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So & Sato Law Offices routinely provides legal advice on the formation of private equity funds and their subsequent investments.

The legal regulations surrounding PE funds in Japan can be challenging, and the firm hopes this brief outline will be helpful.

PE funds in Japan handling so-called small-cap and mid-cap deals are now gaining recognition and attention from overseas investors.

This is largely due to Japan’s geopolitical stability, the relatively stable multiples, and the perceived undervaluation of Japan’s domestic M&A deals, particularly targeting small and medium-sized enterprises, suggesting the potential success of such PE funds.

Furthermore, PE funds handling so-called mid-cap and large-cap stocks are strengthening their presence in tender offers and management buyout deals, anticipating changes to the Tokyo Stock Exchange’s listing standards scheduled for 2030.

This article focuses on PE funds with investors who are primarily Japanese institutional investors, with some participation from overseas institutional investors or family offices.

Legal structure

Investment funds can be classified based on their investment targets, legal structure, jurisdiction of establishment (governing law), categories of investors, and other factors.

PE funds are typically structured as closed-end, partnership-type funds. Under Japanese law, they are often organised as investment limited liability partnerships (toushi jigyo yugen sekinin kumiai) under the Law Concerning Investment Limited Liability Partnerships (LPS Act).

If a certain number of investors are based overseas, parallel funds are often established as limited partnerships in tax haven jurisdictions such as the Cayman Islands.

Legal regulations

Financial Instruments and Exchange Act (FIEA). Theoretically, a general partner (GP) of a PE fund is required to be registered as:

1. 1. A type II financial instruments business operator to conduct the private placements of partnership interests in Japan; and
   2. An investment manager to manage funds and other assets contributed by investor partners, primarily through investments in securities.

However, it may not be practical for many fund managers, including Emerging Managers Programmes (EMPs), to meet the registration requirements, such as hiring personnel (including a compliance officer) with the necessary knowledge and experience, and meeting capital requirements.

Therefore, most GPs rely on an exemption called the Specially Permitted Business for Qualified Institutional Investors, etc. (SPSQII). The SPSQII allows the GP to conduct the business described in the “subject activities” and “categories of permissible investors” sections below, with only a notification. Below is an overview of the SPSQII.

1. 1. Subject activities. Under the SPSQII exemption, the GPs may conduct the following activities:
      1. Private placement of fund interests to one or more qualified institutional investors (QIIs) and up to 49 investors meeting certain requirements (SPS investors).
      2. The management of funds or other assets contributed by the above-mentioned investors, primarily as investments in securities.
   2. Categories of permissible investors. The QII refers to natural and legal persons, such as registered securities companies, banks and insurance companies, or those who have a portfolio of securities worth at least JPY10 billion (USD65 million) and have filed a notification to be treated as a QII.
      1. SPS investors include listed companies, corporations with capital or net assets of JPY50 million or more, and foreign corporations.
      2. At least one qualified institutional investor is required when conducting the SPSQII.
   3. Notification. Before commencing an SPSQII, a notification must be filed with the relevant finance bureau in advance (specifically, before the investor first acquires the relevant fund interest).
      1. If any changes occur in the matters set out in the notification, the SPSQII notifier must provide notice of each change without delay (in practice, within one month).
   4. Regulation on its conduct. Please note that although the SPSQII operator is not a licensed or registered financial institution under the FIEA, it must comply with certain regulations, such as those concerning the handling of conflicts of interest and the provision of explanatory documents that comply with the FIEA.

Act on Prevention of the Transfer of Criminal Proceeds. When the GPs of PE funds engage in the solicitation of their fund interests or management of the funds, they are required to conduct certain “know your customer” (KYC) processes and due diligence about their limited partners (LPs).

Each due diligence process includes verifying customer information, such as identity and purpose of the transaction, as well as beneficial ownership.

Limited Partnership Act for Investment (LPS Act). A limited partnership (LPS) under the Limited Partnership Act for Investment is commonly used for domestic partnership-type funds in Japan. The LPS is similar to limited partnerships in other jurisdictions.

However, the business activities in which the LPS may engage are limited to those specified in the LPS Act, including the acquisition and holding of shares and warrants issued by corporations, the acquisition and holding of certain securities such as corporate bonds, and investments in partnerships.

Furthermore, the acquisition and holding of shares, warrants, etc., issued by foreign corporations shall be limited to less than 50% of the total capital contribution of all partners.

Foreign Exchange and Foreign Trade Act (when foreign LPs participate). When overseas investors participate in a PE fund as limited partners, certain procedures may be required under the Foreign Exchange and Foreign Trade Act (FEFTA).

Under the FEFTA, PE funds that have foreign investors (non-residents or foreign corporations) as their LPs may be required to file:

1. 1. A pre-transactional notification and subsequent reporting; or at least
   2. A post-transactional notification.

PE funds in which 50% or more of the capital is held by foreign investors also fall under the category of “foreign investors”, and are subject to these reporting requirements.

Whether a pre-transactional notification (or a post-transactional notification) is required depends on the business conducted by the investee company when such PE funds make investments.

Following recent amendments to the FEFTA and its administrative rules concerning foreign direct investments, various types of business, such as software services, have been broadly designated. Thus, the process should be carefully monitored to ensure that the pre-transactional notification has been filed.

Antitrust Law. Finally, if a “roll-up strategy” (a strategy of consecutively acquiring and integrating competitors) is involved, it may be subject to merger review by the Japan Fair Trade Commission once it exceeds a certain market share threshold.

The Japanese private equity fund market is expected to remain robust. As a result, legal issues and risks are anticipated to become more complex and sophisticated.

So & Sato Law Offices
Marunouchi Office
937, 9th floor, New International Building,
3-4-1 Marunouchi, Chiyoda-ku, Tokyo 100-0005
Tel: +813 6275 6080
Email: y.sato@innovationlaw.jp