During the height of the dot-com boom in the late ’90s, the mainstream media often referred glowingly to “Bit Valley” – the nascent venture business community springing up in Tokyo’s Shibuya Ward. The area was widely recognized as the center of Japan’s burgeoning high-tech industry and thought to be a fertile environment for creative startups, much like the famed Silicon Valley in the U.S. Ten years later, however, the name “Bit Valley” has all but disappeared from general use, and the heady, entrepreneurial spirit of those times has also fizzled considerably.

It’s not that Tokyo today is lacking in small startup companies – in fact, they seem to be everywhere, with an estimated 80% of companies in Japan consisting of fewer than 40 people. What is missing, rather, is the feeling of a true venture capital community – one in which entrepreneurs can think big and plan strategically for the long term, backed by investors who share their vision and are willing to take calculated risks in order to achieve larger goals. Instead, most entrepreneurs here find themselves engaged in a seemingly endless search for funding, which dilutes their focus and distracts them from working on their core business.

At the root of this problem lies a deep and widespread aversion in Japan to virtually all forms of risk, including the calculated risks that are so vital to the success of a venture business. Most venture capital in Japan currently comes from corporations and financial institutions that have a strong conservative bent and a tendency to hedge their bets. These firms make a large number of small investments in the $100K–$1M range, then for the most part take a “hands off” stance toward the startup company, providing little in the way of management advice or assistance beyond the initial cash injection.

Japanese Companies Today

This lack of vision and of active involvement on the part of Japanese venture capitalists has resulted in a corporate landscape in which an inordinately large proportion of local companies are sole proprietorships or small service/ consulting businesses. These small companies tend to be built around the extraordinary abilities or charismatic personality of a single founder/president, and their survival is highly dependent upon the presence of that one outstanding individual. In general, the employees of these companies have relatively little room for suggesting new ideas, and for the most part expect to be told what to do. This type of structure naturally imposes a hard limit on a company’s capacity for growth and restricts its ability to respond quickly to the fast and frequent changes in today’s business climate.

Even in medium-size companies, a relatively closed management structure and heavy bureaucratic overhead can often inhibit growth and innovation. Japanese companies are well known for favoring a consensus-building approach to decision making, and this frequently results in slower response times and a lack of accountability when problems inevitably arise. Despite all the time spent in reaching group-based decisions, however, discussion of important matters is generally limited to a small group within the company, and key decisions are usually worked out in advance through a series of “pre-board” meetings. The purpose of actual board meetings is to then formally approve whatever decision has already been reached. In fact, most corporate boards in Japan – as well as outside advisors – are largely symbolic and add little in the way of real discussion or advice.

In general, employees at Japanese companies are still trained to conform and act in a manner that is not too different from that of their colleagues. Strong emphasis is placed on maintaining harmony in the group (at least on the surface) and avoiding mistakes. Employees are usually evaluated more on the basis of tangible metrics such as age and sales figures rather than creativity and innovation. Stock option grants tend to be rather small and – like corporate boards and advisors – mostly symbolic in nature. They are rarely used as an effective incentive to attract, motivate, or retain key personnel.

It also appears that stock options are widely misunderstood and unappreciated by a workforce that values a high salary and stable income over the uncertainty and risk associated with stocks and venture business. This view is further reinforced by the lack of companies issuing stock options that have any substantial value. Most employees, therefore, have no real incentive to jeopardize their salaries in favor of an upside that is questionable or nonexistent.

When a venture company manages to find success in Japan, it is often on the basis of a new product or service catering to a specific niche market – for example, creating an online auction or online retail business specifically tailored to a mobile device platform, but completely ignoring other platforms or synergies. After growing to a certain size, however, these companies tend to have a difficult time expanding into new technologies and markets. Rather than take a risk on a new idea, they tend to milk their initial successful product to exhaustion, in an attempt to maintain the status quo for as long as possible. In some cases, they may “reinvent” themselves into something different (such as a mobile game company in the above example). Eventually, many of these companies wind up in a state of stagnation, and if not completely forgotten, are at best remembered as “one-hit wonders.”

