Japanese companies face a ticking demographic time bomb, and private equity investors are racing to defuse it. Across the country, older business owners face the double burden of heirs who have no interest in continuing the family business and high inheritance taxes. For many family businesses rooted in a tradition of handing over management to the next generation, the once taboo option of selling to private equity is rapidly becoming a viable option. Annual transaction value in Japan’s private equity market has exceeded 3 trillion yen ($20 billion) for the fourth consecutive year, according to Bain & Company. Year-to-date, deal value in Japan has increased more than 30% year-over-year to $29.19 billion, according to PitchBook data. Industry experts say much of this deal flow is being driven by a large wave of family-run businesses in the region, as aging founders face succession issues and heavy inheritance taxes. Jun Tsusaka, CEO of Japanese investment firm Nihon Sangyo Suishinkiko, gave the example of a 61-year-old man who recently asked Tsusaka to sell his business. “They’re at an age where they say, ‘I’ve worked hard, but my kids don’t want to take over my business,'” he says. They’re at the age where they say, “I worked hard.” But my children don’t want to take over my business. ” Jun Tsusaka CEO, NSSK Japan has the highest inheritance tax in the world, reaching 55% on large estates, according to the Tax Foundation. The high taxes put even the heirs in a bind. Tax liability must be settled within 10 months of death, and heirs of privately held companies are often forced to quickly sell assets to raise cash, making sales to private equity an increasingly attractive option. More than 90% of Japan’s small and medium-sized businesses are family-owned, and more than 65% of Japan’s acquisitions now result from succession deals, according to data provided by investment management firm Neuberger Berman. According to a report by the World Economic Forum, by 2025, approximately 1.27 million small and medium-sized business owners over the age of 70 will have no successors, representing about one-third of all Japanese companies. Kyle Walters, a private equity analyst at PitchBook, said succession is a strong driver of domestic deal flow. “Japan’s successor shortage and aging population are undoubtedly important factors for the growth of PE activity in this country,” he told CNBC. “With few other options, many sellers are considering PE as a realistic possibility.” Ten years ago, selling to a foreign fund would have been unthinkable. Manoj Purush, a corporate partner specializing in mergers and acquisitions at Reed Smith, said CEOs traditionally didn’t consider selling themselves as an option. “Then this happened: They realized they could consider selling because they needed an investor, but that investor was local. Then they realized they could actually start looking at foreign investors.” Successful turnarounds by foreign giants like KKR, Carlyle and Bain allayed fears that PE would gut companies, and that cultural shift gave legitimacy to global companies, he added. For example, KKR bought 80% of Panasonic’s shares in 2013, changed its name to PHC Holdings, and went public in 2021. “They saw foreigners coming in and it worked,” Prusch said. Ryo Ohira, head of East Asia at Neuberger Berman, said these cultural shifts are driving some young founders to sell amid chronic labor shortages and an inability to attract professional management teams, a trend exacerbated by generational disparities during the “employment ice age.” The “employment ice age” refers to the period from the early 1990s to the early 2000s, when Japan’s job market fell into a deep recession after the bursting of the bubble economy, and mid-level human resources were hollowed out. Due to a lack of experienced professionals, small and medium-sized enterprises have few viable successors or outside managers, exacerbating today’s succession and leadership crisis. Jim Verbieten, a partner at Bain & Company, said the Japanese government’s regulatory reforms are also driving the private equity boom. “The reason why this is such a great time is because it was back in 2015-16.” The government had introduced fundamental reforms such as mandating outside directors and pressure from the Tokyo Stock Exchange to improve return on equity. Corporate carve-outs across successors are driving deals as Japan’s conglomerates seek to free up capital and boost returns on equity under regulatory pressure. Activist investors are also pushing underperforming boards to sell assets or take companies private, industry veterans say. Macro factors also come into play. Neuberger Berman’s Ohira said the weaker yen has made Japanese assets relatively cheaper, especially for dollar-holding investors, adding that PE limited partners (private equity fund investors) around the world are demanding exposure to Japan, and general partners (individuals and companies that manage private equity funds) are expanding and deploying funds to meet that demand. Pitchbook’s Walters added that interest rates in Japan remain significantly lower than in other major developed markets, making leveraged buyouts in Japan attractive. The yen has fallen about 4% against the dollar since the beginning of the year, and currently stands at 150.93 yen to the dollar. Risk of overheating? With the influx of capital, some experts are wary of overheating the market. “If things are really attractive, everyone will want to participate… There will be more money chasing the same market and some people will start paying more. The caveat is that Japan’s 2006-2007 vintage wasn’t that good,” warned Barbieten, alluding to Japan’s private equity boom. During the 2006-2007 funding and implementation cycle, companies rushed to deploy capital, paying increasingly higher prices and driving up valuations. Many of these investments underperformed when the 2008 financial crisis erupted, experts told CNBC. The trade from that time is now referred to as a “weak vintage.” Despite Japan’s current PE boom, PE investment currently accounts for only about 0.4% of Japan’s GDP, compared to 1.3% in the US and 1.9% in Europe. “On the excitement front, yes. But from sophistication? Japan is still a growing market,” Verbeten said. Succession concerns mean that Japan is likely to remain a growth market and fertile ground for PE firms looking for bargain deals.
