An expert discussion on mergers & acquisitions in Japan with Shigeki Tatsuno

Shigeki Tatsuno is a partner at Anderson Mori & Tomotsune and specialises 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 private equity 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.
 
Have there been any recent regulatory changes or interesting developments?
 
On 3 December 2019, a proposal for certain key revisions to the Companies Act (the “Revisions”) were passed at the Japanese Diet. Save for certain items, the Revisions are expected to come into effect on 1 March 2021. The Revisions introduced (among others) the following changes to the Companies Act:

Revision of rules concerning shareholders’ meetings and proposals
 
Companies are now permitted to provide shareholder meeting materials to shareholders through electronic or magnetic means without the need for shareholders’ consent, if certain conditions are met. The Revisions also restrict the number of proposals a shareholder may table at general meetings, to prevent shareholders from abusing their rights.

Revisions concerning directors
 
Pursuant to the Revisions, the Companies Act now facilitates proper incentivisation of directors, while enhancing disclosure of such remuneration. Specifically, the Revisions have made it easier to include stock grants in a director’s remuneration, while requiring directors to explain the company’s remuneration policy for directors at shareholders’ meetings. Companies are now also permitted to indemnify their directors for damages suffered in the course of performing their duties, and to insure their directors against such damages. Additionally, the circumstances under which outside directors will be appointed have been broadened.

Introduction of share delivery system
 
A “share delivery” transaction structure has been introduced under the Revisions to facilitate corporate acquisitions by way of stock exchanges in Japan. Share delivery, in essence, is a scheme in which a Japanese stock corporation (the “Acquirer”) acquires stocks in another domestic stock corporation (the “Target”), as a result of which the Target becomes the Acquirer’s subsidiary, and pays its own stocks to the Target’s stockholders as consideration.
 
Although other stock-for-stock acquisitions schemes are available under Japanese law, the share delivery scheme has the following unique characteristics:

• it involves a simple procedure relative to over-the-counter stock consideration, which requires compliance with regulations on contribution-in-kind and favourable issuance of shares as consideration; and
• it allows for partial acquisition of a target.

 
With the introduction of the share delivery scheme, there are now expectations of a marked increase in the number of stock-for-stock acquisitions.
 
Which industries or jurisdictions currently provide the best opportunities?
 
With the 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, the 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 are some new areas of concern for M&A transactions?
 
Due to the global outbreak of COVID-19, parties in M&A transactions are now paying more attention to material adverse change (“MAC”) provisions and the actual situations in which such provisions can be triggered by a buyer to avoid closing a transaction. For example, because of the COVID-19 outbreak, the Japanese government requested people self-isolate, but did not make self-isolation mandatory. Nevertheless, most households and businesses abided by the government’s request, which resulted in a significant downturn in the Japanese economy. This raises the question of whether an MAC had in fact occurred, since the self-isolation that affected the economy was voluntary in nature. Such concerns have resulted in more care in the drafting of MAC provisions in the domestic M&A transactions in Japan.
 
Another area of concern in M&A transactions is the recent rise in demand for representations and warranties (“R&W”) insurance. Usage of R&W insurance is still relatively rare in Japan, and although R&W insurance brokers can be found in Japan, they usually represent UK and European insurers rather than domestic insurers. Typically, to obtain R&W insurance from such insurers, submission of transaction agreements and due diligence reports in the English language is required. These insurers often also request English language interviews between their in-house counsels and policyholders. As the transaction agreements and due diligence reports in domestic M&A transactions are usually prepared purely in the Japanese language, adherence to these requirements can often prove burdensome and costly. Accordingly, the prevalence of R&W insurance has so far not permeated Japanese M&A transactions, except those with cross-border elements, especially where the counterparty is a UK or other European entity.
 
With the above said, Japanese insurers are gradually catching on to the growing demand for R&W insurance, particularly in the Japanese domestic M&A market; thus, 2020 has seen the offering of such insurance by some Japanese insurers. Going forward, R&W insurance is expected to become more commonly used in Japan.
 
How has the COVID-19 pandemic impacted the M&A landscape in your jurisdiction?
 
The volume of M&A activities in Japan is still generally on the rise, despite the outbreak of COVID-19. In particular, healthy companies largely unaffected by the outbreak are eager to make acquisitions to take advantage of lower prices and valuations resulting from the pandemic.
 
Another factor driving M&A in Japan is the need for business digitalisation. Japanese businesses are still slow in embracing technology, as reflected in the latest IMD World Digital Competitiveness Rankings, where Japan was ranked outside the top 20 most digitally competitive countries. With the onset of the COVID-19 pandemic, however, many Japanese companies now feel the urgency to digitalise their core businesses. To finance the costs of digitalisation, some companies have sold or are considering the sale of their non-core businesses. This in turn has contributed to the rising volume of M&A in Japan.
 
Do you expect to see any change in strategy with regards to deal targets, volume or value as a result of the mid- to long-term implications?
 
Recent global business trends, together with the onset of the pandemic, have increased the urgency for businesses to adopt digital technologies. This has roused many Japanese companies to seek out and acquire technologies and know-how that can be used to grow their businesses.
 
