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Japan’s stock market is producing too many “pennies”

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When EcoNaviSta listed on the new Tokyo Growth Market last year, shares of the AI-powered big data sleep analytics startup rose sharply. Then he started to stagger. Then began a decline that would destroy 60 percent of its market value.

Today, the company rests on a wide meadow inhabited by one of Japan’s most intriguing industrial species: a large herd of moaning “little grains.”

The evolution and proliferation of this creature – the unicorn’s stunted, staid companion – says a lot about how Japan approaches risk, ambition and innovation 35 years after its bubble-era heyday. As the need for post-deflation growth becomes increasingly unrelenting, the existence of scroungers and the environment in which they can survive is likely to become even more problematic than now.

Japan understands the desirability of a full-fledged unicorn with a shiny mane (the term coined by the venture capital industry for an unlisted startup worth more than $1 billion) and the ecosystem in which it exists. They generate and breed these beasts. They are largely formed through increasingly bold rounds of venture capital investment, an underlying appetite for disruption, consensual destruction and reinvention when necessary, and, most fundamentally, sky-high aspirations for business scale. .

Belatedly, Japan has come to the conclusion that it has not been very good at producing a decent portfolio of companies that fit the definition of a unicorn, and that this is urgently needed.

Two years ago, the powerful Keidanren business lobby recommended to the government that Japan would ideally breed 100 unicorns by 2027, from a national petri dish of at least 100,000 startups. Despite that call to arms and the panic in government financial support for startups, the most recent data shows that total funding for startups fell from 970 billion yen ($6.3 billion) in 2022 to 803 billion yen in 2023 and is on track to fall further (to around 650 billion yen) in 2024. It is difficult to find people in Japan’s still small and immature venture capital. who believe the goal of 100 is remotely achievable.

The simplest explanation for the dearth of unicorns is the absence of funding in later rounds for startups that could, in Silicon Valley, be on their way to achieving that status. Japanese startups participate in IPOs much earlier than they should; most are not prepared, either commercially or psychologically, for that jump, and public markets cannot realistically force a recovery. As the head of a Tokyo-based venture capital fund puts it: A company’s journey should begin in earnest when it conducts an initial public offering (IPO); Too often in Japan, the journey ends with the IPO.

This is where petty status lurks: a prematurely listed startup that the market quickly stops labeling as a growth story, whose ambitions become less adventurous through listing status and whose valuation never rises above a few. few 100 million dollars. And many end up there. Only about a third of stocks in the TSE Growth Market 250 Index are up in 2024; The index as a whole is down nearly 14.5 percent since January, even as the broad Nikkei 225 has risen by the same margin.

Japan’s propensity to create nonstarters is partly due to the absence of a vibrant venture capital ecosystem, but it is also actively driven by circumstance. Enough parts of the Japanese business world have been stagnant long enough for a startup to appear innovative and unicorn long enough to convince retail investors to buy its IPO.

The economy remains (for now) large enough for startups to find pockets of significant growth in their early stages, and their founders – forged in a deflationary era – seem content to emerge as millionaires rather than billionaires. They do not need to be as aggressively ambitious as their counterparts in the United States because of the many huge inefficiencies they can exploit.

Many – particularly those involved in e-commerce, IT services and digitalization – can simply replicate business models that have been successful in other parts of the world and transplant them to a corporate and consumer market that has lagged far behind in these areas. They don’t need to alter or evolve globally competitive intellectual property, when they can find willing customers at home for the digital equivalent of an old rope.

On some level, Japan has probably recognized that the pastures in which the insignificant can live unopposed and unchallenged will not remain lush for long. The rise of interest rates, population decline and other factors will require real innovation and aggressively global ambition. Placidity – the p in punycorn – should remain silent.

leo.lewis@ft.com