Q&A on Mergers and Acquisitions with Shigeki Tatsuno

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

Three years of Covid, including the latest wave that swept across Japan in the summer of 2022, has sapped the vitality of many Japanese businesses. This has given rise to an ongoing trend among Japanese companies of selling their ancillary operations to focus on their core businesses.
 
These “carve-out” business divestments have attracted significant interest from both domestic and foreign investors. Coupled with the eagerness of many financially-strong companies to acquire complementary and synergistic businesses at “Covid-discounted” prices, the Japanese M&A market, which saw a significant rebound in 2021, has remained buoyant throughout 2022. Indeed, the 3,272 M&A transactions recorded in the first nine months of 2022 is the highest on record compared to corresponding periods in the past.
 
Both domestic and foreign companies and private equity funds have been very active this year as they continue to seek out growth opportunities in Japan.
 
Some of these acquisitions of carved-out businesses are significant in size, including Hitachi Ltd.’s acquisition of GlobalLogic Inc. for USD8.9 billion.
 
How has the COVID-19 pandemic impacted the M&A landscape?
 
As noted above, the volume of M&A activities in Japan is generally on an uptrend, despite, or perhaps because of, the outbreak of Covid-19.
 
Another factor driving M&A in Japan is the need for business digitalization. The Japanese government has long recognized the need to embrace technology as part of its efforts to enhance Japan’s digital competitiveness. The Covid-19 pandemic has had the effect of driving home the urgency of achieving greater digitalization in commerce. To finance the costs of digitalization, 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.
 
What about the war in Ukraine, the energy crises, rapid rise in inflation rates and looming possibility of a global recession. How have these already impacted decision making and strategies, and what new trends do you expect to emerge as a result of these factors?
 
There is no doubt that the impact of these global developments are being felt in Japan. Although the rate of inflation in Japan has not been as high as those witnessed in North America and some parts of Europe, the recent rise in core consumer prices, coupled with the fall in the value of the Japanese Yen to 30-year or so lows, has significantly shrunk the purchasing power of many Japanese. The inability of salaries to keep pace with price increases has further exacerbated the problem for many Japanese consumers. As a result, businesses operating on the business-to-consumer (“B2C”) model have been adversely affected. Because of this, some B2C businesses are now strongly motivated to turn to M&A to reduce their operating costs, realize greater economies of scale and generally achieve better business rationalization. As a consequence, M&A activity in the B2C sphere in Japan is expected to increase.

Which industries or jurisdictions currently provide the best opportunities?
 
With the shrinking and aging 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.
 
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 for unsuccessful integration of the target into the acquirer group, due to failure to recognize 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 familiarize 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.
 
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 familiarize 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 maximization 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.
 
What are the benefits to implementing a business succession and exit plan and when/how often should it be revisited?
 
There are many privately- or family-owned businesses, including mid-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 utilization 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.
 
What are the most common disputes in cross-border transactions?
 
Cross-border M&A disputes in Japan often arise from breach of representations and warranties, whether as a result of inaccuracy in the target's financial statements, the seller's failure to disclose material documents or information, or other reasons.
 
Disputes about purchase price adjustments mechanisms are also relatively common, particularly in respect of earn-out calculations. This is because earn-outs are typically dependent on future developments, whether in respect of the target company or economic conditions at large, and as such, it is often difficult to devise a formula that produces an earn-out figure mutually acceptable to buyers and sellers.
 
Transactions using short-form agreements with general provisions, sometimes preferred by Japanese parties, also give rise to a higher likelihood of disputes about the interpretation of matters not expressly provided for in the agreements.

Currently, what are the biggest stumbling blocks to closing transactions?
 
Labour issues frequently pose a challenge to foreign investors in Japan. Japanese labour law prohibits the unilateral dismissal of employees unless such dismissal is, among other factors, “objectively justifiable”. The standard for proving objective justification is, however, quite high. As a result, it is extremely difficult for any employer in Japan to unilaterally terminate an employment contract. Foreign investors with the intention of undertaking pre/post-merger integration that involves a reduction in Japanese employee headcount should accordingly bear this in mind. One way of counteracting this problem is to consider negotiating for the seller to take responsibility both for the reduction of headcount before completion and for any subsequent claims that may be mounted by retrenched workers.

What areas are regulators currently focusing their efforts?
 
One area in which regulators are focusing their attention is the fintech arena. As new technologies are being unveiled around the world almost on a daily basis, regulators generally have difficulty keeping up with the latest fintech trends and innovations. With that said, a key concern for regulators in Japan, particularly the Financial Services Agency of Japan, is the protection of consumers. Accordingly, the legal framework in Japan concerning fintech, such as the Payments Services Act and its related regulations, has undergone frequent updates and changes in recent years to increase the level of protection afforded to consumers.
 
Additionally, regulators are also showing greater interest in issues related to the usage of personal data, as businesses increasingly use personal data for economic gain, such as for purposes of delivering targeted advertisements. The growing value of personal data, however, also brings with it increased risk of personal data infringement and, sometimes, significant issues associated with large-scale personal data leakages or breaches. Accordingly, regulators are now examining the ways in which personal data laws can be strengthened to prevent such leakages or breaches.
 
The issue of personal data is also relevant in the context of merger control. Under Japanese law, merger filing is required if certain turnover thresholds are crossed. Considering the value of personal data, however, turnover thresholds are sometimes insufficient for substantive merger control. Being aware of this, regulators in Japan are also increasingly focusing on the concept of M&A consideration, which represents enterprise value (including the value of retained data), when determining whether an M&A transaction would have any substantive adverse impact on competition. 

Shigeki Tatsuno has a thorough knowledge in M&A, Joint Venture and cross-border transactions. In addition, he regularly advises a number of venture companies and PE funds, and engages in general corporate matters, including IP transactions, broadly.

Shigeki can be contacted on +81-3-6775-1098 or by email at shigeki.tatsuno@amt-law.com