The start-up scene in Japan has historically lagged behind the Silicon Valley and China, but several investors told CNBC that things are changing.
Workers have traditionally seen starting a company as "kind of a Plan B," according to James Riney, head of 500 Startups Japan, which has total assets under management of near $50 million.
Finding entrepreneurial talent in the country used to be difficult because of an aversion to risk among Japanese workers. Many wanted the stability of corporate or public-sector jobs.
"If you didn't get into the major companies, the brand name companies, entrepreneurship was kind of like this second option that you could consider," Riney told CNBC.
Talented people join start-ups
Investors said that today, many young people are joining start-ups even as corporate Japan grappled with a labor shortage. They gave several reasons for the shift.
First, the success of e-commerce and internet players like Mercari, Rakuten, DeNA, GREE, and Mixi produced role models and mentors available to guide new entrepreneurs, the investors said, adding that many successful founders are also investing in the new companies.
And those start-up success stories are getting more and more news coverage — so "young people are becoming more attracted to the start-up world," Tetsu Nakajima, chief investment officer at venture firm Mistletoe, told CNBC.
Before, I couldn't really meet founders with certain prestigious backgrounds. Now, almost 80 percent of the founders have ... worked for McKinsey or Boston Consulting Group or Goldman Sachs.Hogil Dohinvestment manager, Rakuten Ventures
He said that the stigma of "failure" is also decreasing and that many science and engineering students from the top universities were now interning for start-ups.
Moreover, young Japanese workers have grown up in a world where innovation is driven by the likes of Airbnb, Uber and Facebook, according to Riney. Unlike their parents' generation, they "never saw a world where massive wealth and innovation-drivers were Sony or Nintendo or some of those more traditional folks."
Government support has been crucial in bolstering the start-up scene, according to Riney.
The quality of entrepreneurs is also increasing as many left their jobs in consulting or banking sectors to either start their own company or join the management teams of existing start-ups, according to another investor.
"Before, I couldn't really meet founders with certain prestigious backgrounds," Hogil Doh, investment manager at Rakuten Ventures, told CNBC. "Now, almost 80 percent of the founders have ... worked for McKinsey or Boston Consulting Group or Goldman Sachs."
More money flowing in
Along with talent, Japanese start-ups are seeing an influx of capital.
A Financial Times report, citing data from Japan Venture Research, said privately-owned start-ups raised nearly 272 billion yen (about $2.5 billion) in 2017, up from about 64 billion ($604 million) in 2012. The FT reported that corporate venture capital spending hit an all-time high of 70.9 billion yen last year, compared with only 1.2 billion yen in 2011.
Rakuten's Doh explained that previously, start-ups focused on sectors like e-commerce and digital media that did not require large sums of capital for initial research and development.
"They're now moving into health care, agritech, Internet of Things, artificial intelligence, even enterprise software — all those areas, you need to put a large amount of initial investment for research and development," he said.
Companies are able to raise anywhere from $10-to-$70 million, $100 million privately — which is basically unprecedented for Japan.James Rineyhead of 500 Startups Japan
The main sources of capital in Japan are the government, banks, insurance players and the corporate sector, according to the investors. They said roughly 80 percent of the funding comes from them while about 20 percent comes from commercial venture capital firms. There's also growing interest from institutional names, Riney said.
"If you look at the size of the growth stage round, they've also increased," he added.
Riney explained that in the past, start-ups would sometimes prematurely go public in order to raise funds. That, he said, stunted growth as companies concentrated early on becoming profitable, so they could please shareholders.
He added that now he was seeing more sizable rounds of funding, "where companies are able to raise anywhere from $10-to-$70 million, $100 million privately — which is basically unprecedented for Japan." As a result, they are able to stay private for longer and focus on generating growth.
Mistletoe's Nakajima said the next challenge will be for Japanese start-ups to attract investment from overseas, and to be acquired. Currently, most start-ups exit that early stage of their development by going public, but the size of initial public offerings are relatively small compared with other countries.
Overall, the amount of money Japanese start-ups are raising is small compared with what companies can raise in Silicon Valley, China and even Southeast Asia. For example, ride-hailing service Grab said last July that it expects to raise $2.5 billion in funds from a single financing round.
Home-turf advantage
Due to a language barrier, Japanese start-ups tend to focus mostly on the domestic market —which is big, since the country's economy is the world's third biggest. When foreign competitors from the U.S. or elsewhere try to enter the Japanese market, they find it "very closed off and hard to penetrate," Riney said.
Rakuten's Doh gave an example of a start-up he invested in: From Scratch, a digital marketing platform that he described as Japan's version of Salesforce.
If From Scratch were to do exactly what Salesforce does, the Japanese brand would not be able to compete head-to-head, Doh explained. Instead, they "customize their product and they do put a lot of effort to support domestic clients, in Japanese," he said. "These two things actually differentiate this company a lot, so customization is important."
On the same note, it's also challenging for Japanese start-ups to expand beyond Japan, because of those same cultural and language barriers, according to Riney.
