An Overview of J-KISS in Japanese Startup Investments and Its Differences from SAFE and Convertible Notes

The startup ecosystem in Japan has experienced remarkable growth in recent years, attracting the attention of international investors. Amidst this vibrant activity, ‘J-KISS’ has become widely used as a crucial means for seed-stage startups to raise funds quickly and efficiently. J-KISS stands for ‘Keep It Simple Security,’ and as the name suggests, it is designed to simplify the fundraising process and expedite its progress. It is a template that adapts the investment contract know-how born in Silicon Valley, especially the concepts of ‘SAFE (Simple Agreement for Future Equity)’ and ‘Convertible Note,’ to fit within Japanese regulatory constraints, developed primarily by Coral Capital (formerly 500 Startups Japan).

The reason why J-KISS is valued in Japanese startup investments lies in its standardization, which reduces transaction costs, and its flexibility, which allows for the deferral of company valuation. These are the main benefits shared with SAFE and Convertible Notes. Traditional equity fundraising poses challenges, as early-stage company valuation is difficult and complex negotiations can be time-consuming and costly. J-KISS addresses this issue by adopting a form of ‘warrant for new shares,’ which converts into equity based on future company valuation. This allows entrepreneurs to focus on business growth, while investors can secure early-stage investment incentives.

This article will provide a detailed explanation of the legal nature of J-KISS, its key contractual terms, issuance procedures, and a comparison with similar fundraising methods abroad. Grounded in Japanese law, we will clarify how J-KISS functions under the Japanese legal system, citing specific legal provisions.

The Legal Nature of J-KISS and Its Comparison with Foreign Convertible Securities

In the Japanese legal system, J-KISS is positioned as a “stock acquisition right.” Article 2, Paragraph 21 of the Japanese Companies Act defines a “stock acquisition right” as “a right that allows one to receive the issuance of shares from a stock company by exercising the right” . This definition clarifies that J-KISS represents a future right to acquire shares, rather than shares themselves at the current time. Investors pay money to the issuing company as consideration for acquiring the stock acquisition right .  

The legal nature of J-KISS shares many similarities with the U.S. “SAFE (Simple Agreement for Future Equity).” SAFE is also designed not as a debt but as a simple agreement for future equity, without the concepts of interest or maturity dates. This allows startups to raise funds without the obligation to repay debts or bear the burden of interest, and founders can defer discussions on company valuation.

On the other hand, “convertible notes,” traditionally used for seed-stage fundraising, are personalityized as debt and thus recorded as “liabilities” on the issuing company’s balance sheet . This presented a disadvantage for startups, as it could make their financial health appear worse. However, since J-KISS takes the form of a “stock acquisition right,” the amounts paid by investors are recorded under the “equity” section of the balance sheet . This aspect, similar to SAFE’s avoidance of debt recording, offers a significant advantage in externally demonstrating a company’s financial health . The legal and accounting personalityistics of J-KISS, designed as a “stock acquisition right” and its paid-in capital being recorded as “equity,” are the result of the Japanese legal system’s recognition and resolution of practical challenges in startup fundraising, particularly the issue of worsening balance sheets due to debt recording. This goes beyond mere legal classification, indicating a policy intent and adaptation to market needs, and serves as evidence that the Japanese legal market is actively contributing to the development of the startup ecosystem. For foreign investors, it is a positive signal that the Japanese legal environment is evolving.  

Another significant feature of J-KISS is the availability of standardized contract templates for public use. This allows investors and startups to significantly reduce the time and legal costs associated with individual contract negotiations and amendments, enabling rapid fundraising. This standardization, similar to the benefits shared with Y Combinator’s SAFE templates, enhances the predictability of transactions and provides an environment where especially early-stage startups can focus on their business.  

Key Contractual Provisions of J-KISS and Their Legal Implications Under Japanese Law

Despite its standardized nature, the J-KISS investment agreement includes several key provisions that clarify the rights and obligations of investors and issuing companies. Understanding these provisions is essential for fundraising using J-KISS in Japan.

As J-KISS represents a warrant for future shares, it specifies various matters such as exercise price and conditions in the “issuance terms,” which are typically attached as an annex to the investment agreement. The conversion conditions of J-KISS primarily contemplate the following scenarios:

The most common conversion event is the occurrence of a “qualified financing round (next fundraising round).” J-KISS converts into shares issued in the next round of financing (such as Series A). The conversion price at this time is usually determined based on the more favorable of either the “Valuation Cap” or the “Discount Rate.” The Valuation Cap sets an upper limit on the company’s valuation at the time of the investor’s share conversion, allowing investors to acquire shares at a favorable price even if the company’s valuation exceeds the cap. The Discount Rate applies a certain discount (for example, 20%) to the share price at the next round of financing, enabling early investors to acquire shares at a beneficial price. These concepts of Valuation Cap and Discount Rate are mechanisms commonly used for investor protection in SAFE and convertible notes, and J-KISS follows these international practices. Notably, J-KISS 2.0 has introduced a post-money Valuation Cap, following the 2018 revision of SAFE, showing adaptation to international trends.

