MPower Partners

Sep 21

Japan's first ESG venture capital fund

By C Bryan Jones

Japan has incredible potential to support innovative startups and for strong economic growth. Yet it continues to fall short compared with the United States and many other countries. Why is this? What can be done to turn the tide, energize business, and bring greater diversity and opportunity to the country?

These questions and more were addressed on July 19, when the American Chamber of Commerce in Japan welcomed Kathy Matsui, Yumiko Murakami, and Miwa Seki, the co-founders of MPower Partners, Japan’s first global venture capital (VC) fund focused on environmental, social, and governance (ESG) criteria. Managing Director Eriko Suzuki joined the three general partners for the virtual event co-hosted by the Women in Business, Alternative Investment, Sustainability, and Kansai Diversity and Inclusion Committees.

Launched in June, MPower is on a mission to empower startups that are providing tech-enabled solutions to societal challenges and to drive sustainable growth through ESG integration.

During the enlightening panel discussion, moderated by Association of Women in Finance President Yuki Hasegawa, the general partners and managing director covered a wide range of topics, including the challenges facing women founders, the importance of diversity on boards, why Japan is falling short of its potential, and why MPower has chosen to focus on startups rather than larger established companies.

Idiosyncrasies

The session began with Hasegawa asking how Japan differs from other countries when it comes to economic potential and ESG.

Murakami explained that, during her eight years with the Organisation for Economic Co-operation and Development (OECD), where she was head of the OECD Tokyo Centre, she worked with a number of interesting data sets which helped her see common elements in different scenarios that lead to economic growth.

“You need to have people who are well educated, you need to have money to invest, and you need to have very good social infrastructure as well as general stability in the society,” she noted, adding that a high level of technology is key.

“When you look at a lot of the data points around those metrics, Japan does extremely well. It is one of the best countries, which has all the elements necessary [in order] to have very strong economic conditions.

“Yet, Japan has not done all that well—especially over the past 20–30 years—relative to the United States and countries in Europe or even Asia,” she said.

The lack of diversity and the aging of society are also great opportunities for companies—and for us as well—to bring diversity to the table.

This left Murakami wondering what is missing in Japan.

“You’ve got all of these great things—people, technology, money, a very stable social and political environment—and realizing this was actually one of the triggers where I started to think, what can I do? What can we do to change that?”

Matsui expanded on this.

“At least for me, I felt the sense of urgency. There was so much potential, but the situation, or the conditions, in this country didn’t feel urgent enough,’’ said the former vice-chair and chief Japan equity strategist at Goldman Sachs Japan. She retired from the company at the end of 2020 to start MPower.

“We know that Japan needs innovation. We know that Japan needs to leverage its human capital. We know that there’s ¥2,000 trillion in cash sitting under futons. So, who’s going to make that change? Who’s going to start that progress?” she asked. “We are, perhaps, one small grain of salt in this vast landscape, but what is it that we can bring to this dialogue from our own experiences and, frankly, what do we want to do with the next chapter of our lives? That’s what prompted this whole idea generation.”

Diversity also played a key role in the genesis of MPower, added Seki, an associate professor at Kyorin University who spent more than 20 years at Morgan Stanley and Clay Finlay. This is something that she, Matsui, and Murakami felt was lacking in Japan which they could bring to the table to help address the lack of global perspective that sometimes hampers Japan’s growth.

Personal Stories

While the struggle of women founders to find equal footing with men remains a serious issue in 2021, Murakami shared the inspiring story of her mother’s entrepreneurial spirit and success three decades ago.

A housewife until age 47, she opened her first “tiny little drugstore” as she neared 50. The shop did very well, so she opened another, and another. Soon she was running the largest drugstore chain in western Japan.

“She was the only woman in this business, and no one else was like her, which really helped her in terms of understanding the marketplace and where opportunities were,” Murakami explained. “This is going back to the 1990s. Japan was starting to have this demographic crisis, but no one knew about it—except for housewives, who were taking care of their in-laws. In my hometown, [aging] was already starting to occur, but it was really not visible to anyone else—especially not to those big companies based in Tokyo. So she was able to identify this incredible opportunity basically to cater to the silver economy.”

