Acquiring Japanese SMEs through M&A

Japan is home to numerous small and medium-sized enterprises (SMEs) with advanced technology, high-quality products and services, as well as well-established markets. Some of these companies are actively seeking domestic or international partners due to financial challenges, while others face succession concerns as their CEOs approach retirement without clear successors. If your company is discussing with them on acquiring their business in Japan, here are some key considerations and strategies to streamline the process. Under Japanese law, two primary options are available for M&A of SMEs: (1) purchasing shares in the Japanese company, or (2) establishing a local subsidiary in Japan and acquiring assets and business operations from the target company. The following is a comparative overview of these options.

1. Share Purchase

Purchasing more than 50% of the shares in a closely held corporation in Japan gives you substantial control over company decisions, such as appointing or removing directors (including CEO), setting their salaries, and distributing dividends. A higher ownership percentage may be required for significant corporate decisions, such as amending the articles of incorporation, issuing new shares, or dissolving the company, which typically require a two-thirds majority. In the case of privately held companies, acquiring shares generally requires approval from the board of directors or shareholders.

The primary advantage of a share purchase is that it allows you to acquire ownership of an existing Japanese company without needing to establish a new entity, making it a relatively straightforward process compared to other business succession options like “business transfers” or “company splits” after incorporating a Japanese subsidiary (See 2 below). Typically, there are no impacts on company licenses, employee status or contracts with business partners. However, share purchases do not allow selective acquisition of only certain assets or business lines; instead, you acquire the company as a whole, including any potential liabilities that may not be reflected on the balance sheet.

2. Establishing a Japanese Subsidiary and Transferring Business

If you are interested in acquiring only specific segments of operations of a Japanese company (“Company A”), it may be advantageous to first establish a local Japanese subsidiary (“Local Subsidiary”) and have it acquire targeted assets and operations through a “business transfer”(Article 467 of Companies Act).

In a business transfer, the Local Subsidiary can acquire both tangible assets (e.g., products, inventory, facilities, real estate, cash, securities) and intangible assets (e.g., patents, trademarks), along with contractual rights (e.g., master sales agreements with customers, enabling the transfer of customer relationships). Note, however, that for each contract to be transferred, the consent of each counterparty of contracts (such as customers under master sales agreements) is required, which can be a time-consuming process.

Despite this, a benefit of business transfers is to allow selective acquisition of assets and contracts, with a reduced risk of inheriting hidden liabilities compared to a share purchase. Consequently, it also enables concise legal proceedings of M&A transaction, simplifying a legal due diligence process. Assets and contracts should be clearly itemized in the business transfer agreement and its accompanying documentation. However, if the Local Subsidiary intends to use any part of Company A’s trade name or brand (e.g., selling Company A’s finished products under the same product name), it may assume liability for Company A’s debts, unless otherwise registered with the Legal Affairs Bureau.

If you establish a Japanese subsidiary, an alternative option also for your consideration is a “company split”(Article 757, companies Act), which differs from a “business transfer.” Unlike a business transfer, a company split does not require individual consent from each contract counterparty. In a company split, a designated portion of Company A’s business and assets can be transferred to the Local Subsidiary as a package. While similar to a merger, a company split enables the transfer of only part of Company A’s business rather than all operations.

In a company split, any debts associated with the target business are automatically transferred to the Local Subsidiary, which distinguishes it from a “business transfer” and necessitates a thorough examination of potential liabilities in legal due diligence. Additionally, advance tax advice is essential to assess the impact of the company split on both the global parent company and the Local Subsidiary and to ensure a “qualified company split” under the Japanese tax law.

3. Reporting Obligations Under the Foreign Exchange Act

For all options above, if your foreign company obtains more than 10% of the shares in a Japanese company through either a share purchase or establishment of a Japanese subsidiary, a report must be submitted to the Bank of Japan within 45 days of the transaction. Moreover, if the acquisition involves certain sensitive industries identified under the Foreign Exchange Act, prior notification to the Bank of Japan is required. Due to recent expansions to this list of sensitive sectors, it is prudent to verify, in advance, if a prior notification is necessary, particularly in the context of M&A acquiring IT software providers or semiconductor manufacturers.

For further information and questions, please contact Ms. Masako Banno, who is in charge of this article, via her email address or the following link. https://www.okunolaw.com/en/contact/