Practical Trends in JV and Shareholders’ Agreements in Japan

This article outlines recent M&A trends in Japan, focusing in particular on the following transactions:

In April 2022, the Tokyo Stock Exchange (TSE) implemented changes to market classifications in order to clarify the concept of each classification and to motivate companies to continuously improve their corporate value. From March 2023, all “Prime” and “Standard” Market companies were required to formulate, disclose and implement policies, targets and plans to improve their own cost of capital and return on capital. In January 2024, the TSE began publishing a list of companies that have disclosed information in accordance with these requirements. According to data released by the TSE on 15 January 2024, at the end of December 2023, about half of the listed companies in the Prime Market had a price-to-book (“P/B”) ratio below 1x, and about 60% of the listed companies in the Standard Market had a return on equity (ROE) below 8% and a P/B ratio below 1x. Improvement in the cost of capital and return on capital is recognised as an ongoing issue.

In response to the TSE’s actions, some listed companies have taken measures to improve cost of capital, such as conducting aggressive investments and reviews of business portfolios to achieve growth while maintaining their listings, while a certain number of companies have chosen to go private. In fact, in 2023, a total of 61 companies – 27 in the Prime, 26 in the Standard, and eight in the Growth Markets – chose to go private. The number of companies going private through so-called MBOs also remained high (17 in 2023 and 12 in 2022).

Where there are multiple methods of going private, typically a takover bid (TOB) and subsequent squeeze-out are implemented. When there are multiple acquirers, it is common to form a special purpose company (SPC) as a single acquirer in the TOB (eg, when conducting an MBO, an acquisition SPC is formed in which management and the private equity fund will invest). Since such SPC is composed of multiple shareholders, a shareholders’ agreement (including operation of the SPC and exit by the shareholders after acquisition) is made in advance, and certain disclosures are legally required at the time of commencement of the TOB.

For companies to achieve sustainable growth in a rapidly changing business environment, it is necessary to concentrate resources on strengthening core businesses and investing in growth and new businesses. Recognising the need for business restructuring, the Ministry of Economy, Trade and Industry (METI) has been placing particular emphasis on this, as evidenced by the publication of its “Practical Guidelines for Business Restructuring” in July 2020. In addition, changes in the social and business environment triggered by the COVID-19 pandemic, and the increase in pressure from activist funds, have resulted in many companies restructuring their business.

One of the recent trends involves carve-outs of indirect departments (eg, general affairs and systems departments), which are recognised as having relatively high potential for improvement and efficiency, with the goal of reducing costs and increasing corporate value through the formation of joint ventures with companies that promote digital transformation. While the services provided by the indirect department itself are essential for a carve-out company, detailed consideration is required from a commercial perspective, including how to establish the service content and fees, how to verify cost reduction methods and plans, and the effects (exit options) in the event of failure to achieve these goals.

As part of its efforts to promote so-called “open innovation”, the Japanese government has been taking measures to promote collaboration between start-ups and mature companies since before the COVID-19 pandemic. In March 2022, METI released the “Guidelines for Business Collaboration with Startups and Investment in Startups”. These efforts are aimed at creating “disruption” by combining the resources of mature companies with the new technology and speed of start-ups, and with the support of the government, start-up investment is expected to continue to flourish.

In many cases, shareholders’ agreements for start-ups have specific provisions. Specifically, there are provisions that impose on the managing shareholder the obligation to devote themselves to their duties, leaving business decision-making in principle to such managing shareholder, while requiring investor approval for certain important matters to prevent damage to the value of the investment; restrictions on share transfers by the managing shareholder (in cases where certain transfers by the managing shareholder are allowed, the investors have right of first refusal and tag-along); drag-along clauses; and deemed liquidation clauses, etc. In Japan, there are no “model contracts” such as the National Venture Capital Association’s model contract. Therefore, it is likely that contracts will be negotiated on a case-by-case basis with a certain degree of freedom, but the expansion of start-up investment may lead to further standardisation in the future.

As described above, JV agreements and shareholders’ agreements have various phases of use, and there are practices and provisions that differ from those in other countries. Therefore, contract negotiation and drafting based on phase-specific practical trends remain vital.