Japan intends to remove a key restriction on overseas investment by domestic venture capital funds dedicated to backing startups, a move intended to attract more foreign investors to the sector.

Domestic start-up funds must currently limit investments in foreign companies to less than 50% of their portfolio holdings. The end of this restriction would allow greater flexibility in the choice of investment targets, encouraging foreign money to flow into these Japanese funds.

The planned deregulation applies to seed funds that take the form of limited partnerships, a common method used by venture capital to limit risk exposure. Investors participating as limited partners are not required to take risks beyond their investment. The arrangement not only provides an easy way for investors to provide cash, but is also suitable for raising small amounts from a wide range of investors.

The requirement for limited partnerships in Japan to invest at least 50% in the country hampers foreign investors who see Asia as a whole as a target. Removing the restriction would help Japanese venture capital funds expand their overseas investment goals, and increased capital flows into the domestic venture capital market would ultimately benefit Japanese startups.

The Japanese government will submit a draft amendment to the law governing limited partnerships to parliament in 2024. The cap on investment in foreign companies was introduced as part of the limited partnership law which came into force in 1998.

Japan has set a target to increase annual investment in startups to 10 trillion yen ($77.2 billion) by fiscal 2027, more than ten times higher than levels current.

Government data shows there are 600 “unicorns” – startups valued at $1 billion or more – in the United States, more than 100 in China and Europe, but just six in Japan.

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