Japan has seen a rise in issues related to mergers and acquisitions involving small and medium-sized enterprises, often due to deceptive buyers that fail to honor contracts.

As M&As gain attention as a viable option for business succession, the Small and Medium Enterprise Agency, alongside industry groups, has introduced countermeasures, including updated guidelines, to raise awareness and safeguard companies.

According to M&A research firm Recofdata, 702 publicly disclosed M&A deals involving SMEs for succession purposes took place in 2023, nearly triple the number from a decade ago.

Even among profitable SMEs, it is not uncommon for business owners to shut down due to aging and a lack of successors. To address this problem, the government is actively promoting M&As to help preserve jobs and vital social resources.

M&A "is now one of the options for business owners (seeking to continue their operations)," an official at the Small and Medium Enterprise Agency said.

But Japan lacks legislation to protect M&As from unscrupulous companies.

For example, the M&A intermediation business has faced criticism over conflicts of interest, as some intermediaries represent both sellers and buyers. Intermediary companies have also been accused of setting brokerage fees in a nontransparent way.

In some deals, both sellers and buyers have held contract negotiations while withholding inconvenient information from each other.

"In this rapidly growing industry, there have long been concerns that (deals and participants) are a mixed bag," an official at the agency said. Reports of unethical buyers failing to honor contracts, in particular, have sparked alarm.

In 2023, Theliault, a Tokyo-based confectionery operator, struggled with financial difficulties due to the COVID-19 pandemic. The company's president at the time decided to sell the business to investment company Lucian Holdings for about ¥1 million, partly to secure continued employment for the staff. The sale was arranged through an intermediary.

However, according to the former president, following the transaction, Lucian transferred approximately 8 million yen from Theliault's funds to its own account and subsequently cut off communication with the confectionery.

Lucian also failed to honor its commitment to assume Theliault's manager guarantee, which obligates company management to repay debts in the event of bankruptcy, leaving the former president burdened with managing the debt.

According to people familiar with the situation, more than 30 SMEs have encountered similar difficulties following acquisition by Tokyo-based Lucian, with some ultimately forced into bankruptcy.

"There is no issue with the parent company using funds from the acquired company," a Lucian official said. "In fact, Lucian also incurred losses, as many companies (introduced to us as takeover targets) were already in (financial) trouble."

Meanwhile, another small Tokyo-based company filed a fraud complaint with the Metropolitan Police Department, alleging that two Lucian executives defrauded it of shares valued at over ¥500 million. The complaint was accepted in July.

The former head of Theliault criticized intermediaries for introducing companies without thorough screening, including checks for past issues.

However, Kentaro Shibata, a lawyer specializing in M&A deals, said, "The role of intermediaries ends with the conclusion of a contract and does not extend to preventing problems." He noted that there are limits to the due diligence intermediary companies can conduct on the management conditions of the companies they introduce to clients.

"Going forward, we must ensure involvement until contracts are fully executed as agreed," said Kunihiko Arai, representative director of the M&A Intermediaries Association, a group representing intermediary companies.

In August, the Small and Medium Enterprise Agency announced a revision of its M&A guidelines, likely in response to the Lucian cases. The updated guidelines recommend that intermediaries take steps such as researching and disclosing the financial situation of the buyer and making it mandatory to cancel debt guarantees by company managers.

In October, the M&A Intermediaries Association began sharing a list of bad-faith buyers with its members.

"This is the first step to ensure that SMEs can engage in M&As with confidence, Arai said. "We are committed to doing more."