Advice to Japanese Entrepreneurs:
Go [to the] West, Young Man!

CJ talks with George Hara of Accel Partners
about venture capital in Japan

interviewed by Terrie Lloyd

George Hara holds a Master's Degree in Engineering from Stanford University (1981) and a Law Degree from Keio University (1985), and is an alumnus of the Stanford University Graduate School of Business. Mr. Hara has been active in venture capital investment since 1983. He is currently Partner of Accel Partners and Accel Japan Partners, a venture capital partnership with $350 million under management, and serves on the Board of Directors of several emerging and established companies, including Borland and The Wollongong Group. Mr. Hara is also a prolific magazine and journal author on the topic of venture capital.

Tell us about your company, Accel Partners.

George Hara: It is a partnership for venture capital. We specialize in special projects.

There are several funds -- the Accel Capital Fund, Accel International Fund, Accel Telecom Fund, and Accel Japan Fund -- and each partner is in charge of one of these funds. I founded and raised the capital for the Japan Fund.

Have you been in Accel Partners from the beginning?

Hara: My connection with the company started in 1984. The two founders were Jim Shore and Arthur Patterson. When the partnership was founded, they came to see me for the cash; I was the first investor in the partnership.

When did you start getting involved in venture capital [VC]?

Hara: I founded a venture capital company in Japan in 1985, but even prior to that I was very interested in investing. I became intrigued by the concept of venture capital while I was studying at Stanford Business School. I immediately thought, "This is w hat Japan needs in the '80s and '90s."

That's what I felt in 1979; I really wanted to start a venture capital fund in Japan. But it didn't work, because in the '80s the economy entered the bubble period, and it was much easier to make money in other ways than in VC. In the US, it takes at leas t three to five years -- and in some cases, eight to ten years -- for a company to progress from the initial seed capital to going public.

For the Japanese market, this start-up period is too long. Think back to the mid-eighties, and compare this kind of investment to real estate, where investors could double their money in a month. It was impossible to convince Japanese that investment in V C was more attractive than real estate, resorts, and golf courses. That's the main reason I gave up trying to form a venture capital fund in Japan and came back to the States in 1989.

What was your first investment?

Hara: The first independent VC investment I made was in 1984, a company called Wollongong. The reason I became really interested in them was that the company was dominant in the Internet market in 1983. At that time, the Internet consisted of the ArpaNet for universities and DDN (Defense Data Network) for the Defense people. About 80% of the Internet gateway machines at that time were DEC. TCP/IP for VMS was the protocol necessary to connect to the Internet, and Wollongong was dominant in that market. The y had 80% market share.

Wollongong must have been near market saturation at that time. Why did you think that they could sustain further growth?

Hara: Because I knew the market was going to grow.

But it took some time, didn't it?

Hara: Ten years.

How do you find ventures for possible funding?

Hara: We receive about 2,000 proposals a year. We interview 100 of those, and fund about 25 to 30.

Back about 1990, when you started the Accel Japan Fund, a lot of Japanese companies were coming in to the US and paying high prices to start up. So Japanese money started to become known as being naive. Did you ever find that a problem: the fact that you had a Japan fund where you channel Japanese (with US and European) money coming into the States, while people were able to get direct access to that money themselves?

Hara: Between 1985 and 1990, lots of Japanese were investing in real estate and other vehicles, but not in VC. But then, some of the more sophisticated investors wanted to start diversifying, into venture capital. I took that money.

But how about, for example, the steel companies that came in with their own money and own deals? They flooded the market for a while. Didn't you find that you were getting crowded out of deals because the Japanese were willing to pay a lot more?

Hara: I don't think so. Those Japanese companies never invested in start-up companies. They usually don't get involved until 3rd- or 4th-round financing.

Are there any US funds going back into Japan?

Hara: At this point, unless they are speculating on the appreciation of the Japanese yen, they may not be very interested.

What about you?

