The fifth meeting of the Phase 2 of the “Impact Investing Roundtable,” which has been held since June 2020, was held online on Tuesday, May 30, 2023. The purpose of the Roundtable is to deepen the understanding of financial market participants and government officials on impact investment, clarify the significance and challenges of impact investment initiatives to solve social issues in Japan and abroad, and discuss how to promote it for the sustainable development of Japan’s financial industry.
The fifth meeting centered on the theme of “Impact investing and innovation,” focusing on deep tech startup investments, what innovation is needed to create impact, and how finance should deal with innovation.

The meeting began with opening remarks by Dr. Takeshi Mizuguchi, Chair of the Roundtable and President of Takasaki City University of Economics, and Mr. Satoshi Ikeda, Vice Chair of the Roundtable and Chief Sustainable Finance Officer of the Financial Services Agency (FSA) of Japan. Chair Mizuguchi cited "profitability" as a point of discussion at a recent meeting of the FSA's "Working Group on Impact Investment," and emphasized the need for different ideas and innovation in order to achieve both solutions to social issues and profitability, He commented on the possibilities of technology and deep tech. Mr. Ikeda noted that the Working Group discussed the difficulty of balancing social issues and returns, and expressed hope that the discussions at this meeting would lead to clues to solving difficult issues.

Presentations on impact investing and innovation followed from Mr. Akitaka Wilhelm Fujii of Real Tech Holdings, Mr. Kotaro Yamagishi of Keio Innovation Initiative (KII), and Mr. Hiro Watanabe of HERO Impact Capital.

First, Mr. Fujii gave a presentation on Real Tech’s impact investing and innovation. After introducing the company’s profile, he talked about the overview and potential of a so-called deep tech investment, which is an investment in R&D-based innovative technologies to address serious social issues facing the earth and humanity, the lineup of investment targets and investors, acceleration programs and ecosystem formation, as well as the impact investment framework that was launched in 2021.

He introduced the four phases of the impact investment framework: (1) due diligence to investment execution, (2) post-investment to value enhancement, (3) exit, and (4) continuous update of the impact investment methodology. He also raised three issues for the future: (1) concern over whether evaluating impact potential rather than created impact is considered impact investment, (2) difficulty in dealing with technologies that drive human prosperity (e.g., space), and (3) difficulty in measuring the contribution of materials and enabling technologies (e.g., AI).

Next, Mr. Yamagishi gave a presentation on KII's impact investment and innovation. After introducing himself and explaining how he started supporting university-launched startups, Mr. Yamagishi explained the current trend of university-launched startups. While the number of university-launched startups is increasing, the number of Keio University-launched venture companies is the third largest in Japan, and in terms of the amount raised, Keio University became the top university-launched venture company in 2022. KII was established as an official venture capital of Keio University, and its mission as a company is to solve social issues and change the world by utilizing university research.

He then introduced the funds that KII is managing. He mentioned that KII is currently managing two funds and that many financial institutions are interested in not only the returns but also the impact. He also mentioned that the third fund, which is under preparation, is considering the introduction of IMM, and expressed his hope that institutional investors will join the fund. He also introduced investment results and achievements in each sector. In terms of investment strategy, he expressed his belief that "there are opportunities to create attractive business opportunities by solving social issues with inventions and new technologies," and introduced the idea that the sweet spot for investment is where the three areas of "inventions and new technologies," "social issues," and "business opportunities" overlap, taking advantage of the strengths of the university. KII's view of impact investment is "to invest in and provide funds to projects that aim to solve social issues and whose social impact can be understood," and the significance of introducing IMM in this context is to recognize issues, expand opportunities, provide funds, and contribute to increasing the value of the investee. He also mentioned the difficulties of (1) strengthening VC resources in the investment execution process and (2) developing measurement/reporting methodologies in cases where no quantitative outputs are generated during the life of the fund.

Next, Mr. Watanabe gave a presentation on the new circulation of funds to next-generation researchers through sustainable finance. After introducing himself and his activities in the " Future Design by Science and Finance (FDSF)," Mr. Watanabe introduced his activities to support young researchers, which started when he invested his personal assets in researchers when he was in undergraduate. This activity led to the current business of HERO Impact Capital, which aims to create impact on global issues such as decarbonization and super-aging as a venture capital company that co-found R&D startups with young researchers.