Today, the silver economy—products and services designed to meet the needs of people aged 60 and over—is very lucrative, but at the time that Murakami’s mother was building her drugstore business no one yet knew this was going to be the case. It was a different perspective that allowed her to see things from outside. “My mother, because she was a minority in this business, was able to identify that,” Murakami said.

MPower has been developing its own framework for measuring and reporting, one better suited to VCs than to large companies

The story also highlights something that remains an obstacle 30 years later, something MPower hopes to change.

“It was really hard for her to obtain capital. Because she was a woman, because she was a housewife, she had to use my father’s name to take out loans. It was the only way for her to raise funds for her business expansion,” Murakami continued. “So, the moral of the story is, I think, opportunities like that are actually abundant. You just have to be able to look at the same opportunity or situation from a different angle and realize, oh, that is not yet addressed in terms of potential demand or needs. And I think that’s really exciting for us, because there are so many opportunities that have not been discovered. I think we can unlock some of these really interesting opportunities in the Japanese business setting.”

Focus on ESG

Moving to the foundation of MPower, Hasegawa asked about the areas on which the group would like to focus.

Suzuki, a former general partner of global VC fund Fresco Capital and former director of Mistletoe, a social impact-focused VC fund founded by Taizo Son, noted that while most people are familiar with the concept of ESG, they may not realize that it is still early days for ESG in the VC space. MPower sees this as an opportunity and is working on solutions to help startups.

“What we mean by early is there aren’t many frameworks or agreed-upon metrics to measure ESG progress within the startups and private-company space,” she explained. “We are assembling a lot of tools on our end and customizing them for each company. It differs by industry, so startups in a healthcare sector would have different metrics from a startup in a pure software and digital transformation sector. It is customized by the industry of the startup, and also slightly by stage.”

Given that startups in the early stage of development will have a different environment and probably fewer resources compared with those in later stages, MPower is focusing on mid- to late-stage companies, Suzuki said. This is because, she explained, they have a more established foundation on which to incorporate ESG principles.

Globally, ESG is becoming more important to venture capitalists, according to Suzuki. This is especially true in Europe. In the United States, while ESG is important, there has been more focus on diversity, equity, and inclusion given the social dialogue around gender and racial diversity that has been taking place there in recent years. When it comes to ESG, which parts of the acronym are most important differs by company, and some organizations may choose to focus on just one.

“Our stance, and I think this is the overall trend, is that they are all important,” Suzuki said. “But what we are seeing is that startups may not realize this. They might think, oh, we are doing something in [a particular] sector—perhaps it’s an edtech company focusing on social, the S—and we’re contributing to progress in society, so we are okay. However, investors are looking at all aspects and, once these companies go public, they will be looked up on the E and the G as well. So, we are tailoring a lot of these materiality concepts.”

Case Study

Suzuki gave as an example of MPower’s approach its investment in Japanese startup UniFa Inc., which uses the latest technologies to support safe and secure childcare environments by reducing the workload on childcare workers. The company is in the mid to late stages of its launch.

“They are growing and are on their way to becoming a public company quite soon. We have invested in them because we think they are a growing business with all the types of innovation needed in Japan. This is a childtech company that, in Japan, is selling into childcare centers—public and private—and they start out by selling sensors to prevent sudden infant death syndrome. These are high-margin, high-technology solutions. With that, they build relationships with these childcare centers and provide other forms of digital transformation tools for the back end, to enable the service providers to focus on actually taking care of the children rather than doing a lot of paperwork.”

Suzuki explained that, before MPower invests in a company, they want to make certain that the founders are interested in making ESG part of their core business. “We truly believe that incorporating ESG will grow the business and contribute to the bottom line and enterprise value.” They identified such a desire in the leaders of UniFa prior to investment, and the company is very willing to work with stakeholders on all aspects of ESG.

“In terms of next steps, we will be identifying together with the company—and the company itself will be setting—the most relevant ESG metrics that they want to follow, and we will be working with them very periodically, at least quarterly, to achieve some of these,” she said. “We understand the challenges, because startups are resource constrained but, at the same time, they need to grow two or threefold per year. So, they need to balance what types of initiatives they can take on. But we really tried to align with the company that this is not a cost but is really an investment in their growth.”