Teams, Groups, and Communities

One of the key characteristics of most successful venture companies is a strong emphasis on team-building. Microsoft, Google, Yahoo, and Cisco all began with a core group of founding partners who proceeded to build world-class teams. While this might seem at first glance to be an area in which Japanese entrepreneurs excel, the reality is that most startup companies here tend to resemble well-disciplined groups performing their assigned tasks to the letter, rather than autonomous teams with a shared vision and the freedom to create “on the fly.”

Much like a seasoned baseball team led by an all-controlling manager, Japanese group members are highly proficient and precise in executing their set patterns. A successful business team, though – especially in a venture business – functions more like a soccer team, where there is a clearly defined goal but no central command, and each player must decide for himself what to do when the ball comes his way. Often – like the revered baseball manager – the president/founders of startups in Japan feel they deserve an almost “god-like” status, placing themselves at a level that is clearly much higher than that of their employees. There is even a Japanese expression meaning “above the clouds” that is used to describe these people. While their feelings may be somewhat justified given the difficulty of starting companies here, the unfortunate result of this attitude is that the founder is often cut off from valuable information coming from the workers who are down in the trenches.

The ability of a business to move as a swift and flexible team rather than a rigid group depends not only a flatter organizational structure, but also a high degree of mutual respect among team members, a willingness to learn from others, and a variety of complementary skill sets. Here again, many Japanese companies run into trouble when too many key employees share the same basic strengths and weaknesses, and are all vying for essentially the same or similar positions (job titles) within the fixed company hierarchy. Japan currently has many excellent managers, but needs more charismatic leaders who understand their own limitations and are willing and able to hire the right mix of talented people – in particular, those with the skills that the entrepreneur lacks.

In addition to a strong team, venture businesses in Japan also need the support of a vibrant venture community – one with an understanding and awareness of how a successful venture works. It is essential for entrepreneurs to be able to network actively and regularly with people from a wide range of different backgrounds, including service providers such as lawyers and accountants, as well as investors and officials from government and academia. It is this kind of human infrastructure that has helped make Silicon Valley such a powerful force for venture companies. Tokyo is actually remarkably close to Silicon Valley in this respect. The infrastructure is already in place, and Tokyo has no shortage of networking opportunities for entrepreneurs and business leaders.

Another key factor in creating a venture community is the nearby presence of strong research universities. Silicon Valley and other major technology clusters in the U.S. owe much of their vitality to the close proximity of scientists and students, which enables them to discover and capitalize on new advances in technology. A venture community centered around a strong technology cluster and supporting universities can greatly enhance local competition and cooperation among talented scientists and entrepreneurs.

Although Tokyo has some reputable universities, there is still a noticeable lack of cooperation between business and academia, with very few professors serving on corporate boards or otherwise involving themselves in commercial ventures. This is one area in which a bit more interaction between Japanese businesses and universities could lead to an increase in young entrepreneurs who graduate from university with the capacity for thinking bigger and more imaginatively.

Entrepreneurs in Japan

So what does it mean, exactly, for an entrepreneur to “think bigger”? For starters, it means focusing energy and attention on the long-term direction and development of a business rather than on short-term sales figures and the often demoralizing process of raising capital. It is exceptionally difficult for a company founder to think and plan strategically for the long haul when he must constantly raise funds from multiple sources just to keep the company afloat.

Japanese entrepreneurs also have a tendency to focus exclusively on the Japanese market, and thus miss out on opportunities for reaching global markets, which are potentially an order of magnitude larger in size. In addition, the entrepreneur in Japan must become more open to outside feedback, particularly from her investors. Many founders here have become quite used to the comfortable “hands off” style of Japanese venture capitalists, and actually hope the investors will simply stay quiet and not take much of an interest in the business.

More important, though, entrepreneurs in Japan must develop a more progressive attitude toward the idea of calculated risk. This does not mean that founders should blindly take on more risk, but rather should be more discriminating, looking for the “right kind” of calculated risk that is needed for strategic planning of any type. Entrepreneurs can increase their chances of success by taking intelligent business risks that are strategically calculated to work out for them in the end. Perhaps ironically, an attitude that embraces calculated risk may results in a greater chance of success for the business. For example, Japanese companies have a tendency to want to build everything themselves, because then they know it will work the way they want. But by taking a chance on using off-the-shelf components, they may be able to bring a product to market with less time and money.

