Exclusive Q&A on Mergers and Acquisitions with Shigeki Tatsuno

Have there been any recent regulatory changes or interesting developments in your jurisdiction?

There have been no major legislative changes in Japan over the past year. With that said, the Ministry and Economy, Trade and Industry (“METI”) issued new guidelines for the conduct of corporate takeovers (the “Guidelines”) in August 2023. The Guidelines – titled “Enhancing Corporate Value and Securing Shareholder Interests” – is part of a series of guidelines issued by METI over the past decade or so, with the aim of promoting fairness in corporate M&A.
 
Long-time observers of Japan would know that the country has been resistant to hostile takeovers for both historical and cultural reasons. Accordingly, foreign funds that attempt hostile takeovers in Japan are generally not well-received.
 
From the perspective of corporate value creation and enhancement of shareholder interests, however, hostile takeovers are not necessarily harmful. There have been cases of hostile takeovers in Japan where the acquirer has added considerable value to the target company. There have also been cases where the management of target companies are believed to have opposed prospective hostile takeovers principally for self-serving reasons, instead of assessing takeovers purely for their commercial merits.
 
To remove the negative connotations attached to the term “hostile takeover”, the Guidelines propose replacing the term with “takeover without management consent”. Among other things, the Guidelines also recommend assessing prospective takeovers based on considerations of whether they would secure or enhance corporate value and shareholder interests.
 
Although the Guidelines constitute only recommendations of best practices and have no legally binding effect, they are anticipated to have a significant impact on the way takeovers will be conducted in Japan going forward. Furthermore, these “best practices” are expected to be taken into account in M&A-related disputes going forward.

How important is it for companies to assess the value of a business’ intellectual property before undertaking a merger or acquisition?

With the growing importance of technology across all industries, intellectual property has become, in many cases, central to the valuation of companies. Over the past several decades, the bulk of the enterprise values of companies have been shifting gradually from tangible assets to non-tangible assets. As a result, intangible assets, including intellectual property, have grown in significance. Moreover, these days, how well a company is managed is also determined in large part by how well its intellectual property and data are managed. This includes not only technology companies like those specialising in fintech and AI, but also traditional B-to-C businesses that handle consumer data.

In terms of pre-merger due diligence, where do cultural fit and business values rank?

Cultural fit has always been an important aspect of pre-merger due diligence. Nowhere is this more apparent than in employment. Japanese labour laws are considerably pro-employees, which makes it quite difficult for companies to conduct retrenchment exercises or to change the working conditions, including wage levels of employees following a merger. Accordingly, inbound investors should bear this in mind when conducting mergers or planning for post-merger integration.
 
Business values - such as social responsibility, integrity and respect in the workplace – have been gaining in prominence internationally, and Japan is no exception. When assessing the suitability of a merger, companies now often look closely at the business values of the counterparty to determine whether it shares the same business principles and standards. Similarly, SDGs and ESG considerations are now more common in the Japanese M&A market, particularly since listed companies in Japan are required to report on the progress in their SDGs and ESG efforts.
 
What other elements of pre-M&A due diligence are you seeing being underutilised by businesses today?

In recent years, companies have started paying attention to human rights issues, such as ensuring that none of their products involve the use of forced-labour or other abuse of human rights. Indeed, human rights diligence is now increasingly being factored into the scope of due diligence reviews in the M&A context. With that said, human rights diligence is usually focused on the employees of the target company. To ensure a holistic treatment of human rights issues in the context of M&A, it would be necessary to look at the human rights records of not only target companies, but also of the entities within their supply chain, including their suppliers, business partners, customers and other stakeholders. As the scope of review of the entire supply chain of a target may be too broad or impracticable, however, parties to M&A transactions often find it necessary to prioritise the scope of due diligence reviews, without compromising on certain universal values.

In your jurisdiction, which industries are offering the best opportunities for acquisitions and why?

With the shrinking and ageing population in Japan, policymakers are promoting greater interest in Japanese start-ups involving the latest technologies, such as the internet of things (IoT), artificial intelligence (AI) and financial technology (FinTech), in hopes of leveraging them to enhance productivity and economic growth in various industries. As the Japanese government is expected to introduce more initiatives in the coming years to incentivise investments in these areas, they present opportunities for foreign investors.
 
