This document provides an explanation of the investment risks inherent in venture funds that should be particularly noted.
When investing in individual venture funds, please do so at your own risk after properly reading the disclosure documents for said venture funds.
Risks That May Arise due to the Profit Structure of Venture Funds
In no event is there any guarantee as to whether or not any distribution or the amount of such distribution will be made to investor.
The income of venture funds is dependent on dividends from investees (income gain) and profit on sales of investee's equity (capital gain).In this respect, venture funds are not products that can expect constant dividends, as they are designed to recover the invested funds when the investee goes public or engages in M&A. In other words, there is no guarantee that the investor will be able to receive continuous dividends for the venture fund, as investees of venture funds often have weak financial and business foundations, and their earnings are often unstable due to minimal sales or no sales at all. Therefore, there is no guarantee that venture funds will receive continuous dividends, and (unlike REITs and infrastructure funds) there is no guarantee of stable cash flow to the venture fund.In addition, the purchase and sale of investee interests are generally conducted through negotiated relative transactions between the parties involved, and since liquidity is low, transaction terms tend to fluctuate significantly depending on the intentions of the parties involved, and it may also take an unexpected amount of time before a sale can be made.Even if the investee of a venture fund goes public or engages in M&A, there is no guarantee that the expected profit on sale will exceed the investment cost.
In addition, a venture fund can make a distribution in excess of earnings when it has accumulated losses that do not involve an outflow of cash, such as when it has accumulated impairment losses on securities.
However, since distributions in excess of earnings are accompanied by an outflow of cash reserves, there is a possibility that the necessary cash reserves will be insufficient when dealing with unforeseen circumstances or when trying to make new investments, etc., and this may be a cause of restrictions on the management of the venture fund.Furthermore, the distribution in excess of profit is a refund of investment paid out of the net assets of the venture fund, and the total amount of assets and net assets of the venture fund will decrease as a result of this distribution.As a result, the size of the venture fund will be reduced, which may adversely affect the financial condition and viability of the venture fund.
Risk That Expansion of Asset Size Will Not Proceed as Expected
In expanding the asset size of the venture fund, it is expected that the venture fund will receive a certain amount of support from the sponsor in finding new investment opportunities.
However, there is no guarantee that the sponsor will be able to continuously find companies to newly invest in for the venture fund, and the number of companies that could be considered for investments for the venture fund may decrease due to deterioration in the market environment.
The investee itself is an entity independent from the sponsor, and the sponsor cannot grant the venture fund preferential negotiation rights, etc. for the acquisition of the investee's equity to the venture fund, except in cases where the sponsor transfers its equity in the investee to the venture fund.
Furthermore, because the investment by the venture fund in the investee is made based on negotiations on a relative basis with the investee or the holder of the interest in the investee, there is no guarantee that the venture fund will acquire the interest in the investee at an appropriate time and at an appropriate price that the venture fund determines to be appropriate.
Therefore, unlike REITs and infrastructure funds, where the process of asset scale expansion (i.e., the sponsor develops properties and the fund acquires such properties (upon acquisition, preferential negotiation rights are expected to be granted as part of sponsor support)) is relatively predictable, venture funds may not be able to smoothly build up their portfolios.
Risks Associated With Borrowing and Issuing Investment Corporation Bonds
A venture fund may borrow cash or issue investment corporation bonds if certain matters are stipulated in its articles of incorporation or similar documents.
However, venture funds plan to recover invested funds when investees go public or conduct M&A, etc., and since stable cash flow is not expected, the amount of net assets may decrease due to interest and other payments.
Risks Related to Dependence on the Sponsor Group for Human Resources, etc. and Conflicts of Interest
The sponsor of a venture fund may find and introduce investees for the venture fund, provide management support for such investees, etc., and is also expected to dispatch personnel to the venture fund's asset management company.In addition, they are also expected to be involved in the timing of the listing or M&A exits of venture fund investee companies. Therefore, it can be said that the sponsor has a lot of influence on the growth potential of the venture fund.
Therefore, if the venture fund and its asset management company are unable to maintain a good relationship with the sponsor, if the positioning of the venture fund in the sponsor changes due to changes in the sponsor's business policy, etc., If the sponsor's know-how, reputation, brand power, etc. declines, or if the sponsor's business performance or financial condition deteriorates, the venture fund may be adversely affected.
