The dual challenges faced by Japanese family businesses include a lack of interested and professionally managed heirs, as well as high inheritance tax rates. This has led to an option that was once not considered by Japanese family business leaders, namely selling the company to private equity funds, becoming a popular choice in recent years and fueling the Japanese private equity boom.

With the continuous increase in trading volume, some market participants have begun to warn of the risk of overheating.

This year's transactions have increased by over 30% year-on-year

According to consulting firm Bain&Company, the annual transaction volume of Japan's private equity market has exceeded 3 trillion yen ($20 billion) for four consecutive years. According to PitchBook's data, trading activity in Japan has increased by over 30% year-on-year so far this year, reaching $29.19 billion.

One major reason behind this is the difficulty in obtaining heirs. According to a report by the World Economic Forum, by 2025, approximately 1.27 million Japanese small and medium-sized business owners aged 70 or above will have no successors, accounting for about one-third of all Japanese businesses.

Jun Tsusaka, CEO of Nippon Sangyo Suishin Kiko, a Japanese investment company, gave an example that a 61 year old Japanese company has recently commissioned the sale of his business. The older generation of Japanese entrepreneurs are in a situation where 'I still have to work hard, but my children don't want to take over my business.' This has prompted more elderly Japanese entrepreneurs to be more willing to sell their businesses.

PitchBook's private equity analyst Kyle Walters stated that corporate succession is a powerful driving force behind the volume of private equity transactions in Japan. The lack of inheritance rights and Japan's aging population are key factors behind it, "he said." Many sellers see the private equity market as a viable possibility because there are hardly any other better options

Ryo Ohira, the head of Neuberger Berman's East Asia region, stated that Japan's "employment ice age" has exacerbated this trend. The "employment ice age" refers to the period from the early 1990s to the early 21st century, when the Japanese economic foam burst, the employment market entered a deep recession, and the talent pool in the middle of career was hollowed out. This has led to a lack of experienced professionals to take over the company, in addition to the desire of supervisors to succeed, deepening the succession and leadership crisis of Japanese companies in recent years. O'Hara added that even some young Japanese business founders choose to sell their companies to private equity funds due to long-term labor shortages and inability to attract professional managers.

In addition to the difficulty of inheritance, according to the Tax Foundation, Japan also levies the highest inheritance tax in the world, with a high inheritance tax of up to 55% on large estates. Sometimes, high taxes can even put business heirs in a difficult situation. Meanwhile, the Japanese tax law also stipulates that inheritance issues must be resolved within 10 months after the death of the inheritor, which often forces family business heirs to quickly sell assets to raise cash, with private equity becoming an increasingly attractive option.

According to investment management firm Neuberger Berman, over 90% of small and medium-sized enterprises in Japan are family owned, and over 65% of private equity mergers and acquisitions stem from related corporate inheritance cases.

The shift in mindset has also accelerated this process. Manoj Purush, a partner at Reedsmith law firm specializing in mergers and acquisitions, stated that traditionally, Japanese family owned COEs do not consider selling company equity as an option. But over time, their thinking changed and they thought, 'Okay, we can consider selling because we need investors, but these investors must be local institutions in Japan.'. Then, they realized that we could actually start considering foreign private equity investors.

He said that this cultural shift provides global private equity investors with the possibility of legitimacy for acquiring and merging Japanese small and medium-sized enterprises. In addition, KKR、 The successful transformation of foreign private equity giants such as Carlyle and Bain has also eased concerns among Japanese local business owners that private equity fund takeovers will weaken their companies. For example, KKR acquired 80% of Panasonic's shares in 2013 and renamed it PHC Holdings, but it did not weaken the company's operations and instead led to its listing in 2021.

Overheating risk

Jim Verbeeten, a partner at Bain&Company, stated that the Japanese government's regulatory reforms have also contributed to the prosperity of Japan's private equity market. This boom can be traced back to 2015-2016. The Japanese government had already introduced comprehensive reforms at that time: mandatory external directors of companies and the Tokyo Stock Exchange's requirement to increase the return on equity of listed companies. In this way, Japanese companies are striving to release capital and increase their return on equity under regulatory pressure, and the resulting divestitures are also driving private equity transactions. Industry veterans say that radical investors have been pushing underperforming boards to divest corporate assets or push for corporate privatization.

On a macro level, O'Hara stated that the long-term weakness of the yen has also made Japanese assets relatively cheap, especially for US dollar investors. Since the beginning of this year, the overall exchange rate of the Japanese yen against the US dollar has still recorded a decline of nearly 4%. As a result, global private equity fund investors are also increasing their investments in Japan, and general partners managing private equity funds are expanding and deploying funds to meet this trend. Vaters said that Japan's interest rates are still much lower than other major developed markets, which makes the country's leveraged buyouts equally attractive.

But with the continuous influx of capital, some market participants have also begun to warn against the overheating of the Japanese private equity market. Wei Beiteng said, "If a certain transaction or market is really attractive and everyone wants to participate, it leads to more money chasing the same market, and some participants start to have to pay higher premiums

He is referring to the Japanese private equity boom. During the financing and deployment cycle from 2006 to 2007, many private equity firms were eager to participate in Japanese corporate investments and paid increasingly high prices, thereby driving up valuations. But with the outbreak of the 2008 financial crisis, many of these investments performed poorly that year. The private equity transactions reached in those years are still marked as' weak years' by relevant investors to this day.

In addition, despite the booming development of private equity investment in Japan, private equity investment currently accounts for only about 0.4% of Japan's gross domestic product, compared to 1.3% in the United States and 1.9% in Europe. Wei Beiteng said, "From the perspective of market heat and vigorous development, Japan ranks among the top. However, from the perspective of market maturity, Japan is still a growing market