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During the heady days of the information technology boom of the late 1990s through early 2000, many foreign venture-capital firms were lured to Japan in search of Internet-related business startups.

The seemingly bright prospects of IT companies, however, were not the only attraction.

Venture capitalists were attracted by the expanding opportunities brought about by Japan’s attempts at corporate restructuring and the improvement in domestic capital markets. Some venture capitalists even referred to Japan as “the world’s last frontier.”

But since the collapse of the IT market, some foreign venture capitalists have been struggling to find prospective ventures to invest in.

They also face the hard reality that Japan is still a difficult place for entrepreneurs, partly because large companies are often competitors to venture firms in the same field.

“Compared with spring last year, the business environment totally changed,” said Yoshitaka Yamazaki, president of Net Capital Inc., a Japanese affiliate of Net Group Inc. in the U.S. “So we cannot help becoming more selective. It became difficult to find a company that met our criteria.”

In May 2000, Net Capital raised 1 billion yen from investors in Japan. Although the firm did not make a loss when the IT bubble burst, the company nevertheless invested in only one venture last year, Yamazaki said.

The firm, seeking investment possibilities in other high-growth regions such as coastal China, invested in a Chinese firm earlier this year, he said.

Net Capital is one of a number of foreign venture-capital firms that in recent years entered the Japanese market, where about 180 domestic and foreign venture-capital firms operate.

Although no official data are available on foreign venture-capital firms in Japan, at least 10 such companies from the United States, Hong Kong and Taiwan have entered the Japanese market independently or by forming joint ventures with Japanese firms since 1998, according to Nippon Technology Venture Partners, a Tokyo-based venture-capital firm.

Venture-capital firms operate by purchasing stocks of startups and, if the startups prove successful and go public, make profits by selling the stocks on the market.

Making capital gains by investing in technology ventures is easy during an IT boom or economic recovery, Yamazaki said, because a favorable business environment makes it easier for startups to succeed. Neither of these conditions now exist in Japan.

Not all foreign entrants gave up on Japan at the end of the IT bubble, however, with many attracted by the nation’s accelerated corporate restructuring.

As part of restructuring, large firms often outsource and sell out noncore operations, creating business opportunities for entrepreneurs.

“Real opportunity in Japan has nothing to do with the bubble,” said Robert V. Delaney, managing director at Goldman Sachs (Japan) Ltd. and chairman of Kyocera Goldman Sachs Venture Capital.

In the U.S., massive corporate restructuring coincided with the development of IT throughout the 1990s, allowing many technology ventures to flourish. This in turn led to a decade-long economic expansion.

Many venture capitalists believe there will be a similar effect in Japan, which has been mired in economic stagnation since the burst of the bubble economy a decade ago.

The lifetime employment system at large firms is gradually eroding, encouraging competent workers to start up new businesses, some venture capitalists say.

Compared with the U.S. and Europe, domestic venture capital in Japan is relatively weak, leaving room for new market entrants and boosting the country’s popularity among foreign venture capitalists.

At the end of fiscal 1999, the amount of Japan’s venture capital investments under management was 775.7 billion yen. This figure compares with $134.5 billion (about 16.6 trillion yen) in the U.S. and 58.35 billion euros (about 6.4 trillion yen) in 21 European countries, all in calendar 1999, according to the government-affiliated Venture Enterprise Center.

Another appealing factor was the opening of new capital markets for ventures — TSE Mothers in November 1999 and Nasdaq Japan in June 2000. Both make it easier for venture-capital firms to achieve capital gains through initial public offerings of ventures they invest in.

The new stock markets have less stringent requirements for IPOs than the older stock markets, enabling younger firms to go public in a shorter period of time.

“It used to be said that it took a new company 17 years on average to go public,” said Tetsusya Fukagawa, managing director at Warburg Pincus (Japan) Ltd., a Japanese arm of a U.S. venture-capital firm. “But the new stock markets enabled companies that could not even think of public listing to do so.”

Whatever the reason, foreign venture capitalists appear to benefit Japanese entrepreneurs.

Most foreign venture-capital firms operating in Japan invest in startups within a few years of their founding.

The firms employ the so-called hands-on approach, providing management expertise to young ventures in order to boost their corporate value and earn more on the sale of their stocks.

In contrast, conventional Japanese venture capitalists do not advise their ventures’ management.

“We received advice on management, finance and knowhow to set up a company,” said Shigeru Urushibara, 36, who in July 2000 set up UL Systems Inc., an Internet-related company, with the help of Warburg Pincus (Japan). Ltd. “Besides, I hope investment by Warburg Pincus gives us some corporate credibility because nobody knew us.”

After its link with the venture-capital firm was made public, UL Systems received inquiries from about 20 other investment firms, Urushibara said.

For all the seeming merits in investing in Japanese ventures, some foreign venture capitalists feel that difficulties still remain in Japan.

Todd Walzer, president of iLand 6 Capital & Development, which offers investment banking service in Japan, is pessimistic. Japan has few promising technology ventures at present, he said.

“There are few interesting technology venture companies in Japan,” said Walzer, who until recently was leading the Japanese arm of a U.S.-based venture capital firm specializing in technology companies. “Venture business in Japan is not visible yet.” Since Japan’s promising technologies are often held by large companies and their affiliates, there are few spinoffs for technology ventures, an industry pundit said.

Big firms create another hurdle to venture-capital firms because they are potential competitors to ventures.

Delaney of Goldman Sachs (Japan) cites a contrasting situation in the U.S., where large companies tend to buy out ventures after the ventures become successful, instead of setting up affiliated companies and starting venture businesses on their own.

“In Japan, what we see is not competition among ventures,” said Soichi Kariyazono, a partner of Apax Globis Partners & Co., an affiliate of a major U.S. venture-capital firm. “Instead, big companies do the same thing as ventures do, backed by their financial base. To avoid competition with large companies, ventures have to find out what large companies don’t do.”

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