Over the past 5 years or so, there has been a flood of Japanese corporates setting up startup engagement programs such as accelerators, venture capital arms, and offices with some variation of the phrase “open innovation” or “digital transformation.” While I welcome the interest in startups, sometimes I worry that many corporates can’t see the forest for the trees.
Presumably, they set up these programs with the intention of discovering new business lines or “synergies” with their existing ones. However, somewhere along the line, they get caught up in the short term execution of these programs without focusing on the long term goals. They set up an accelerator because everyone else set up an accelerator. They started investing in startups because everyone else was investing in startups. They set up innovation offices because…. everyone else was. They executed all of these programs flawlessly, but in the midst of this herd mentality, they lost sight of why these programs exist in the first place.
These programs exist to create a pipeline for high impact, tangible strategic moves for the company. In a lot of cases that could mean partnerships, but I believe the true high impact moves are through M&A. Acquiring a company that could become the next major business line is ultimately the most impactful move.
While M&A has increased during this startup boom, the number of those that were startups and their scale is still relatively small. In September, Bloomberg ran an article pointing out that firms listed in Japan held ¥506.4 trillion, the highest level on record. Considering that Japanese firms are sitting on mountains of cash, there is still so much more that can be done.
That said, acquiring a company can be daunting. Most acquisitions will be failures. That is okay. Corporate executives should look at M&A through the lens of a venture capitalist. While most of the investments will be unfruitful, there may be a few outliers that become home runs. Facebook acquired Instagram for $1 billion. The value is now estimated to be around $100 billion, representing a 100x return. Google acquired YouTube for $1.65 billion. With 2 billion monthly active users, it is probably worth something similar. Both of these acquisitions were ridiculed at the time but turned out to be pretty good bets.
Note that Facebook and Google also happen to be two of the most active startup acquirers. Most of their acquisitions failed, but it is the Instagrams and the Youtubes that made up for all of those failures, and then some. In order to find the winning bets, corporate executives have to invest like venture capitalists and be comfortable with the downside risks.
They should also consider that the level of risk decreases with stage. If they acquire a seed stage company, while the price may appear cheap, the probability of that acquisition being a failure is high. As a startup progresses through stages, the risk decreases but the corresponding price increases. This may seem obvious but I mention it for a reason. In Japan, executives can be receptive to small acquisitions under JPY 5 billion (~$46m), but once startup valuations pass this threshold it is decidedly “too expensive.” Price is relative. If a startup is sufficiently de-risked and a corporate has the resources and a viable case to make a larger acquisition, it should.
I am obviously biased. As a venture capitalist, it is in my favor for Japanese corporates to make more acquisitions. However, it is also in their favor if they do it right. I commend them for setting up all these programs to work with startups, but in order to capitalize on all these initiatives, they will need to make bigger, bolder moves. Going to a demo day is fun, but it won’t move the needle. It creates the illusion of progress, when the real progress comes from making the hard decisions. Acquisitions are hard, and most will fail. But among those bets there may be gems that will impact the company for decades.