This column explains key legal rules and business practices in Japan that foreign investors should understand when investing in Japanese start-ups.

Chapter 2: Methods of Equity Finance by Japanese Start-ups

The principal methods of equity finance commonly used by Japanese start-ups are as follows:
– Issuance of common shares
– Issuance of preferred shares
– Issuance of convertible bonds
– Issuance of convertible equity (e.g., J-KISS)

(1) Issuance of Common Shares

The issuance of common shares is the most basic method of equity financing. However, venture capital (VC) investors are often reluctant to subscribe for common shares, as they provide no downside protection. Accordingly, common shares are typically subscribed by founders, friends, and angel investors.

(2) Issuance of Preferred Shares

The issuance of preferred shares is the most common form of equity financing for VC investors in Japan, particularly from Series A onward. Under the Japanese Companies Act, a company may issue different classes of shares with respect to the following matters (Article 108):

(i) Dividends of surplus
(ii) Distribution of residual assets
(iii) Voting rights in shareholder’s meeting
(iv) Restrictions on share transfers
(v) Shareholder put options or conversion rights
(vi) Issuer call options or conversion rights
(vii) Issuer’s right to acquire all shares upon shareholder resolution
(viii) Veto rights (so-called “golden shares”)
(ix) Class voting rights

In Japanese start-up practice, preferred shares typically provide preferences regarding:

(i) dividends of surplus, and
(ii) distribution of residual assets

In many cases, dividend preference is not emphasized, as start-up investors generally do not focus on dividends, and some preferred shares only have preference in distribution of residual assets.

Preferred shares also usually include conversion rights (items (v) and (vi)) enabling both investors and the company to convert preferred shares into common shares, which is expected to be exercised when the startup apply for listing for its IPO.

In addition, certain governance rights—such as veto rights and the right to appoint directors—are typically provided in shareholders’ agreements rather than embedded in the rights of class shares. Although these rights could theoretically be structured as class share rights (items (viii) and (ix)), this approach is not common in Japan.

The reasons for this practice are not entirely clear, but may include:

– the risk of invalidity of corporate actions if procedural requirements for class shares are not strictly followed, and
– concerns regarding public disclosure through commercial registration

Another practical limitation is that class share structures do not easily allow rights to be granted to specific shareholders.

A potential weakness of relying on shareholders’ agreements is enforceability, as remedies are generally limited to damages, which can be difficult to quantify. However, in practice, VC investors are typically granted put options under shareholders’ agreements, allowing them to exit in the event of a material breach. As a result, enforceability concerns are mitigated.

With respect to economic terms:

– 1x participating liquidation preference is the most common structure in Japan
– Non-participating preferred shares are relatively uncommon
– Anti-dilution provisions are typically included, adjusting conversion ratios in events such as stock splits or down-round financings
– Voting rights are generally one vote per share; multiple voting rights are not permitted under Japanese law, and “fully diluted basis” voting is not commonly used

Liquidation preferences are generally applied not only in liquidation but also in M&A transactions (including mergers and transfers of a majority of shares). For this purpose, a “deemed liquidation” clause is typically included in shareholders’ agreements (and sometimes in the Articles of Incorporation, although enforceability in the latter case is not entirely settled).

I understand that a merger structure is mainly used for startup M&A with many non-insider shareholders in Silicon Valley to avoid holdup issue. In contrast, share transfers are commonly used in Japan as the structure for M&A transactions—even where there are many shareholders—partly due to tax considerations. Accordingly, it is important to ensure that deemed liquidation provisions apply to share transfer transactions, and in this context, drag-along rights, which forces the dissenting shareholders to sell its shares, play an important role in preventing holdout issues, although I understand that they are rarely exercised in practice.



Where multiple classes of shares are issued, the company must hold class shareholders’ meetings for certain matters (Article 322).

(3) Issuance of Convertible Bonds

Start-ups may also raise funds through convertible bonds. In early-stage financing, convertible bonds are sometimes used to defer valuation discussions by linking the conversion price to the valuation in a subsequent qualified financing round. However, in recent practice, convertible equity instruments have become more common for this purpose. This is because start-ups are generally reluctant to incur debt, and convertible equity structures are simpler.

(4) Issuance of Convertible Equity (e.g., J-KISS)

Recently, convertible equity in the form of stock acquisition rights (shinkabu yoyakuken in Japanese) has become widely used, particularly in seed-stage financing. A prominent example is J-KISS, a standardized form developed and published by Coral Capital.

A stock acquisition right is the right to acquire a specified number of shares at a predetermined exercise price during a specified period. From economic perspective, it is a type of call option and therefore has economic value. Accordingly, it is generally issued for consideration.

Stock acquisition rights are also used for stock option plans, which are often granted without consideration to officers and employees as incentives.

In principle, the issuance of stock acquisition rights requires shareholder approval (Article 238).

In convertible equity structures:
– The exercise price is typically nominal (e.g., JPY 1), as the parties do not intend to provide additional funding upon exercise
– The number of shares to be issued upon exercise is determined based on a formula tied to the price in the next qualified financing, usually with a discount to compensate early investors
– This structure allows the parties to defer valuation

A valuation cap is often included. Where a cap is set, the number of shares issuable upon conversion is calculated based on the lower of the valuation implied by the next financing or the cap.

In practice, valuation caps in Japan are often set at relatively modest levels. As a result, convertible equity can function similarly to an equity financing conducted at the capped valuation.

Go back to the previous chapter ((1) Overview of Japanese Company Act)

Proceed to the next chapter ((3) Corporate Governance Matters)

Disclaimer: This column intends to provide a high-level summary of the subject matter, and it does not aim to provide exhaustive information. Also, this column is for informational purposes only and does not constitute legal advice. For specific issues, we recommend consulting an expert. If you have any query, please contact us via inquiry form in this homepage.