Some Japanese start-ups possess advanced unique technologies involving, for example, the IoT, AI and FinTech. This has made them acquisition targets by prospective acquirers hoping to leverage their know-how to enhance productivity and economic growth. The transaction values in these acquisitions are usually relatively small. This, coupled with the lower corporate valuations as a consequence of the pandemic, and the growing acceptability of hostile takeovers in Japan, have resulted in the rising number of transactions involving acquisitions of tech start-ups. This trend is expected to continue in the near- to mid-term.
 
How are acquiring parties able to effectively complete their due diligence given the restriction of movement resulting from border closures and stay-at-home orders?
 
As noted above, because of the current pandemic, the Japanese government requested people self-isolate, but did not make self-isolation mandatory. Similarly, no prohibition against domestic travel has been imposed. Accordingly, physical due diligence and site visits have by and large been unaffected as far as domestic M&A transactions are concerned. The clear global shift in recent years toward virtual due diligence has also reduced the need for on-site M&A due diligence in domestic transactions.
 
Although travel restrictions have to some extent hampered the conduct of onsite M&A due diligence in cross-border transactions, such concerns have largely also been assuaged by the availability of virtual data rooms that enable safe storage of sensitive and confidential information and documents, while providing prospective buyers with convenient access to such information and documents. Moreover, in cross-border deals where physical information gathering is necessary, acquiring parties would typically engage local counsel, who would be much better placed to conduct site visits.
 
What role do cultural incompatibilities play in cross-border M&A considerations?
 
Many M&A transactions do not close or, even if closed, ultimately fail to successfully integrate the target into the acquiring group. This is due to 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 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.
 
What strategies should be employed to identify and manage potential risks for high-profile, distressed M&A transactions?
 
There have been some (though not many) distressed M&A transactions in Japan in recent years. Typically, one of the key concerns in high-profile, distressed M&A is the reputational and branding damage that a target company may experience as a result of its insolvency, and the measures that can be taken to limit the adverse effect such damage could potentially have on the target’s future business and value.
 
To address this, target companies should narrow their search for buyers to companies that are creditworthy and reputable, and that demonstrate a clear intention to protect the target’s brand. Prospective buyers, on their part, should ensure the target’s ability to retain key customers, suppliers and other stakeholders. This would require, by extension, the retention of key executives in the target after the acquisition, as such personnel would often be critical to the target’s ability to continue cultivating relationships with important stakeholders.
 
What are the key considerations for new business integration in capability-driven deals?
 
An important consideration in such deals is the retention of key persons, whether in managerial or technical areas. For example, in transactions driven by a target’s technological capabilities, retention of principal officers and employees, such as chief technical officers and high-performing R&D staff, would be crucial to the target’s continued ability to generate value.
 
It is also vital for an acquirer to respect the target’s culture rather than to impose the buyer’s culture wholesale on the target, or to make tectonic changes to the target’s manner of operation for the mere sake of change. Instead, changes to the target should be made with the aim of enhancing its capabilities, and for purposes of leveraging such capabilities to achieve greater synergy with the acquirer.
 
Can you talk us through the key steps to developing a business succession plan?
 
Business succession plans are particularly relevant to family-owned small- to mid-sized firms. Of primary importance in such plans is the identification of a suitable candidate to take over the reins of the company. Such candidate should be someone with experience in the relevant industry and the ability to run and grow the company’s business. Provisions should also be made for the company to have sufficient cash flow to ensure its survival in unforeseen circumstances. This would include taking into consideration the prohibitively high inheritance tax rates in Japan, which have sometimes forced business owners to sell their companies instead of passing them on to posterity. Last but not least, the departing leadership should inform the relevant stakeholders (including customers, suppliers, bankers, contractual counterparties, employees, and even family members) well in advance of the business succession, to ensure that the incoming leadership will continue to have their support.
 
What key trends do you expect to see over the coming year and in an ideal world what would you like to see implemented or changed?
 
The trend toward a global digital economy is expected to continue. Shortly after Mr Yoshihide Suga took over as Prime Minister of Japan in September 2020, he declared the embracement of digitalisation as one of the priorities in his agenda for reform. In line with this, he has set the process in place for the establishment of a digital agency to digitalise governmental agencies by next year, followed by the digitalisation of Japanese society more generally. With office and logistics management currently undergoing digital transformation around the world, and the higher priority consumers are now placing on data privacy and appropriate use of personal data, the need for digital data management technology is also on the rise. These developments, together with the increasing recognition of personal data as a valuable business resource, are expected to translate into more M&A transactions in the areas of technology and data digitalisation in the foreseeable future.
 
Shigeki Tatsuno – Partner (Corporate/M&A/IP)
Anderson Mori & Tomotsune
Address: Otemachi Park Building
1-1-1 Otemachi, Chiyoda-ku, Tokyo 100-8136, Japan
E: shigeki.tatsuno@amt-law.com
T: 81-3-6775-1098
F: 81-3-6775-2098