Next, a “merger and acquisition (M&A) event” can be a conversion condition. If an M&A occurs while J-KISS warrants are outstanding, investors may have the option to either convert their J-KISS into shares or have the issuing company buy them out without exercising the J-KISS. The J-KISS template may stipulate a cash redemption of twice the investment amount or conversion into common stock at the Valuation Cap. This resembles the investor protection clauses seen in SAFE and KISS (a convertible security developed by 500 Startups in the US) during acquisitions.

Finally, there is the scenario of “no qualified financing or acquisition within a certain period.” If no qualified financing or acquisition occurs by the conversion deadline (typically around 18 months), J-KISS may convert into common stock. This “conversion deadline” functions similarly to the maturity date of a convertible note, unlike the interest-free and maturity-free SAFE, serving as part of investor protection. The contractual provisions of J-KISS, particularly the Valuation Cap and Discount Rate, along with the incorporation of major investor rights, demonstrate a sophisticated balance that provides specific protection and incentives for early investors while allowing startups to enjoy the benefit of “deferring valuation,” reflecting a design that considers the distribution of risk and return in venture investments and indicates that Japan’s startup investment market is following international venture capital best practices.

The J-KISS investment agreement includes representations and warranties by both the issuing company and investors regarding certain facts. For example, the issuing company represents and warrants matters such as lawful incorporation and existence, authority to issue the warrants, compliance with laws, ownership of intellectual property rights, and no association with anti-social forces. Investors represent and warrant their own judgment, investment experience, and no association with anti-social forces. These representations and warranties are crucial for ensuring the transaction’s reliability and preventing future disputes.

The J-KISS template may define “major investors” as those who invest a certain amount and grant them special rights. These include the “right to request information,” where major investors have the right to request the company’s financial statements and information on business operations, ensuring access to important information for ongoing investment decisions. Another is the “right of first offer,” which gives major investors the right to preferentially subscribe to new shares issued in the next round of financing, allowing them to prevent dilution of their shareholding ratio due to future financing. These investor protection clauses are often not included in standard SAFEs but are features seen in KISS and convertible notes, suggesting that J-KISS places a greater emphasis on investor protection.

It may be stipulated that the issuing company will reimburse the reasonable legal fees and related legal expenses incurred by investors in connection with the issuance of J-KISS. Additionally, obligations for damages in the event of the issuing company’s breach of contract or representations and warranties are also defined.

Issuance Procedures for J-KISS and Related Japanese Legal Regulations

Since J-KISS represents a type of stock acquisition right under Japanese corporate law, its issuance requires strict adherence to the procedures stipulated by Japanese corporate law. This means that while the ‘simple’ aspect of J-KISS focuses on the negotiation of contract terms, legal procedures remain crucial. The fact that J-KISS, despite its ‘Keep It Simple’ slogan, necessitates strict issuance procedures (such as shareholder meeting resolutions and registration) under Japanese corporate law, reflects the formalistic nature of the Japanese legal system. This suggests a need to balance contractual flexibility with legal certainty, and for foreign investors, it necessitates adapting to the importance of formality in Japanese business culture.

The issuance of J-KISS stock acquisition rights, being paid rights, is conducted in accordance with the procedures for “issuance of solicited stock acquisition rights” from Article 238 to Article 247 of Japanese corporate law. These procedures primarily include the following steps:

To issue stock acquisition rights, it is necessary to determine the solicitation terms. For companies with a board of directors, the solicitation terms are determined by a board of directors resolution (Article 240, Paragraph 1 of Japanese corporate law) or by a decision of the directors (Article 238, Paragraph 2 of Japanese corporate law). For companies without a board of directors, the solicitation terms are determined by a decision of the directors. Subsequently, a special resolution at the shareholders’ meeting (Article 309, Paragraph 2, Item 9 of Japanese corporate law) is generally required. However, if the articles of incorporation provide for it or if there is unanimous consent from all shareholders, a deemed resolution of the shareholders’ meeting based on Article 319, Paragraph 1 of Japanese corporate law may also be utilized. At this shareholders’ meeting resolution, key terms such as the total number of stock acquisition rights and the exercise price are determined.

After the resolution at the shareholders’ meeting or the determination of solicitation terms, the issuing company enters into an investment contract with investors. Based on this contract, investors pay the consideration for the stock acquisition rights into the designated financial institution account, which serves as the payment handling place. The payment due date is usually the same day as the allotment date.

The issuing company of the stock acquisition rights must apply for registration related to the issuance with the Japanese Legal Affairs Bureau within two weeks from the allotment date. This registration is mandated by Article 915, Paragraph 1 of Japanese corporate law. The registration application requires attachments such as the minutes of the shareholders’ meeting, a shareholders list, and documents certifying the payment (if the payment due date is after the allotment date).