Hara: If there are two similar opportunities in Japan and the USA, it is much easier for us to choose the opportunity in the USA and materialize profits from it. The market conditions are better -- IPO [the initial public offering] is much easier to do, N asdaq is much more sophisticated, it is much easier to recruit key people and management, the market itself (and distribution) is open, and there are more customers and end users who are open to new ideas.

What if an entrepreneur took the strategy of having the ownership of the company in Singapore, even though it was a Japanese company?

Hara: If you choose the location of a start-up company according to the stock market it will be released into, then Nasdaq is the best, followed by Singapore, then Hong Kong. Japan comes in last.

A Japan-based Internet service provider or hardware-oriented company might find Singapore best. But more sophisticated software and telecommunications companies will find the States easier. ATM companies, for example; since they have no supporting compani es or technologies in Singapore, it's easier in the States because the market is mature enough to accept new ideas.

The reason for this, I presume, is that to do an IPO, you have to have people willing to buy the shares?

Hara: Let me explain it this way: In order to start a new company, you need entrepreneurs and capital. These, and the market itself, are the most important components. For entrepreneurs, the easiest place to access capital is the US. For Singapore, Hong K ong, and Japan, there is no comparison. The amount of money in Singapore, for a high-tech venture, is tiny.

Second, after you form a company and have the capital, the entrepreneur has to optimize three things: marketing/sales, finance, and production/operations. To do this, you need good people to run things. In Japan, Hong Kong, and Singapore, there are not ma ny likely candidates to be CEO, COO, or other senior executives of these new companies.

Yet in Japan, there are lots of companies being run by top-notch senior people who would change for the right opportunity.

Hara: I don't think so. For someone used to large corporations, it is very hard to change their mentality to that of the small-company entrepreneur. The entrepreneur has to do everything. But experienced executives, even though they may be very capable -- if they have worked for many years in large corporations, when they leave it is difficult to do things for themselves.

Also, it is much easier in the USA to get fresh new graduates. The best and brightest from Stanford and MIT all want to go into small companies. In Japan, this is almost impossible. Everyone wants to work for large corporations or the government -- especi ally in this kind of recession. Young Japanese prefer risk-averse jobs.

So, in Japan, it is hard to get senior management, and hard to get new recruits from college. Also, expenses such as salaries, cost of living, utilities -- everything is expensive in Japan to start a new company.

I know some entrepreneurs in Japan, Japanese who function within the existing framework, who are doing quite well. But the fact that they are not getting VC is notable.

Hara: There are many Japanese entrepreneurs who have managed, either through luck or fate, in the current structure of society without challenging it. But if they came to the USA and did the same thing, they would achieve much bigger businesses.

A lot of potential entrepreneurs want to stay in Japan because they are Japanese, and this is home for them. Also, the Japanese market, if current trends continue, will become much bigger over the next couple of years. For those people, their choices are to go to the bank, where they can get 1% to 2% of their sales in loans, or to find some other way -- such as loans from the family.

Is there another way? Can an entrepreneur in Japan get the money from overseas? In talking to American VC companies, I find that none of them are interested in being outside the States: it's too hard, they don't know the economies of other countries, or t hey don't know if the prospect has a chance because they don't understand the cultural context. Are there people like yourself, people who do understand these things and also have picked up the culture of US-style VC investment, who would consider VC inve stments in Japan?

Hara: Not now; but probably, in a couple of years, that may happen. I have always been preparing for re-entry into the Japanese market.

What kind of activities do you suggest for encouraging young Japanese to take a risk?

Hara: They should come to the States, first.

JAFCO, for example, seems to be monitoring what is happening in the marketplace, and is quite sophisticated in seeking out prospects. Is this common amongst VC companies in Japan, to aggressively seek out those companies that are doing well? In the States , usually the entrepreneur has to approach the VC company, not the other way around.

Hara: JAFCO is probably the only Japanese VC company that is really active today. They have the backing of Nomura Securities, and are probably the only company in Japan capable of raising the money needed for VC activity.