The firm's impact investment efforts include: (1) supporting and co-founding a company even before it is established; (2) establishing an investment committee and an impact evaluation committee as a dual evaluation committee; and (3) providing hands-on support, including building equity stories, as part of IR support. In addition, a foundation is incorporated as a member of the partnership, and success fees are distributed to future researchers, positioning the foundation as the core for the formation of an ecosystem. This has led to the creation of a network of researchers and the circulation of funds to the next generation of researchers. Finally, he pointed to the need for dialogue on how to encourage asset owners/managers to be accountable for aggressive allocations and how to create best practices.

After the above presentations, a panel discussion was held among the three presenters under the facilitation of Chair Mizuguchi. First, the panel discussed what is required on the investment side to foster deep tech and research seeds.

While Mr. Fujii's position is to focus on how to increase the probability of success of the startups in which he invests, he said that it is important for investors to be discerning in avoiding investing in the wrong technology or in areas where there is no scientific basis for the investment. In addition, since the deep tech ecosystem has not yet been established in Japan, simply providing money alone will not work, and it is necessary for startups to work together to increase the probability of success by recruiting people with business development experience. Mr Yamagishi stated that it is important to understand the initiatives of researchers and develop a business plan that increases feasibility and profitability by coordinating experts, based on the stance of participating as a lead investor from the seed/early stage and increasing value before other investors. In addition, as funding is also important, he stated that it is important to set up a platform to provide people, funding and support while utilizing a variety of stakeholders. Mr Watanabe expressed the view that the key is to create a mechanism for CEO candidates and management candidates to enter the ecosystem, and that it is also important to create a flow of interest by successfully interpreting and communicating researchers' initiatives to younger PE professionals. Chairperson Mizuguchi expressed the view that there are various ways to find seeds, such as acceleration programs, university partnerships and researcher support, but that the importance of creating an ecosystem and a mechanism for fund circulation is common.

The panellists then discussed where the difference lies between traditional investments and impact investments in deep tech investments. Mr. Yamagishi explained that while the concept and investment strategy are not that different, the introduction of IMM leads to funding from institutional investors with strategic intent, and the verbalization and explanation of the fund's Theory of Change and how it will improve society is different from conventional investments. Mr. Watanabe explained that from the perspective of fulfilling accountability for IMM throughout the investment chain, it is important not only for LPs but also for startups to understand the social impact and the potential of their business. He also said that understanding the social impact of a startup will lead to clarification of its potential, such as "how much value it has to the world and how big the market is," and will also lead to the development of capitalists. Mr. Fujii stated that the significance of IMM is not only accountability to investors and society, but also that it is a good framework for identifying the essence of a business. On the other hand, there is a slight concern that the definition and methodology of impact investment is becoming more rigid, especially in Europe, and that it will be difficult to apply, especially for deep-tech startups. He expressed his view that he would like to discuss impact investment methods suitable for seed and early tech startups.

Chair Mizuguchi pointed out the need to discuss the impact of deep-tech investments, noting that when the investment targets areas that have the potential to create value over the long term, such as quantum computers and medicines development, the method of quantifying the specific impact does not fit the conventional method of impact investment, and it is difficult to evaluate the impact. He pointed out the need for discussion on this issue.

Mr. Yamagishi mentioned that it is difficult to evaluate the fair value of a venture at the time when no sales have been made, and expressed his opinion that it would be good if a new framework unique to deep-tech impact evaluation could be proposed in the impact aspect as well. Mr. Watanabe suggested that it would be a good idea to first create a format that would be acceptable to stakeholders in a way that fits with practical operations, and then to spread the format as it is updated.

Mr. Fujii stated that, as the global trend is that funds must be channeled to impact investments, investments in deep tech are seen as the mainstay of revitalizing the Japanese economy, so it is necessary to revitalize these investments. He also stated that it is important to be able to explain the hypothesis in a transparent manner.

