Court's decision in 2009. However, since this Supreme Court decision, lower courts have issued several rulings which are not entirely consistent with the Supreme Court decision. District Courts have tended to be friendly to buyers while High Courts have been friendly to minority shareholders. Consequently, funds undertaking buyouts of listed companies should ensure they are well advised when planning buyout structures.


Principal documentation

18. What are the principal documents produced in a buyout?

The principal documents produced in a buyout include a:

  • Share purchase agreement or business transfer agreement.

  • Senior loan agreement.

  • Security agreement creating various security interests over the target company's assets.

  • Shareholders' agreement.

  • Management agreement between the investment vehicle, the investee company and the investee's management.

  • Share option agreement or other contract providing a performance incentive for management.

Subscription agreements between investors and management to form an acquisition vehicle are rarely produced. The acquisition vehicle is set up by the investor only. Terms and conditions among the parties are generally provided in the shareholders' agreement, management agreement and stock option agreement.


Buyer protection

19. What forms of contractual buyer protection do private equity funds commonly request from sellers and/or management?

The forms of contractual buyer protection depend on the type of transaction and whether the transaction is between domestic parties only or involves a foreign buyer. If involving a foreign buyer, the buyer may request forms of protection similar to those typically requested in his home market. In a domestic transaction, the following forms of protection are usually requested:

  • Share acquisition. In a share acquisition, the forms of protection most commonly requested by the buyer are representations and warranties in relation to the target's business and assets, supported by an indemnity from the seller. If the acquisition is leveraged, the buyer typically requests a warranty that the target company's assets are legally disposable.

  • Business transfer. In a business transfer, where the period between signing and completion is typically longer than for a share acquisition, the buyer typically requests a price adjustment. In a share acquisition deal, where the period between signing and completion is typically shorter, the buyer does not usually request a price adjustment, but instead takes into account the risk of material change between the due diligence and completion phases of the transaction in pricing the company.

The forms of protection usually sought in a shareholders' agreement include:

  • Having a majority of board seats (if a hands-on deal).

  • Requiring prior consent on making, or a reporting obligation concerning, any major decision.

  • Restrictions on share transfer, including the right of first refusal, tag-along and drag-along rights.

  • Equity ownership in case of management's retirement or death.

  • Setting a target date for an initial public offering (IPO).

The forms of protection usually sought in a management agreement are:

  • An agreement on the exercise of voting rights (as management will acquire some equity as a performance incentive).

  • A covenant to achieve target earnings before interest, taxes, depreciation and amortisation, or long-term business plan.

  • A management obligation to secure board approval of a fund's exit by trade sale or secondary buyout (share transfer in a closed company requires board approval).

  • Management remuneration.

  • A non-compete clause.

20. What non-contractual duties do the portfolio company managers owe and to whom?

The portfolio company managers owe the company's shareholders non-contractual fiduciary duties (duty of care and duty of loyalty). To avoid direct conflicts of interest, portfolio company directors generally do not take managerial positions or acquire equity in the acquiring company until closing.

Since 2005, there have been many buyouts, and several court rulings on squeeze-outs. Issues such as minority shareholder protection and the duties of portfolio company managers received considerable attention in 2007 as a result of the Lex Holdings case (see Question 17). Safe harbour rules are provided in guidelines issued in September 2007 by the Ministry of Economy, Trade and Industry (see Question 17).

21. What terms of employment are typically imposed on management by the private equity investor in an MBO?

The relationship between a portfolio company and management is not one of employment, but of directorship founded on entrustment. For the key terms of a typical management agreement, see Question 19.

22. What measures are commonly used to give a private equity fund a level of management control over the activities of the portfolio company? Are such protections more likely to be given in the shareholders' agreement or company bye-laws?

Measures commonly used to give a fund management control are found in the shareholders' agreement and management agreement (see Question 19).

However, it is possible to include parallel restrictions in a company's articles, such as special quorum and super-majority voting requirements, for certain matters decided by the board of directors and rights of first refusal.


Debt financing

23. What percentage of finance is typically provided by debt and what form does that debt financing usually take?

A typical debt-to-equity ratio is 60:40 (although tighter ratios are sometimes seen). Japanese debt financing generally takes the form of a long-term senior loan and a revolving working capital facility. Mezzanine debt is also often provided in large transactions.


Lender protection

24. What forms of protection do debt providers typically use to protect their investments?


Debt providers typically request security over all or substantially all of the borrower and/or target group's assets. However, there is no central system in Japan for registering security interests created by corporations. The Japanese system focuses on the nature of the asset provided as security rather than the entity creating the security interest. Consequently, security must be granted on an asset-by-asset basis.

Lenders will usually consider a range of assets including:

  • Subsidiaries' shares.

  • Inventory.

  • Insurance claims.

  • Rental deposits.

  • Intellectual property.

  • Receivables.