In addition, the know-how, reputation, and brand power, etc. of the sponsor are largely dependent on the sponsor's human resources. Therefore, in the event of a significant decline in the ability of such personnel or the loss of such personnel by the sponsor, etc., the know-how, reputation, brand power, etc. of the sponsor may decline and the venture fund may be adversely affected.Also, upon receiving such support, it is expected that transactions will take place between the venture fund and its asset management company and sponsor (or its group company).If the sponsor (or its group company) falls under the category of parent corporation, etc. (Article 31-4, Paragraph 3 of the Financial Instruments and Exchange Act, Article 15-16, Paragraph 1 of the Order for Enforcement of the Financial Instruments and Exchange Act) of the asset management company of the venture fund, the said asset management company is prohibited from conducting transactions that are unnecessary for the venture fund for the purpose of benefiting the parent corporation, etc. (Article 44-3, Paragraph 1, Item 3 of the Financial Instruments and Exchange Act). In the event that a transaction is conducted in violation of these codes of conduct and harms the interests of the venture fund, there is a possibility that investors will suffer damages.In addition, if the sponsor is not prohibited from conducting business that competes with the venture fund, the possibility of business competition between the venture fund or its asset management company and the sponsor, or other situations where conflicts of interest may become an issue, is high.
Risk of Dependence on the Personnel of the Venture Fund's Board of Directors and its Asset Management Company.
The operation of the venture fund relies heavily on the personnel of the venture fund's directors and its asset management company, and the loss of these personnel could have a negative impact on the operation of the venture fund.
In particular, the investees of venture funds are subject to significant investment risks, and careful consideration must be given when selecting investees. In addition, even after an investment by a venture fund, the asset management company of the venture fund is expected to provide various types of support to the investee to promote the growth of the investee.
For such efforts to be successful, it is essential to secure and maintain personnel with broad knowledge of the industries in which the venture fund invests and expertise in the management of the investment business. If the asset management company of the venture fund is unable to secure and maintain sufficient human resources with such competence, the maintenance and expansion of the venture fund's investment scale and investment growth may be adversely affected.
Risks Associated with Investments Without Control
In relation to the conduit requirements, venture funds are required not to own more than 50% of the shares/stocks or capital contributions of other corporations (including investments in silent partnerships, excluding certain overseas subsidiaries) (Article 67-15, Paragraph 1, Item 2 (f) of the Act on Special Measures Concerning Taxation).
As a result, the venture fund may not be able to make a controlling investment in the investee, and its ability to protect its interest and influence the management of the investee is expected to be limited. In such cases, the growth of the investee is highly dependent on the ability of the management (which may include members who have competing interests with the venture fund) of the investee or the intention and ability of the parent company, etc. (if any), which has a controlling interest in the investee. (There may be conflicts of interest with the venture fund.)
Risk of Concentrating Investments in Specific Companies
In accordance with the Securities Listing Regulations of the Tokyo Stock Exchange (TSE), a venture fund may not invest more than 10% of its net assets in a specified security at the time of acquisition (however, it may invest up to 15% of its net assets in unlisted equities or unlisted equity-related assets (“Unlisted equities” mean “unlisted stocks, etc.” defined in Item 16 of Rule 1201 of the Securities Listing Regulations and “unlisted equity-related assets” mean unlisted stocks, etc.-related assets defined in Item 17 of Rule 1201 of the Securities Listing Regulations).Unlike investment vehicles, which are expected to find one or two specific companies to invest in and then acquire those companies in order to recover the investment, the investment vehicles are expected to reduce risk to a certain extent by diversifying the investment portfolio.However, it is not easy to find a large number of companies to invest in that meet the qualifications for investing in a short period of time, and there is a possibility that the number of companies to invest in will be concentrated within the limits mentioned above, at least during the initial period of operation.
In such cases, it can be said that the degree of dependence on individual investees is large in relation to the total income of the venture fund's assets under management.Therefore, if the income of individual investees were to significantly decrease or disappear, or if the corporate value of investees were to be significantly damaged or disappear, as described in "Risks Associated With Large Fluctuations in the Corporate Value of Investees" below, there may be a significant impact on the venture fund's profit, etc.
Risks Associated With Dispatching Directors to Investees
The asset management company of a venture fund may dispatch its directors to work as employees at the investee of the venture fund in order to improve its corporate value.However, in the event that a claim for damages, etc. is filed against the individual director for negligence of their duties at the investee, the asset manager may bear all or part of the economic loss incurred by the individual, or the asset manager's employer's liability or social credibility may be damaged, which may adversely affect the performance and financial position of the asset manager.