Investments in the healthcare technology sector have been particularly favoured in recent years by both domestic and overseas companies. Opportunities in this sector have been abundant, what with the continued rise in the number of local “med-tech” start-ups and the recent inclination of large domestic companies, such as Hitachi, to spin off some of their ancillary medical technology divisions to focus on their core businesses.
 
Beyond the domestic market, Japanese companies in recent years have been particularly focused on emerging markets, including Southeast Asia, where sizable and young demographics provide an attractive counterpoint to Japan's shrinking population. The flourishing tech ecosystem that is emerging from the Southeast Asian region is also drawing venture capital from Japan. With that said, legal, commercial and political systems differ significantly from country to country within Southeast Asia, and care needs to be taken in navigating the potential pitfalls presented by the diversity of systems.

What challenges do rising interest rates pose to potential M&A deals today?

Japan is unique in this respect in that the government continues to maintain ultra-low interest rates in comparison to most other advanced economies. As a result, interest rates do not factor much in domestic M&A transactions. Cross-border M&A transactions are of course a different matter. More specifically, foreign investors may find it more difficult to invest in Japan due to the higher interest they have to pay for loans and other leverage obtained outside Japan. On the other hand, outbound transactions – particularly where the Japanese party can obtain a loan in Japan – have largely been unaffected. That being said, the interest rate environment, and market conditions in general, are constantly changing, and no one can project with any certainty how the M&A market may be affected in the medium, or even short term.
 
Aside from interest rates, the strength of the Japanese Yen is also an important factor. With the Japanese Yen currently near historic lows, the ability of Japanese companies to conduct M&A abroad and, conversely, the capacity of foreign companies to make acquisitions in Japan, would undoubtedly be affected.
 
What best practice procedure should be implemented to help buyers and sellers get the very best out of their M&A activity?

Generally, from a buyer’s perspective, due diligence on the target of acquisition is crucial. Due diligence, when properly conducted, would enable the buyer to sift out important information regarding the target’ business, identify significant red flags or even deal killers, or better understand how the target would fit into or complement the buyer’s business. As mentioned above, senior executives with a deep understanding of the acquirer’s culture should also be involved in the M&A process from the start, to familiarise themselves with the corporate culture of the target company, and to draw up pragmatic plans for the manner in which the acquirer’s corporate philosophy can be introduced to the target to create synergistic outcomes.
 
From a seller’s perspective, an auction process, where permitted by circumstances, would enable maximisation of price and also enhance the seller’s ability to obtain the most advantageous transaction terms. A bidding situation would also open up a sale transaction to the most number of prospective buyers, through which the seller would be able to pick the most suitable buyer, whether in terms of price, employee protection, commitment to completion, financial resources or otherwise. Understanding that information on the target would be key to a buyer’s assessment of a deal, sellers should also take the time to organise their data on the target in a way that is easy to access and understand.
 
Last but not least, parties to an M&A transaction should take care to select the right external legal and financial advisors. These advisors should have proven track records, the experience to identify with their clients’ perspectives and objectives, and the ability to steer a transaction toward the desired terms and outcome.

How important is local knowledge when conducting cross-border M&A and what other considerations need to be factored in?

Many M&A transactions do not close or, even if closed, ultimately fail due to unsuccessful integration of the target into the acquirer group, resulting from a failure to recognise and address differences in corporate culture.
 
Ideally, senior executives with a deep understanding of the acquirer’s culture should be involved in the M&A process from the start, to familiarise themselves with the corporate culture of the target company, and to draw up pragmatic plans for the manner in which the acquirer’s corporate philosophy can be introduced to the target to create synergistic outcomes.
 
A successful and efficient integration process is also often dependent on key persons at the target company. It is therefore important, even as early as at the due diligence stage, for the acquirer to identify personnel capable of contributing to a smooth integration and successful future operations. The acquirer should as soon as practicable after identifying such personnel, induce them to stay with the target company through reassurance or discussion of future incentives.
 
Placing key persons from the acquirer within the target company would also enable the acquirer to win over the target’s employees through the establishment of rapport between the acquirer and the management team of the Japanese target. Respect towards the target's employees is also essential.

Acquiring distressed assets is largely of interest to investors with a bigger appetite for risk. What factors should these investors be considering before entering into such deals?