Why VC?

Given that Murakami, Seki, and Matsui have a collective background that is much more in the public equity market rather than VC, they are often asked why MPower is focusing on unlisted companies as a VC fund rather than as a public market investor. Matsui explained that it is a matter of finding the right companies with which there is a better chance of achieving ESG goals.

Noting fast-moving global trends toward more diversity on boards, she gave as an example Nasdaq, which has a woman president. A change to the requirements being proposed would mandate that a company have at least two diverse board directors to be listed on the exchange.

And such moves are not limited to the United States.

“We’ve already seen here in Japan, over the past few years, institutional investors—be it State Street Global or Goldman Sachs [in] asset management, or proxy advisors like Glass Lewis—demanding in their voting guidelines that at least one diverse board member be present—or at least be worked on—otherwise, they will cast an automatic no vote against management,” Matsui said.

She also noted that many Japanese startups with which MPower speaks say that they have a strong desire to diversify their boards and are desperately looking for candidates. So, if you are interested in becoming a board member, MPower would like to know, as they are starting to help match companies and candidates. “It’s quite different, of course, serving on the board of a startup versus that of a large publicly traded company, but we think there are a lot of amazing learning opportunities that could be had,” Matsui added.

Returning to the reason MPower is focusing on startups, she explained: “We felt that trying to change larger, established companies is quite difficult for a whole host of obvious reasons. It’s important here to recognize that we know there’s a lot of what we call greenwash risk. It’s very easy to tick boxes but much more difficult to actually implement ESG in your core business strategies.”

For MPower to achieve its goals, the founders feel that it is better to work with startups and younger companies, “maybe in their teenage phase,” as Matsui put it, to integrate ESG.

“Perhaps it’s not easy, of course, but it’s easier to integrate ESG values and principles at that younger stage of a company’s development, before they go public, before they are acquired,” she explained. “And we’ve been very positively surprised. We look at domestic Japanese startups as well as overseas startups. Maybe its selection bias, but most of the entrepreneurs we’re meeting are very keen to fix the ESG areas that they deem weak. So, we’re really positively surprised by the direction thus far.”

Fostering Change

Matsui recalled with a laugh something said to her by a foreign investor when she began researching Japanese corporate governance more than 20 years ago: “Kathy, you’re trying to convince vegetarians to become carnivores.” But eventually Japan adopted a stewardship code, in 2014, and a corporate governance code, in 2015. Despite these requirements, the management of many companies is seen as reluctantly going along with something they know they must do but which they “do not really have in the bottom of their hearts and do not really get,” Matsui said. Many do not want to spend money on initiatives around gender diversity, for example. They don’t see the benefit.

When it comes to ESG, which parts of the acronym are most important differs by company, and some organizations may choose to focus on just one.

“I think the biggest roadblock is that of mindset, [understanding] that this is not a cost, but an investment in their future,” she continued. “And I think that a lot of the governance-related challenges that Japanese companies—at least the large ones—have faced, if you look at the root cause of these problems, stem from an echo-chamber decision-making process. Their past presidents or chairmen—even though they don’t have an official vote—are all hanging around. We call it ghosts in the boardroom.”

Once a company does see the need and benefit, the next step is helping them understand that the process is a marathon, not a sprint, Matsui explained. It must be understood that all the training and education involved in the transition is being done because it makes business and economic sense, not because it is being mandated by regulations.

“If you don’t start with that argument, I think it’s very, very difficult to convince the naysayers or the skeptics why this is important,” she said. “So, to me, having a different perspective and a different point of view to challenge the status quo is one of the most important things that diversity of thought brings to the discussion.”

Social Solutions

What is it that attracts MPower to the ESG space, and what do the partners see as Japan’s competitive advantages and weaknesses?

Seki began her answer by highlighting Japan’s position as a kadai senshin koku, a country with many emerging social issues to tackle. Aging is at the forefront, but the lack of diversity in corporate management and low productivity are problems as well.

“Identifying startups to provide the best solutions to those social issues will be a huge opportunity for us,” she said. “Putting ESG aside, there is a huge funding gap in the VC field, especially in the growth to later-stage funding. That provides us with a huge opportunity to support those startups that are willing to—or are trying to—go global. And the lack of diversity and the aging of society are also great opportunities for companies—and for us as well—to bring diversity to the table.”