Risks Associated With the Lack of Accuracy, Truthfulness, Completeness, and Sufficiency of Information Used to Form the Basis of Investment Decisions
In many cases, venture fund investees are not subject to disclosure regulations under the Financial Instruments and Exchange Act. In general, the information that can be obtained when making investment decisions is more limited than for listed companies, and the accuracy, truthfulness, comprehensiveness, and sufficiency of the information cannot be guaranteed.
Because there are situations in which investment decisions must be made based on such limited information, there is no guarantee that the venture fund will achieve the investment results originally envisioned.
Risks Associated With Prolonged Investments
Since it usually takes a long period of time before an investee goes public or its equity is sold to a third party, the corporate value of the investee may differ from initial estimates due to deterioration in business performance or other factors during the process.In addition, the profitability of an investment may differ from initial estimates due to external factors such as the economic environment and trends in the stock market.
Risks Concerning Liquidity of Portfolios
It is assumed that there is no secondary market for the equity interest in the investee of the venture fund, and liquidity concerning the realization of the investment will be low, and there is a possibility that the investment will not be realized at an appropriate market price or at an appropriate time. In particular, as described in “Risks Associated with Investments Without Control” above, since the equity interest in the investee held by the venture fund is less than 50% of the total equity interest in the investee, liquidity is expected to be even lower than if the entire equity interest in the investee were sold. In addition, it is possible that the venture fund may have agreed with other equity holders of the investee that there are restrictions on the sale of the investee's equity interest, in which case, the venture fund would also be subject to such restrictions.
Also, if the venture fund transfers its interest in the investee to a third party, the venture fund may be requested to make representations and warranties regarding the business and financial condition of the investee.If such representations and warranties are untrue, the venture fund may be liable for damages to the transferee.
Even if the venture fund's investee's interests are listed, if the market size or trading volume for such interests is small, the venture fund may only be able to sell them at a price below what would be expected based on prevailing market conditions in order to not miss a sale opportunity.
Risks Associated With Large Fluctuations in the Corporate Value of Investees
Venture fund investees often have weak financial and business foundations, and their earnings are not stable due to no or minimal sales, and there are high risks and uncertainties associated with the possibility of bankruptcy, financial instability, limited human and management resources, and limited research and development capabilities, all of which contribute to the high degree of risk associated with the investment.In particular, it is not easy to determine the potential value of a business of a seed-stage (preparatory stage for launching a business) or early-stage (launching a business) investee, and investments in such investees are particularly uncertain.
In addition, the business activities of investees of venture funds may be affected by increasing political, social, or military tensions in certain regions, such as conflicts and terrorism; the global spread of infectious diseases and epidemics, such as SARS (severe acute respiratory syndrome), MERS (Middle East respiratory syndrome), and pneumonia caused by COVID-19 (novel coronavirus infection), and other infectious diseases and epidemics.Furthermore, changes in the regulatory environment related to the investee may prevent its business activities from developing as expected, and rapid changes in the industry environment to which the investee belongs may render the technology and business model of the investee obsolete at an early stage. In addition, the industry sector itself may decline for whatever reason. Also, the industry environment and competitive conditions in which the investee's customers operate may also have an impact on the company's business.
The above factors may have an adverse effect on the venture fund's revenue.
Risks Associated With the Difficulty in Predicting the Sale of the Investee's Shares at the Time of Listing.
Although the venture fund expects to recoup its investment primarily by selling its stake in the investee at the time of listing, it may not always be able to earn the expected capital gains because the recovery of the invested funds is affected by the stock market environment at the time of the investee's stock listing and thereafter.
Even if an investee goes public, the relevant rules of the respective exchange or the contract with the investee may restrict sales for a certain period of time after listing, which may prevent the sale of the investee's interest for a considerable period of time and cause the investee to miss the most appropriate time to sell.
Risks Associated With Competition From Other Investment Funds and Other Funds Investing in Unlisted Companies
In recent years, a number of investment funds have been established for the purpose of investing in private equity companies, and the business of investing in private equity companies has become increasingly competitive.In an intensely competitive environment, if a venture fund cannot offer investors more attractive terms and conditions than other investment funds, it may not be able to raise the necessary funds and may not be able to make the investments it intends to make.
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