  • Promissory notes.

  • Bank deposits.

  • Real property.

One alternative to asset-by-asset security is for the parent company of the Japanese target to grant a pledge over the Japanese target's shares. As there is no concept of financial assistance in Japan (see Question 25), pledges can be granted more easily than in many other common law and civil law jurisdictions where financial assistance is an issue. There are two types of share pledges, but generally, a share pledge need not be a complicated document and does not necessarily need to be registered. A pledge over non-listed shares is usually perfected by the pledgee taking possession of the share certificates.

Since January 2009, all listed shares are dematerialised and held in the securities depository system operated by Japanese Securities Depository Center (JASDEC). Listed shares that are pledged are held in a pledged sub-account of the pledgee's general account with JASDEC (or a (sub)custodian participant of JASDEC).

In reviewing a target's assets, lenders may need to assess on an asset-by-asset basis the:

  • Relative complexity of taking security over a particular asset or asset category (including perfection procedures).

  • Cost of perfecting the Japanese security.

  • Approximate time it would take to perfect the security.

Contractual and structural mechanisms

Japanese law does not prevent the use of either contractual or structural subordination.


Financial assistance

25. Are there rules preventing a company from giving financial assistance for the purpose of assisting a purchase of shares in the company? If so, how does this affect the ability of a target company in a buyout to give security to lenders? Are there exemptions and, if so, which are most commonly used in the context of private equity transactions?

There is no equivalent concept under Japanese law to the concept of financial assistance found in many common law and civil law jurisdictions. If all other Japanese corporate law requirements are met, nothing prevents a Japanese target company from giving security or other assistance in connection with its own acquisition.

However, if there are minority shareholders, there may be a directors' liability issue if security or a guarantee is given in support of a third party's debt (including for the purpose of assisting a purchase of shares in the company). To avoid such potential liability, security packages are often implemented in two stages where:

  • The security package is initially limited to the granting of a share pledge by the parent company.

  • After any minority shareholders are squeezed out, the full security package is implemented.


Insolvent liquidation

26. What is the order of priority on insolvent liquidation?

Secured creditors are not subject to bankruptcy procedures and can exercise their rights by selling the secured property, with the consent of all other secured creditors with an interest in the property, through either:

  • Court auction.

  • Voluntary sale outside the bankruptcy process.

The general order of priority after payment of trustee costs and taxes is:

  • Employment claims.

  • Unsecured creditors.

  • Shareholders.

Debt providers have priority over equity holders and this priority is determined by the Companies Act.


Equity appreciation

27. Can a debt holder achieve equity appreciation through conversion features such as rights, warrants or options?

Debt holders can achieve equity through bonds with warrants or stock subscription rights (shinkabu yoyakuken tsuki shasai). Simple loans cannot be converted into equity unless a debt-equity-swap is undertaken.


Portfolio company management

28. What management incentives are most commonly used to encourage portfolio company management to produce healthy income returns and facilitate a successful exit from a private equity transaction?

The most commonly used management incentives are shares and options. Ratchets are not commonly used in the market and cash earn-outs are sometimes used.

29. Are any tax reliefs or incentives available to portfolio company managers investing in their company?

There are no tax reliefs or incentives available to portfolio company managers investing in their company.

30. Are there any restrictions on dividends, interest payments and other payments by a portfolio company to its investors?

The Companies Act provides statutory limits on the amount of dividend distributable by a portfolio company. More importantly, however, debt providers will normally contractually restrict the ability of a portfolio company to pay dividends and make other payments to its investors.


Exit strategies

31. What forms of exit are typically used to realise a private equity fund's investment in a successful company? What are the relative advantages and disadvantages of each?

Forms of exit

PE funds typically use trade sales and IPOs to realise their investments in Japan. Funds also use secondary buyouts, but these are less common than in other jurisdictions.

Advantages and disadvantages

Trade sale. The advantage of a trade sale is that it usually gives the selling fund(s) a 100% exit. Trade sales are usually the favoured option unless the Japanese stock markets are particularly buoyant and offer the potential for greater returns.

The disadvantages are that a trade sale:

  • Usually has an ongoing (but limited) contingent exposure for warranties and indemnities negotiated with the buyer.

  • Is potentially exposed to price adjustments not found in IPOs.

IPO. The advantages of an IPO are that:

  • Listing on a major exchange can enhance business reputation and prospects.

  • There is no contractual warranty or indemnity risk.

  • There is potential for a higher earnings multiple.

The disadvantages are that:

  • Preparing to list requires management time and effort.

  • Funds often do not achieve a 100% exit from the investment on listing.

Secondary buyout. The advantages of a secondary buyout are that:

  • A fund can achieve a 100% exit.

  • It is generally easier to negotiate warranties and indemnities as the buying fund understands the selling fund's issues and the buying fund has management on its side.

The disadvantage is that management may be required to roll over part of their investment into the new investing vehicle.