In general, Japanese companies feel more comfortable to participate in the follow-on investments.

Therefore, your comment about them being more likely to be 2nd-, 3rd-, or 4th-round investors in the US market.

Hara: Which is a perfect combination, because we are not so interested in later stage investments. You have to pay a higher price. There is more risk at the early stages, though.

So, you prefer to get involved at the point where you can influence who will be on the board of directors, etc.

Hara: Yes. There are many young engineers and managers in large Japanese electronic companies who have great ideas. But I didn't see many of those people dare to quit their companies and start a new venture. I saw the first one this year: a key engineerin g manager of a large computer company who had developed a very interesting device, a computer peripheral and software having a unique algorithm.

Has he already started his own company?

Hara: He started it in the spring, and I am the first board member. I'm in the process of recruiting some other strong board members and getting VC for his company. I will probably be involved with his company for years, up to when he goes public.

How did you find him? Japan can be a very closed country.

Hara: Actually, he was here in the States, in charge of a project here. Once he came to the US, I was quite visible for him -- he found and contacted me, and wanted to discuss his ideas. He asked me to help him because he did not want to take US venture c apital.

Will the company be run in the US or in Japan?

Hara: In the States. It will be the first venture founded by a Japanese citizen and funded with Japanese money -- but all in the States. It will probably take three to five years to go public. I am quite optimistic. I did a review and a drastic change in the business plan.

Do you think that he will set an example for other young Japanese?

Hara: Yes, I think so. Accel invests in 10 to 20 ventures every year. I am personally interested in doing about 3 Japanese ventures a year.

What about non-Japanese in Japan?

Hara: They're OK, too, but the condition is that they have to come here.

Why is that? You mentioned the problems of recruiting, but when a companies like Oracle, Dell, or Compaq got started in Japan, they had to recruit people and find people to run the business. They may not have got the very best, but they are still doing OK , and they recruited on the open market. Isn't it possible to tailor your expectations to allow someone to get started in Japan and not the USA?

Hara: I don't think so. Those companies you mentioned are large enough to be familiar. They have $100 million in sales in the States, which makes them large enough to be qualified to make subsidiaries overseas, and large enough to recruit decent people as a country manager. Companies with around $20 to $30 million in sales in the USA are too small to hire the right person if they open up a subsidiary in Japan. It is difficult.

One of my companies is PictureTel, which Accel invested in. The company succeeded very well, and went public in 1990. This year, their sales will probably reach around $350 to $400 million. I opened PictureTel Japan in 1992. Right after I acquired Ashton- Tate, I moved the ex-President of Ashton-Tate Japan over to PictureTel Japan. Between him and me, PictureTel in Japan has been growing very quickly. Sales for this year will be around $30 million.

But for the person who has no contacts, who must rely on the headhunters -- you have to depend on luck. My idea is that, for Japanese, it is much easier to come to the States. If you are lucky enough to be able to choose between the same kind of funding f rom US or Japanese venture capital, in the US there is common stock and convertible preferred stock, and warrants, and stock options. If VC and the financier continue to fund the venture, with an equal amount of money, the Japanese entrepreneur in the US will end up with a much greater ownership of the company. In Japan, he will lose a much larger number of shares by the time the company goes public.

Then there are the management issues. The managers in the US usually also hold a significant number of shares by the time the company goes to IPO. In Japan, managers hold very few shares.

Isn't that just because it's the traditional approach? There isn't any rule that says it has to be that way.

Hara: It's because of the law. In Japan, stock options are not allowed. In order for managers to get stock, they actually have to buy in cash. But they have no funds.

Yes, but the entrepreneur could make loans to the employees. That would be regarded as pseudo-salary, for example.

Hara: Yes, that can be done. But in the US, you don't have to find work-arounds. Stock options are allowed. It's easier. I'm not saying that it's impossible in Japan, just more difficult.

