JAPAN Trends and Developments Contributed by: Sadao Maeda, Yusuke Hayashi and Masato Tanaka, TMI Associates
Acquisition Rights” (J-KISS), a convertible equi - ty instrument which is open to the public, as bridge financing. J-KISS is created based on the “KISS” (Keep It Simple Security) methodology, which was proposed and published by the US accelerator 500 Startups. At the time of acquir - ing J-KISS, the number of shares to be issued upon conversion by the future exercise thereof is undetermined. While this may seem unfavoura - ble to investors, it also includes investor protec - tions such as “discounts” and “valuation caps” , which are mechanisms that lower the price per share required to acquire a share or prevent that price from being higher by determining the share price based on an assumed valuation. Since the acquisition of J-KISS does not fall under the category of FDI, prior notification is not required, regardless of whether the start-up is engaging in business in a Designated Busi - ness Sector, and J-KISS may be used by Foreign Investors as a means to make quick investments in Japanese start-ups. However, it should be noted that if J-KISS are exercised and converted into shares, this would constitute FDI. Similar to J-KISS, convertible bonds with stock acquisition rights (CBs) are sometimes used. CBs differ from J-KISS (which have equity char - acteristics), in that they are debt instruments, but they share the same mechanism for determining the number of shares to be issued upon conver - sion, namely discounts and valuation caps. Venture debt Japan’s venture debt market has experienced rapid growth in recent years, with financial insti - tutions introducing a variety of venture debt arrangements with diverse terms. Venture debt, a type of financing primarily aimed at start-ups, is gaining attention as a funding alternative to equity financing. Unlike traditional loans, it is
characterised by its evaluation of future growth potential and technological capabilities. Some experts predict that the Japanese venture debt market could expand from its current scale of approximately JPY200 billion to over JPY1 tril - lion within the next five years. The market is also seeing increased diversification of players, with independent venture debt providers entering alongside traditional banks and securities firms, intensifying competition. Each financial institu - tion offers venture debt arrangements with var - ied terms, including CBs and loan agreements combined with stock acquisition rights. In addition, in order to encourage financial insti - tutions to take initiatives in cash flow-based lending to start-ups and other entities, the “Act on the Promotion of Cash Flow-Based Lending” was enacted in June 2024 (scheduled to take effect at some point in spring of 2026), which creates a new type of security interest called the “Enterprise Value Charge” . This will allow even start-ups with limited tangible assets to have their intangible assets, such as know-how and customer base, included in the valuation of col - lateral, thereby increasing the ability of start-ups to obtain debt financing. This is also expected to increase lenders’ interest in the start-up’s busi - ness, leading to timely lender support for the start-up’s business improvement. Stock options as incentives While recruiting talented people is essential for start-ups to grow, Japanese start-ups often grant stock options (the precise legal name for these rights is stock acquisition rights) to their direc - tors and employees as an incentive. While there is a variety of different types of stock options, the one most often used for start-ups is the tax- qualified stock option. If the legal requirements for a tax-qualified stock option are met, hold - ers are not taxed when they exercise the stock
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