12 -14 February 2003 - United Nations Conference Center, Bangkok, Thailand

By Andrew Thorson, Partner, DORSEY & WHITNEY LLP (Tokyo Office)

Changes in the world and Japanese domestic economy have resulted in increased opportunities, not only for large but also for small and mid-sized foreign companies seeking financial and strategic opportunities in Japan. Foreign investors, once scared off by linguistic and cultural barriers, the high cost of doing business and a lack of market access, are now taking a second look.

Distressed assets and strategic tie-ups are hot. In the wake of Japan’s so-called “Big Bang” financial reforms, investment barriers are slowly loosing ground to market realities. Nonetheless, closing cross-border acquisitions in Japan is not easy. Foreign investors must understand the local dynamics. Here are some tips they should keep in mind:

Find the right advisors. Japan has a rich and complex business environment embracing both traditional and modern aspects of business culture. As the sophistication level of M&A has risen in Japan, so has the importance of in-depth experience with sophisticated structures and transactions. More importantly, taking advantage of recent deregulation and newly opened doors for state of the art transactions in Japan demands that the acquisition team and its advisors have in-depth experience utilizing cutting edge tools.

Examples of such opportunities include recently adopted laws facilitating M&A techniques such as MBO’s and the “new shares reservation right” (shinkabu-yoyakuken) which has a function similar to that of an option. To name only a few of the other significant advances, the Japanese Commercial Code has been revised to: permit a two-tier governance structure similar to the U.S. model comprised of directors and officers; prescribe stock-for-stock acquisitions; and relax burdensome restrictions on contributions-in-kind, stock options and the issuance of preferred and other types of stock. Most notably, Japan has also enacted a new Civil Rehabilitation Law, which can expedite the restructuring of debt-ridden companies. Recent changes in accounting rules are also anticipated to facilitate cross-border acquisitions.

This new environment provides opportunities for foreign investors to engage in creative strategic and financial investments. Optimizing the acquisition possibilities requires a team, which is equipped to think outside the traditional box in Japan. Unfortunately, such professional advisors in Japan are not inexpensive, and there is a shortage of qualified, experienced and bilingual service providers. Accordingly, it is important for small to mid-sized investors to consider potential transaction costs in the planning stages.

Communicate on a business level. It is said that Japanese executives prefer to do business with people that they know. During business negotiations, the Japanese negotiating team will often try to establish direct personal ties with foreign counterparts. If foreign negotiators fail to engage in effective personal interaction, Japanese counterparts might doubt their sincerity. Worse, they may be reluctant to provide frank information to the acquiring company.

In addition, Japanese companies also tend to rely less on outside attorneys and advisors. As a result, phrases like “our attorneys” or “our advisors will be contacting you regarding this” are heard less often. The hurdles to closing a deal are often overcome without lawyers present in a less formal setting outside of the conference room. In practice, deal-killer issues are often resolved informally by smaller groups over a discrete dinner or whisky and water.

Effective communications requires establishing personal ties at not only the executive, but also the managerial and operations levels. There is no substitute for an acquisition team, which can expedite person-to-person contacts with, and learn first-hand knowledge from, the target company itself. This is one aspect of doing business in Japan in which small to mid-sized companies that have a "hands on" management might find they have a natural advantage.

Keep concepts simple. Japanese executives often disdain complex, legalistic proposals. Instead, one often hears Japanese executives’ state “we should work things out together as Japanese do.” Typically, this requires compromises together with a deference to trust and pre-existing relationships.

The emphasis in Japan on informality and simplicity in cross-border M&A arises from both practical and cultural causes. On the practical side the parties often negotiate in English. Like international executives from most countries, many high level Japanese businesspeople are fluent in English. However, negotiations are more manageable when the documentation and proposals are in “plain English” and do not include convoluted provisions and concepts. Quite often the Japanese team faces a greater disadvantage than might the typical European or American negotiators when having to deal in the English language.

More than likely, the transaction will be reviewed at various levels by senior executives within the Japanese corporation. These executives may be unfamiliar with and even suspicious of Western ways of dealing. And it is quite likely that they will be unfamiliar with the mechanics of Western-style mergers and acquisitions. Senior Japanese executives are more likely to okay a transaction if it is as straightforward as possible.

Understand the dynamics of your counterpart. Some Japanese companies are trying to encourage greater flexibility in decision-making. But many large Japanese companies still operate under a burdensome managerial hierarchy. While Western companies give mid-level executives discretion to negotiate deals based on their independent judgment, Japanese negotiators may be expressly or implicitly required to consult closely on minute details with senior executives before accepting any proposal.
Negotiating in this environment is usually challenging for Western executives. In addition to patience, a few simple techniques may minimize frustration.

Western negotiators should put their proposals on the table early to allow a timely response by their Japanese counterparts. Western negotiators also should avoid surprises. That will help their Japanese counterparts, who must achieve consensus among senior executives. Reaching a new consensus often requires time. Worse yet, going back to the executives provides them an opportunity to raise additional new issues.

For the reasons above, the Japanese negotiating team itself may also seek to minimize the involvement of its executive decision-makers. This urge to avoid senior executives may lead Japanese negotiators to reject even reasonable requests out of hand. Surprises can kill a deal.

On the contrary, it is not uncommon for a Japanese negotiating team to raise untimely last minute demands based upon suggestions by executives who have not been involved in the transaction to date, but who also cannot be ignored once they become involved. Sometimes Western negotiators misinterpret these untimely proposals as a bad faith change in the deal terms. Quite often it is simply a matter of poor management of the negotiating process.

Understanding the source of a counterpart’s reactions to proposals and untimely demands requires patience. It is also an essential requirement for determining appropriate responses.

Understand the inter-company relationships. In Japan, companies in certain industries often form a tight web of relations with affiliates, customers and suppliers. Such networks are loosely referred to as “keiretsu.” In cases where suppliers and customers own stakes in each other’s companies, these ties are obvious. But companies often maintain less obvious ties by sharing technology, production and management. Inter-company debt guarantees are also common.

Commonly, ongoing transactions and other important relationships within networks are poorly documented or not documented at all. Nevertheless, investors should strive to evaluate and clearly understand these relationships and the inherent liabilities early in the acquisition process. Otherwise, foreign investors may learn about such issues only at the last minute when closing appears inevitable. Such untimely disclosures do not necessarily indicate bad faith. Often, it reflects the complex nature of the Japanese keiretsu. Even the target company itself might fail to understand or appreciate the impact of keiretsu relationships on the proposed deal.

Accordingly, early clarification of these relationships is absolutely crucial. Investors must confirm transactions that are not at arms length, insider deals, and inter-company guarantees, etc.

Unfortunately, Japanese companies also provide notoriously conservative and vague disclosures. To avoid misunderstanding and stonewalling later, investors should consider walking the target company’s management through due diligence requirements in the planning stage. Management interviews are also an important means for understanding the target company and for finding any hidden “land mines” not disclosed in documentation.

Japan is truly a complex blend of the traditional and modern and often defies Western attempts to fully understand it. Nevertheless, the right team and knowledge of the basics can help ensure that valuable transaction time is not wasted and that deals that should have happened are not lost. Hopefully, this article has offered a useful guide, but these are only generalizations. Each situation must be evaluated first-hand by qualified individuals with extensive knowledge of Japanese language, culture and business environment.