Organised crime-related issues are important factors to consider when acquiring distressed assets in Japan. Sometimes, companies may go into financial distress as a result of transactions with organised crime groups (also commonly referred to as “anti-social force” in Japan). Accordingly, investors wishing to acquire distressed assets should conduct careful due diligence to verify whether the assets had initially been acquired through proceeds from illegal transactions and whether they are subject to third party rights (whether direct, by way of recourse, in the form of the right to claim damages or otherwise).
 
From a purely financial point of view, investors may also wish to carefully assess the economic value of the distressed assets proposed to be acquired, based on, for example, the nature, condition and economic utility of the assets.
 
Moreover, acquisition of distressed assets can sometimes give rise to reputational risks. The recent Bigmotor scandal is a case in point. Bigmotor, a used-car dealership and repair chain, was recently found to have intentionally damaged the cars of their customers in order to charge excessive repair fees and to make fraudulent motor insurance claims. Based on media reports, the company is now considering business rehabilitation with its financial advisor. Any investor which may be considering acquiring Bigmotor itself or the assets of Bigmotor would have to consider the company’s damaged reputation and the likelihood of customers avoiding that company for their future vehicle and repair needs. In other words, any assessment of the value of Bigmotor itself or Bigmotor’s assets would have to take into account the impairment to the goodwill and reputation of Bigmotor.

What are the benefits to implementing a business succession and exit plan and when/how often should it be revisited?

There are many privately- and/or family-owned businesses, including mid-cap and, occasionally, relatively large-cap companies, in Japan. Many of these businesses are now confronting the urgent need to transition out of their current leadership. One way of resolving the issue of leadership succession is through utilisation of M&A. Many of these companies possess high or unique technologies, manufacturing capabilities and other know-how, and their liquidation or cessation of business would present a loss to the Japanese economy and Japanese society as a whole. Sensing the opportunity, many larger companies and investment funds, both foreign and domestic, have been making strategic investments in these companies.
 
As the global and domestic economic environment is constantly changing, business succession and exit plans should ideally be revisited on a regular basis. Succession and exit plans should also be dynamic and adaptive to changing circumstances.

In your jurisdiction, how can the regulations surrounding M&A transactions be improved?

The best and most direct way of improving regulations surrounding M&A is through legislative changes. In Japan, however, laws surrounding M&A – such as the Companies Act and the Financial Instruments and Exchange Act – have not undergone regular, significant revisions from the prospective of enhancing M&A practices. Instead, the Japanese government has sought to make improvements to the conduct of M&A and promote increased M&A activity through advisories and guidelines (issued by METI or some other ministry or government agency) that technically have no legally binding effect.
 
Another way by which M&A regulation can be improved is though judicial precedents. With that said, judicial precedents may not always be helpful in providing certainty in M&A deals. One example is the recent case involving COSMO ENERGY HOLDINGS Co., Ltd., one of the largest oil refiners in Japan. Due to a difference of opinion between the company’s management and a prominent activist shareholder of the company, the management decided to implement a restricted issuance of stock acquisition rights that excluded the activist shareholder in order to dilute his shareholding. For purposes of obtaining approval for the proposed issuance of stock acquisition rights, a shareholders’ meeting was held without the presence of that shareholder in June 2023. However, as current legislation does not expressly permit shareholder meetings under so-called “majority of minority” conditions, the activist shareholder is challenging the validity of the shareholders’ approval that had been obtained for the issuance of stock acquisition rights. It is unclear whether court proceedings will be initiated in this case and, if this matter is litigated, how courts will rule. Since court decisions in matters of this kind will likely be adjudged on a case-by-case basis, time will be needed for the accumulation of sufficient judicial precedents to provide more clarity on where the courts stand in respect of certain M&A practices.
 
Shigeki Tatsuno is a partner at Anderson Mori & Tomotsune and specializes in the area of mergers and acquisitions, joint ventures, and cross-border investments in every field, including life-science sector.  Mr. Tatsuno has extensive experience in advising venture companies and advising on PE funds. He also provides advice to foreign and domestic clients on intellectual property issues/transactions and general corporate matters.  He has served as a member of the Human Research Ethics Review Committee of Graduate School of Pharmaceutical Sciences, Faculty of Pharmaceutical Sciences, the University of Tokyo since November 2014.
 
Shigeki can be contacted on 81-3-6775-1098 or by email at shigeki.tatsuno@amt-law.com