The open discussion, which also included roundtable members, saw a variety of comments and questions raised, including the following:

Q: Many startups are aiming for IPOs, but there are still a few listed equity investors in Japan who include ‘beyond ESG’ positive impact in their investment decisions. The reality is that it is difficult to match the expectations of foreign investors (especially size of IPOs) to Japanese IPOs, and we would like to come up with a solution. Is IMM more effective in the unlisted phase? Is M&A more suitable for exit?

Yamagishi: One of the challenges of IPOs in Japan in general is that it is difficult for institutional investors to enter the market and that they are small cap. In order to aim for a big exit in deep tech, I think one of the current solutions is to be able to make a global offering or, in some cases, to go NASDAC. It is necessary to increase the size and be able to talk to foreign investors.

Q: Assuming that long-term and patient investment is necessary, there is the question of how long LP investors can wait, but what kind of mechanism is needed in Japan? For example, is it better to have LP investors wait, or is it better to take over in cooperation with secondary investors, or is it better if crossover investment is possible?

Watanabe: As the share price will not rise without a large number of investors who are impact-oriented and inclined to hold onto their shares for the long term, the current situation is that the only way to go public is to list in the U.S. The realization is that start-ups that are trying to create impact will not be able to benefit from IMM as they get closer to the public market. We believe that efforts to lengthen the duration of the fund, creating an environment that allows trade sales in the secondary, crossover investment by asset owners and gatekeepers, all have to be done at the same time. It is also necessary to dialogue and prepare for accountability to asset owners before listing.

Fujii: Even if fund maturities are extended, listing criteria and the market itself would have to be changed to make it work. As speed is important in this world, there needs to be a strong debate on whether extending the fund maturity is good for start-ups.

Yamagishi: It is difficult to say whether it is better to extend the term of the fund. It is also important to change the ecosystem.

Q: Regarding IMM methods, what is the difference between general IMM, i.e., methods that create logic models and ToCs, and technology-based deep tech impact measurement? In some cases, the impact is clear, such as how many patients can be saved in the case of medicines development, or how much CO2 can be reduced in the case of materials, but in other cases, it is not so clear. For inputs, it is necessary to include inputs that are more technology-oriented, such as the base technology that supports the technology, rather than people, money, and resources as in general impact investment.

Fujii: The reality is that there is no particular change from the usual method of creating a logic model in IMM. For example, in the case of a company in the materials sector, the supply chain is long and complex, and if we try to write everything down, it becomes very complicated and time-consuming to evaluate, and frankly speaking, it is difficult to draw a pathway to impact without gathering various experts. The challenge is that it would be difficult to draw a pathway to impact unless a certain hypothesis is set and rewritten if the hypothesis is wrong.

Yamagishi: In some cases, it is difficult to work through all ‘5 dimensions of impact’. It is difficult to understand baselines and thresholds at the investment decision stage. To be honest, quantitative analysis of counterfactuals is also difficult.

Watanabe: When there are multiple scenarios, we quantify them to some extent, but we have not created logic models for all scenarios. However, we feel that it is effective to have multiple scenarios so that the members of the evaluation committee will be in the same boat with us.

Q: Does the implementation of IMM add substantial value? How concerned are you that the IMM approach is becoming rigid and static globally? In the EU and the US, the starting point is that "the earth cannot survive if things continue as they are, so something must be done", whereas the basic premise/ground may not be shared in Japan.

Fujii: The perception is that Europe has top-down rule-making, and that is how processes and standards are designed. There are areas where basic technology fields and impact investment are incompatible. For example, enabling technologies such as quantum computers have the potential to transform social structures in the future. However, their applications are uncertain, and there is a concern that such fields are not considered impact investment. It is difficult to say whether investments in basic technologies can be discarded, and there is a risk of being called a wash in the future if investments are made without discarding them, and it is a question of whether to use the term 'impact investment' even if IMM is done, as it is part of the portfolio and the future applications are unknown. We are debating whether it is worth applying the rules of impact investment when investing in a technology that has no known future application as part of a portfolio.

Watanabe: It may be better not to quantify how unexplored technologies contribute to society and not to measure their impact seriously. How to successfully reconcile the two at the operational level should be shared among venture capitalists to find an appropriate way.

The meeting was attended by 28 Roundtable members from the financial market, business, and industry sectors, and 120 people observers participated including related ministries and others.