Another obstacle in Japan is the reliance on banks. In the States, almost all companies start with equity financing, from inception through to IPO.

Isn't that just because the technology stocks can't get financing from the banks.

Hara: Yes, but that is good, because technology is a high-risk investment. They shouldn't go for debt-related financing that doesn't like taking risks.

I have invested in seven Japanese high-tech ventures; but after I invested, the banks came in to provide further financing. They felt that I must have gone in with due diligence and evaluated the feasibility of the technology. The trouble was that I wasn' t told, and those companies loaded up on debt. They were advised by the banks to buy a lot of real estate, build a new headquarters building, and buy luxurious cars -- all the things that I do not want them to do! This actually happened.

Did any of those companies go out of business?

Hara: Some of them went out of business; some are still surviving.

That must have disillusioned you about Japanese start-ups.

Hara: Yes, in Japan, in order to be successful as a venture capitalist, you should be a later stage investor, or co-invest with a mainstream VC company such as JAFCO. Independent VC may not work very well in Japan.

How do you explain the success of someone like Mr. Son of Softbank? What did he do? I realize that he came to the States, but he really built the business in Japan. What did he do that is different from what you think is possible now?

Hara: He and other successful people had an opportunity to make a strategic alliance with US venture with major potential -- at the beginning.

What did Softbank have opportunities to do?

Hara: Well, Cisco and many others. They took the distributorship rights, which has been a major factor.

I think that this is a solid business model for Japanese entrepreneurs: to find opportunities to be the evangelist for a future de facto standard product, at an early stage, and to act as the master distributors in Japan. This is a very good business mode l.

Still, those US ventures will grow up and leave the fold pretty quickly, and set up for themselves --such as Microsoft did with ASCII, and Oracle with Ashisuto. Where does that leave the Japanese entrepreneur then? They will have lost one of their most va luable assets. Do you think that by that time they should have built up their business sufficiently to withstand that loss, and spread their risks so that they can keep going.

Hara: They have to have their own products, based on the products that they introduced. Otherwise they will always be just distributors.

I've been told that one-third of CEO's receiving VC in the States were not born in the USA. I wonder if that might not happen in Japan, too.

Hara: If the immigration policy was easier and more generous to foreigners in Japan, it might happen. In any case, the first generation in the US are usually the most successful entrepreneurs, because they are hungry.

Do you look for that? When you meet entrepreneurs, do you look to see how hungry they are?

Hara: Oh yes; it's important, very important.

What advice do you have for young Japanese entrepreneurs? If someone did come to the States first, what should they do next? What would you respond to?

Hara: The Japanese markets in computers and the IT industry are good, although the choice of business they can be in is limited because of regulatory issues. Also, core technologies -- because most of the enabling technologies are invented and used in the US first, and become the de facto standard. It is too late if someone comes up with a technology in Japan or Europe to make it the standard, in the face of developments in the US.

What about multimedia and games?

Hara: Anything related to applications is ideal. For example, to develop ATM in Japan is difficult; but once ATM is the de facto standard, opportunities such as writing videoconferencing applications on top of ATM become possible and are a great business opportunity. Creating a tool is difficult, because finding a large enough market of the people who might use that tool is a problem. But taking a tool from the US and writing applications that use it (whether games, factory automation, or financial applic ations) is possible.

I see huge opportunities in virtually every industry for new companies to write client-server applications.

Let's say that a company does have a product. Then what?

Hara: They need to have a strategy that does not require a lot of capital to develop the product. By "not a lot," I mean less than a half-million dollars. That is probably the maximum capital for young entrepreneurs under, say, 35. So they have to grow fr om internally generated funds.

What kind of networking do they have to do to make the VC connections?

Hara: In Japan, they have to start their own companies without venture capital, and run it for three years and make it profitable. Then they can get VC. To get VC in Japan from the beginning is impossible, a waste of time. There really is no one in Japan with the willingness to take a risk on a fresh start-up.