Jafco America Ventures, Inc.: Building a Venture Capital Firm

The case describes the second attempt at entry of JAFCO, a large Japanese venture capital firm, into the U.S. venture capital market. At the time of the case, Barry Schiffman, president and chief investment officer of JAFCO's U.S. subsidiary (JAV), is faced with four important decisions: investment focus, deal flow generation, compensation and cooperation with the Japanese parent company. While most venture capital firms are independent entities and therefore do not face the fourth decision, the first three decisions are fairly typical for any venture capital firm. I have found that the case can be used as a powerful illustration of the goals, characteristics and performance of a venture capital (VC) firm. The case provides students with an opportunity to discover, in the context of a turnaround situation, how the venture capital system works in the U.S. The case can also be used as a very effective supplement to a lecture about the venture capital system. Specifically, the case helps students understand how VC firms get access to potential investment opportunities, how the firm's managers assess these opportunities, how investments are carried out, monitored and divested and how venture capitalists are compensated. The case also illustrates dramatically how a misalignment of incentives between a VC firm's owners and investment managers can drain a firm of its principals within a very short period of time. A rather unique feature of the case is the level of detail provided on JAV's investment portfolio and its performance to date. The data in the case enables students to calculate rates of return for JAV's current fund and to analyze both best and worst case scenarios for the fund's returns. Students can also estimate the profits that would be allocated to the firm's partners under standard industry compensation structures. Furthermore, the case also contains a detailed description of the investment process at JAV. Thus, depending on the instructor's teaching objectives the case can also be used to present a process view of venture capital investing. Beyond this general purpose of teaching how a VC firm works (and how it doesn't), the case illustrates three additional topics. First, the case permits a good juxtaposition of entrepreneurial and VC systems in Japan and the United States. The comparison of the context for VC in both countries (described in the analysis below) should lead students to the insight that the VC industry in the U.S. is part of a 'system' that includes universities creating new technologies, entrepreneurs seeking to exploit them and capital providers seeking to achieve superior returns through private equity investments. It should become clear that the creation of a VC industry comparable to the one in the United States is a difficult endeavor that requires much more than just a change in legislation that facilitates asset allocation by pension funds and other potential capital providers to private equity. Second, the case allows for a good discussion of the difficulty of integrating a U.S.-style VC firm into a larger company. While class discussion will first focus on the differences between the national context for venture capital in Japan and the U.S., class discussion should show that the challenge of managing JAV might not be so much an issue of national cultures but of company size and culture. JAFCO is a large firm by U.S. VC standards while JAV is a small firm. JAFCO's managers are compensated under a flat salary plus bonus system while JAV's managers are compensated primarily through a carried-interest structure driven by the performance of their investments. The question can then be raised how sustainable a small VC firm structure is as part of a large firm. This question is highly relevant to many large firms who contemplate establishing internal venture capital funds. Third, the case can be used to assess the international expansion of a financial services firm. JAFCO initially entered the U.S. in order to raise capital for investment in Japan. Only over time did the firm decide to create a U.S.-style VC firm that would invest Japanese capital in the U.S. Class discussion can highlight the fact that this 'piggybacking' of activities without a detailed understanding of the requirements for success in the U.S. VC industry will lead to suboptimal results. Class discussion can then assess the leadership performance of JAV's chairman, Hitoshi Imuta, and president, Barry Schiffman who are trying to turn JAV around. The case has been used with MBA students and executives at Harvard Business School as well as many other business schools.