Finally, along with an expansion of calculated risk, Japanese entrepreneurs could also stand to take a broader view of failure. In a society that attaches a deep and lasting stigma to failure, this can be difficult, to say the least; and any risk, however well-calculated, can easily be seen as something to avoid altogether. Here again, it is useful to look at the example of Silicon Valley, where failure is viewed as a valuable part of the business learning process. The key condition, though, is that the entrepreneur does in fact analyze what went wrong and take away a critical lesson or two from the experience. For venture businesses to truly thrive in Japan, potential entrepreneurs must look at failure as something from which to learn. When an entrepreneur does fail, he must be willing to absorb the lessons, and then muster up the courage to get back in the game.

To be sure, much of the risk-avoidance and narrow thinking currently seen in Japanese business has its roots in the education system. Typically, Japanese students move in lock-step through a set schedule comprising four years in university (which are surprisingly undemanding), followed by the job hunt, multiple interviews and acceptance by a company. This process is expected to follow a pre-determined pattern, right down to the first day of a new graduate’s employment being on April 1st; any deviation can reflect negatively on a young worker’s resume. This system, which is strongly reinforced by the media and most parents, acts as a powerful agent of social pressure against venture businesses in Japan. It takes a very strong will indeed to establish or take a job at a startup company, when the overwhelming message from friends, parents, and teachers is to go work for a “proper” company. Finally, as if all this weren’t enough to dissuade one from starting his own company, the prospective entrepreneur must also contend with other strong and prominent attitudes that work against him every step of the way. For example, the president or founder of a failed venture is almost never given a second chance in Japan, whereas it has been shown in the U.S. that most successful venture founders have had at least one total failure prior to their first success. In general, Japanese society allows the entrepreneur one try and one try only.

Success and failure can be misread in other ways: if an entrepreneur is “too” successful (and some people are partly to blame themselves by becoming ostentatious), people will with suspect that you gained the wealth illegally. Conversely, if a venture fails, people will also suspect that they did something immoral, or worse, illegal.

Even if the venture founder manages to overcome the odds by succeeding on her first attempt, she is still likely to face social pressure not to be seen as too successful. In a society that still values egalitarian harmony, the very wealthy are generally viewed with suspicion, and often are assumed to be involved in some type of illegal activity.

Japanese Venture Capital

But enough about the entrepreneur in Japan – let’s turn now to the other side of the equation: the Japanese venture capitalist. Despite the fact that many corporations and financial institutions make investments in smaller companies, the kind of venture capital activity found in the U.S. does not really exist in Japan. In fact, some would go so far as to say that Japan actually has no venture capital, in the sense that investors don’t really “venture” anything, nor do they really provide significant capital. In other words, the sources of capital in Japan tend to function more like banks: on the whole, they are heavily biased toward lots of relatively low-risk, low-return deals. Accordingly, the entrepreneur can expect only a relatively low amount of capital from any one investor.

The investing companies (usually various types of financial institutions), meanwhile, are generally content just to sit back with their diversified portfolio of small investments and not involve themselves much in the management of the companies they have funded. In fact, these financial firms have most of their managers rotate out of the venture sector after two to five years. It is in the best interest of the manager to finish her rotation with a decent track record free of any major losses. This, in turn, leads to managers who have no incentive to take calculated risks in their investments.

In some ways, the investment patterns of the firms and financial institutions providing venture capital in Japan resemble those of individual “angel” or “friends and family” investors in the U.S.. Not only are the investment amounts similarly small, but there is also often a prior personal relationship between the founder and the lead investor, and the objectives and criteria for success are not as explicit and clear cut as they are for most true venture capital deals.

It is interesting to note that while there are a fair number of individual angel investors in Japan, there is not much of a network or organization for such investors, and virtually all angel deals are based on strong personal connections. In addition, Japan does not have an equivalent of the Small Business Innovation Research (SBIR) program in the U.S., which provides funding and other support for small businesses involved in innovative research or technology development.