32. What forms of exit are typically used to end the private equity fund's investment in an unsuccessful/distressed company? What are the relative advantages and disadvantages of each?

Forms of exit

Funds will do their best to turn around the company but typically seek to, as a last resort, cut their losses as much as possible through a trade sale. Bankruptcy is not a recognised option in Japan.

The decision to sell a poor performer, and at what price, usually depends on factors such as how much life is left in the fund and overall portfolio performance.

Advantages and disadvantages

The main advantages of a trade sale include management remaining in control of the business and the potential for selling the business as a going concern. Conversely, the disadvantage of bankruptcy from the fund's perspective is loss of control over the sale or realisation process.


Private equity/venture capital associations

Venture Enterprise Center (VEC)


Status. The VEC is a governmental organisation.

Principal activities. The VEC provides information relating to PE funds and investment opportunities.

Japan Venture Capital Association (JVCA)


Status. The JVCA is a non-governmental organisation.

Membership. Members consist of venture capital members and supporting partners.

Principal activities. The JVCA's principal activity is to publish information relating to PE investment in Japan with a view to improving the business environment for start-ups and investors.

The Small and Medium Enterprise Agency


Status. The Agency is a governmental organisation.

Principal activities. The Agency's principal activities are researching and providing support for small and medium-sized enterprises in Japan.

Contributor details

Chris Hodgens

Baker & McKenzie GJBJ Tokyo Aoyama Aoki Koma Law Office (Gaikokuho Joint Enterprise)

T +81 3 5157 2763/2765
F +81 3 5157 2904

Qualified. Victoria and New South Wales, Australia, 1996; Foreign Registered Lawyer (gaikokuho jimu bengoshi) Japan, 2002

Areas of practice. Corporate; M&A.

Recent transactions

  • Represented Daiwa Securities SMBC Principal Investments in the formation of a series of investment funds focused on PE, debt, distressed assets and real estate investments mainly in Japan.
  • Represented Daiwa Securities SMBC Principal Investments in the acquisition of the HMV Japan business, comprising 62 entertainment retail stores throughout Japan, from HMV Group.
  • Represented a US PE fund in relation to the Japan aspects of an acquisition and sale of an automotive components business.

Norihiro Sekiguchi

Baker & McKenzie GJBJ Tokyo Aoyama Aoki Koma Law Office (Gaikokuho Joint Enterprise)

T +81 3 5157 2765
F +81 3 5157 2904

Qualified. Japan, 1997; New York State, US, 2004

Areas of practice. Corporate; M&A.

Recent transactions

  • Represented SPARX Capital Partners in their exercise of shareholders' rights against PENTAX Corporation in relation to its potential merger with HOYA.
  • Represented the arrangers and lenders on the financing of Bain Capital's acquisition of Bellsystem24, which was awarded the TMT Deal of the Year at the ALB Japan Law Awards 2010.
  • Represented a Japanese PE fund in relation to an acquisition of an automotive components business in China.

Gavin Raftery

Baker & McKenzie GJBJ Tokyo Aoyama Aoki Koma Law Office (Gaikokuho Joint Enterprise)

T +81 3 5157 2771
F +81 3 5157 2907

Qualified. New South Wales and Queensland, Australia, 1998; England and Wales, 2003; Foreign Registered Lawyer Japan, 2007

Areas of practice. Banking and finance.

Recent transactions

  • Represented the arrangers and lenders on the financing of Bain Capital's acquisition of BellSystem24, which was awarded the TMT Deal of the Year at the ALB Japan Law Awards 2010.
  • Represented the arrangers and senior lenders on the financing of Bain Capital's acquisition of D&M Holdings, which was awarded the TMT Deal of the year at the ALB Japan Law Awards 2009.

Ryutaro Oka

Baker & McKenzie GJBJ Tokyo Aoyama Aoki Koma Law Office (Gaikokuho Joint Enterprise)

T +81 3 5157 2809
F +81 3 5157 2901

Qualified. Licensed tax attorney Japan, 1998

Areas of practice. Tax.

Recent transactions. Represented US private equity fund in relation to the Japan aspects of an acquisition and sale of an automotive components business.

Yusaku Ono

Baker & McKenzie GJBJ Tokyo Aoyama Aoki Koma Law Office (Gaikokuho Joint Enterprise)

T +81 3 5157 2716
F +81 3 5157 2908

Qualified. Japan, 1978; New York State, US, 1986

Areas of practice. Capital markets (specialising in investment funds).

Recent transactions

  • Represented the Hong Kong and Shanghai Banking Corporation in a public offering of equity investment funds in Japan.
  • Represented Black Rock Securities in the filing of a Notification with the FSA of Japan for multiple ETFs.
  • Represented US and UK PE limited partnerships in relation to Special Exempted Business for Qualified Institutional Investors filings.

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