Matsui noted that Japanese companies tend to score relatively high for the E in global sustainability studies, but are weaker when it comes to the S and the G. And in terms of the E, meeting the government’s ambitious target of being carbon neutral by 2050 will bring serious challenges to corporations in Japan.

“What some companies are complaining about is that this effectively is a tax on them, if they have to go in that direction,” Matsui said. “So, even though on the surface Japanese companies look like they’re really stronger in the E, just given how rapidly the world is changing they are going to have to double down on their efforts on the E. But also on the S and the G there is a lot of work to be to be done. That is an absolute opportunity for a fund like ours and investors like ourselves to help companies who want to provide those solutions in those spaces.”

Frameworks and Urgency

One need only turn on the news to see how climate change is impacting our lives on a daily basis. Murakami said there has been a lot of discussion about climate risk, but people are beginning to realize that the problem isn’t going away. Efforts must be accelerated, and more agreement on how to measure and report the effectiveness of actions is needed.

Among the initiatives underway this year are the United Nations Climate Change Conference (COP26), to be held November 1–12 in Glasgow, Scotland, and a working group announced on March 22 by the International Financial Reporting Standards (IFRS) Foundation, “to accelerate convergence in global sustainability reporting standards focused on enterprise value, and to undertake technical preparation for a potential international sustainability reporting standards board under the governance of the IFRS Foundation.”

Murakami said these are very exciting moves that everyone should be watching, because one of the problems is that, with so many frameworks in use around the world, it is difficult to really measure what is driving the climate change we are seeing. “Yes, it is hotter, it rains more, and we feel climate change impacting us … but it’s difficult to move the needle when you don’t know where the needle stands.”

MPower has been developing its own framework for measuring and reporting, one better suited to VCs than to large companies, and they have looked at various existing frameworks in the process. But Murakami is looking forward to a consolidation of the hundreds that are currently out there down to just two or three globally accepted standards that can be used as guidelines for companies to measure where they stand on ESG. “I think that’s a very exciting development that we’re actually watching this year.”

Shifting Needs

The aging of society, expanding role of technology, and efforts to mitigate the impact of climate change are all remaking the job-market landscape. Hasegawa asked if the Japanese government is doing enough to address the need for skills in emerging areas and the potential displacement of workers as industries change as a result of the country’s pursuit of carbon neutrality.

Murakami said one of the greatest challenges for Japan is to address the very rigid employment system that makes it difficult for people to reskill themselves and find jobs.

“One thing the government really needs to do is to encourage companies to become a lot more flexible and understand the changing demands of the labor market—and of their customers as well—so that they can adjust the skill sets of their employees by not only reskilling or upskilling them, but also making sure that they can provide opportunities for people who may be joining a company at the age of 25 or 35 instead of 22,” she said.

In addition, there must also be a merit-based compensation system and promotion scheme. That is an area where Murakami feels many companies are trying to change, but have not fully done so yet—in part due to policies and regulations that are preventing them from moving to more merit-based systems.

Empowering Women

While MPower is not focused exclusively on female founders, encouraging more women to pursue entrepreneurial paths and working to close the gender gap in financing is one of their goals. And as Murakami’s story about her mother shows, women often bring a perspective and insight that reveals a solution which men may not see.

But traveling the road to that solution requires money, and one challenge for women looking to raise capital is that most investors are male. Suzuki pointed out that fewer than 10 percent of decision-making investors in the VC space are female, and just four to five percent of VC is invested in woman founders.

A common belief among investors, Suzuki said, is that women are unable to take risks. But studies have found that female founders actually return capital at a greater rate than their male counterparts. They may also be more conservative in terms of the projections they share with investors compared with their male peers, who tend to be more aggressive. But whereas the men don’t necessarily hit their targets, the women tend to be very stable.

“So, there’s a lot of great potential there, and we’d love to see entrepreneurialism in various areas solving some of the issues that women are facing,” Suzuki added, pointing out how the caretaking burden disproportionately falls on women. “That is something we hope to see in the next generation.”