Venture Capital: A Tale of Two Cultures

Many venture capitalists in Japan take only observer seats on a company’s board, rather than active board seats with voting rights. The ostensible purpose of this policy is to protect the venture capital firm from potential liability/ lawsuits that might spread from the venture organization to the firm and ultimately to the financial institution that funded it. It also shields the board observer from possible criticism in the future of decisions he made while on the board.

Venture capital firms in the U.S., on the other hand, are more likely to do just the opposite, getting actively involved at the board level and making changes in management when needed. These firms often put equal amounts of capital and experience/support into a company – rolling up their sleeves and providing hands-on management. They also provide assistance in augmenting the human resource needs of the venture. In fact, the introduction of partners, suppliers, and customers is considered a vital function that U.S. venture capitalists provide the venture company in addition to capital.

While U.S. investors favor early-stage, higher-risk ventures, the Japanese funds tend to go to companies that have been around for a few years and appear to be more “stable” (lower-risk). Additionally, U.S. investors expect employees to be compensated based on their performance, but in Japan it is still the norm for employee salaries to be based on age (literally all 25 year olds in a particular company would make the same pay grade) and length of service within different parts of the organization, but only rarely skill or experience.

Venture businesses in the two countries also show significant differences regarding their approach toward initial public offerings. For most Japanese ventures, the IPO is the main and ultimate goal, and a company that succeeds in getting its stock listed on JASDAQ is considered to have “made it.” This is considered a successful exit for the founders and the initial investors, but also represents a serious conflict of interest if the investment bank in charge of the IPO has a close relationship with one of the venture capital investors.

In the U.S., on the other hand, the IPO is more of a starting point, signifying the beginning of the “real company,” where the funds raised during an IPO are used for market expansion or other types of growth. Whether or not the venture is deemed successful depends in large part on how the stock performs after the IPO.

Japanese companies also tend to go public at a much earlier stage and lower valuation than most U.S. ventures, offering a smaller proportion of shares for sale. Finally, while U.S. founders tend to gradually sell off the bulk of their company shares, entrepreneurs in Japan have shown more of a tendency to hold on to their shares, with the founder often holding as much as 60% of the company even after the IPO.

Finding the Lost Valley

Given the lack of truly entrepreneurial ventures in Japan today, combined with the paucity of significant venture capital, potential investors looking to fund innovative companies might be inclined to write Japan off as a lost cause. Indeed, the “Bit Valley” moniker now has a somewhat derogatory ring to it, conjuring up images of failed Japanese Internet ventures from the dot-com era.

Attitudes toward business and career in Japan continue to reflect a strong bias toward the conservative and traditional. And lest anyone forget: the state of the Japanese economy has not exactly sparked massive excitement in recent years. Add this all together, and it’s easy to conclude that the idea of turning Tokyo into an Asian hub for venture business is simply too far-fetched to merit serious consideration.

However, upon closer inspection, the situation does not seem quite as bleak as outward appearances would suggest. While we have been generalizing a bit and discussing the state of Japanese venture businesses in fairly broad terms, there are actually many exceptions to the patterns and tendencies described here, and a slow but steady course of change is already underway. The human support infrastructure – including lawyers, accountants, consultants, and the finance community; the high-tech R&D and manufacturing activities; and the highly educated, mobile workforce – are all major strengths for Tokyo. In addition, there is an abundance of ideas and opportunities around which venture businesses can be built. The real question now is whether or not these individual forces can somehow be made to work together to overcome the complacency and attachment to the status quo that have recently proven so detrimental to growth.

It may be that what is most needed in Japan right now are a few real-life, high-profile case studies – examples of true venture businesses with big-thinking founders who receive the right funding and guidance from the right VC firm and go on to achieve success on a massive scale. Aspiring entrepreneurs and investors in Japan need to see concrete examples of Japanese venture companies that are able to break through and make an impact, not just in the local Japanese market, but internationally as well. More than anything else, this type of example has the potential to act as a catalyst in bringing together the powerful but isolated pieces of Tokyo’s dormant venture capital community.

Far from a lost cause, there are actually numerous opportunities in Tokyo for the right venture capital fund. Whether that fund will find an appropriately entrepreneurial environment will be the gating question for the next phase of Japanese economic growth.