These should be the glory days for Japan's venture capital industry. For decades venture businesses - the preserve of banks, insurance companies and over-extended domestic private equity groups - have finally attracted the attention of big Japanese corporations and foreign investors.

Investment in Japanese ventures jumped to almost $1bn last year. It was a record high claim industry executives, although the figures are poorly monitored. Most of this funding went to internet and technology companies, reflecting growing global interest in the sector. But the flurry of excitement has left some investors in Tokyo wondering how long this can last.

The concern is not about a lack of experience but about the aftermath of the last few years. The term "venture business" first surfaced in Japan in the 1960s, but it was not until the bubble-economy years in the 1980s that funds began pouring in volume. At this time, corporations accounted for the lion's share of investing, spending Y20.5bn in 1989, according to the Ministry of International Trade and Industry. Banks invested Y15.8bn in ventures that year.

As the bubble deflated, investor enthusiasm for venture businesses flagged: banks and corporations were strapped for cash. Funding dropped off sharply through the 1990s and did not pick up again until 1998.

However, by 1998 the situation had changed dramatically. Instead of bank employees and corporate salarymen, this time around it was young mavericks from two new Japanese companies that were investing.

Softbank and Hikari Tsushin altered the course of Japanese venture capital single-handedly by sending dozens of employees out on the street to look for deals. Softbank turned up 450 such companies; Hikari Tsushin does not disclose the size of its portfolio. Both groups were led by charismatic, if iconoclastic, chief executives who wanted to bring the internet to Japan.

US groups such as Broadview, Warburg Pincus, H&Q Asia Pacific and Whitney & Company followed their lead. And Japanese trading companies, which see the internet as a direct threat to their business, wasted no time in launching their own venture capital units as well.

This fever in Japan echoed the spending spree going on in the US and Europe. But Japanese venture capital groups - Softbank and Hikari included - tended to invest less money in more companies than their US and European counterparts. They also spent less time on due diligence, a weakness that provoked criticism from many foreign investors.

"They were really just kicking tyres," says one such investor.

The enthusiasm was confirmed at periodic meetings of the Bit Valley Association - a group whose name is a pun on Shibuya, the fashionable area in Tokyo where many new internet ventures were founded. Originally intended as a place for investors and entrepreneurs to discuss business prospects, the meetings turned into lavish parties where foreign investment bankers distributed stacks of business cards and Japanese government officials watched from the sidelines with interest.

The other key factor in stirring up excitement was the launch in December 1999 by the Tokyo Stock Exchange (TSE) of Mothers, the country's first new stock market to be launched in years. This market, which was intended to pre-empt the opening of Nasdaq Japan in June 2000, provided investors with the exit strategy they needed. Mothers had much looser entry requirements than the TSE, which only accepted initial public offerings (IPOs) from companies that were generating profits.

But when most of the first issues on Mothers dropped below their listing prices, some investors became disillusioned. The Bit Valley parties had left Japan's young venture industry with a painful hangover: the chances of an IPO for hundreds of companies that received funding had fallen sharply, almost overnight.

"Everyone got caught up in it," said Paul Slawson, general partner at Whitney & Company. "We clearly have companies which had fantastic valuations. We are now trying to figure out what we should do with them."

Today, this consolidation process is in its earliest stages. Hikari's venture capital arm is mulling over mergers and alliances within its portfolio of companies. Many investors, including Hikari, have slowed the pace of new investments. Others are focusing exclusively on business-to-business e-commerce and wireless applications, as well as services for the broadband internet.

However, the biggest challenge going forward is not likely to be a shortage of money. Rather, venture capitalists are looking for skilled managers, accountants and lawyers who understand technology. In Japan, where the lifetime employment system has limited labour mobility, these specialists are in high demand.

Brian Riordan, director at Broadview in Tokyo, says: "We don't have the cult of the entrepreneur here as in the US. There is no one with high growth experience over 40 years old, and whereas in the US you can find lots of people willing to work for a $5bn company, it is very difficult here."


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