Comparing J-KISS, SAFE, and Convertible Notes Under Japanese Financing Practices

J-KISS was developed in Japan, inspired by funding mechanisms born in Silicon Valley, USA, such as ‘SAFE (Simple Agreement for Future Equity)’ and ‘Convertible Notes’, and tailored to fit the Japanese legal system. Understanding the similarities and differences between these instruments is crucial for international investors to grasp the personalityistics of J-KISS. The fact that J-KISS incorporates features of both SAFE and Convertible Notes in a ‘hybrid’ manner, and particularly that J-KISS 2.0 has swiftly adopted the latest trends in SAFE (post-money valuation cap), indicates that the Japanese startup investment market is highly sensitive to international trends and actively engages in ‘catching up’ and ‘optimizing’. This is not mere imitation but an ‘evolution’ adapted to the legal and market context of Japan, and for foreign investors, J-KISS represents a reliable investment vehicle that is ‘customized’ to suit Japanese personalityistics while understanding the global venture investment trends.

Below is a summary of the key comparisons between J-KISS, SAFE, and Convertible Notes.

The Advantages, Disadvantages, and Practical Considerations of J-KISS

J-KISS brings numerous benefits to the Japanese startup ecosystem, but there are also several important considerations to keep in mind when utilizing it.

Advantages for Entrepreneurs

Valuing early-stage startups can be challenging, but J-KISS allows the deferral of concrete company valuation and investment terms until the next funding round. This is a key advantage shared with instruments like SAFE and convertible notes. It enables founders to avoid the risk of diluting their shares at a low valuation and to focus on growing their business. The ‘valuation deferral’ benefit of J-KISS is a practical and market-compatible solution to the intrinsic issue of ‘immature company valuation’ for seed-stage startups. However, this benefit comes with the hidden risk of ‘unexpected dilution’ in the future, suggesting a trade-off between ‘simplicity’ and ‘complete predictability.’ This trade-off provides a crucial lesson to foreign investors and entrepreneurs about considering not only the short-term benefits but also the long-term impact on capital structure when choosing funding methods.

Using standardized contract templates significantly reduces individual contract negotiations, legal fees, and coordination efforts, enabling rapid fundraising. This is vital for startups, which are prone to running out of funds. Unlike convertible bonds, the invested funds are recorded as net assets, which prevents the deterioration of the balance sheet and makes it easier to maintain external creditworthiness.

Advantages for Investors

By setting valuation caps and discount rates, early investors can secure incentives to acquire shares at favorable prices in the future. Options for monetary redemption at acquisition and set conversion deadlines provide investors with a degree of protection in worst-case scenarios, such as M&A due to funding depletion. Furthermore, the investment process is streamlined as complex due diligence and negotiations are unnecessary.

Practical Considerations and Disadvantages

While J-KISS defers valuation, there is a possibility that founders’ shareholdings may be diluted more than expected if the company’s value significantly increases in a future funding round. This is a point to consider with SAFE and convertible notes as well. J-KISS conversion terms account for multiple scenarios, such as qualifying funding rounds, acquisitions, and conversion deadlines, which can be complex to calculate and understand. In particular, setting the valuation cap often becomes a focal point in practical negotiations. While convertible securities like SAFE are widely used in the United States, it is noted that J-KISS is not yet sufficiently recognized within Japan.

J-KISS is an extremely effective means for seed-stage startups in Japan to secure funding quickly and flexibly. However, it is crucial to fully understand its personalityistics and consider the future impact before utilizing it.

Summary

The J-KISS, as explained in this article, is an extremely effective means for Japanese startups to rapidly and efficiently raise funds during their seed stage. Its legal nature as a “stock acquisition right,” standardized contract templates, and investor protection mechanisms such as valuation caps and discount rates, symbolize the maturity and internationalization of Japan’s startup ecosystem. Even when compared to foreign securities like SAFE and convertible notes, J-KISS offers unique advantages tailored to the Japanese legal system and market practices, making it an attractive option for both entrepreneurs and investors.

However, utilizing J-KISS requires strict adherence to the issuance procedures based on Japanese Corporate Law, an understanding of complex conversion conditions, and expert insight to accurately predict the impact on future capital structure. This is especially true for foreign investors and startups with foreign nationality aiming to expand their business in Japan, where a thorough understanding of the nuances of Japanese legal and accounting practices is key to success.

Monolith Law Office boasts a wealth of experience in handling numerous cases involving J-KISS, serving both domestic startups and investors from within and outside of Japan. With multiple attorneys who are fluent English speakers and possess both Japanese legal qualifications and foreign legal credentials, Monolith Law Office is capable of providing seamless legal services in both Japanese and English. From J-KISS contract negotiations to complex issuance procedures, registration applications, and future fundraising strategies, we provide robust support to our clients at every stage.