Sponsor-to-sponsor sales barely registered during the first 17 years of Sunrise Capital’s life, but there have now been three in the past 24 months alone. The most recent of these is very much on trend.

The Japanese mid-market private equity firm confirmed the sale of Earth Technology, a bilingual IT services provider, in October 2024 to an unnamed financial sponsor of Chinese heritage. It underlines Earth Technology’s cross-border expansion potential and Japan’s status as a priority market for China-centric investors looking to diversify.

Sunrise has worked with Chinese counterparties before. It sold a majority stake in Baroque Japan in 2013 – 32% to Belle International, 23% to CDH Investments – enabling the apparel brand to build out a China presence ahead of an IPO. But the deal was exceptional for its time. Chinese sponsors are now descending on Tokyo in much greater numbers and facing competition from local mid-market GPs.

“It used to be that you sold to strategics and did the occasional IPO. We expected the sponsor-to-sponsor space to evolve, but that it would be closer to the large end of the spectrum. However, with all the capital flowing into Japan, the previous mid-cap GPs are now sizeable, and we see them participating in sponsor-to-sponsor transactions,” said Shota Kuwaki, a managing director at Sunrise.

“At the same time, some Chinese sponsors have put teams on the ground. In almost every process we run now, there’s a [domestic or international] sponsor in the top three bids.”

Other investors and advisors make similar observations. However, much as sponsor interest has contributed to Japan’s robust mid-market exits landscape in recent years, it is not yet to the point of dominance. While domestic strategic investors remain the most acquisitive counterparties, the nature of the participants in competitive processes points to a more diverse exit landscape.

“When we run processes, we are going to strategic investors in Japan and globally and to private equity buyers,” said Jeff Acton, a partner and head of the Tokyo office at BDA Partners.

“There is more interest from everywhere. That’s driven by attractive market factors in Japan, such as large B2B corporate client bases, good technical capabilities, and strong underlying business fundamentals. Perhaps more importantly, there is a higher ability to get deals done than in the past.”

Size matters

Asia exits have struggled in the wake of the 2021 post-pandemic boom, failing to replicate the steady ascent that characterised the industry through 2018, according to AVCJ Research. Sponsor-to-sponsor sales represent the most meaningful upward trend. Their share of proceeds went from 19% in 2015-2019 to 37% in 2020-2024, climbing steadily to an all-time high of 45% last year.

Japan is one of the region’s bright spots. Private equity and venture capital exit volumes have increased in each of the past two years: the 2024 total of USD 11.8bn is not far from the 2021 peak of USD 14.9bn and nearly twice the annual average for 2015 through 2019.

The sponsor-to-sponsor share has risen from 6% during that period to 32% in 2020-2024 without plotting a course to becoming the single largest source of exit proceeds as seen in Asia as a whole. This reflects the distorting impact of intermittent transactions in a relatively shallow large-cap market. Based on exit count rather than exit proceeds, sponsor-to-sponsor is in the low single digits.

The larger an asset becomes, the smaller the pool of potential acquirers. Of Japan’s 12 largest private equity exits to date for which valuations are known, five are sponsor-to-sponsor transactions. Three of those were announced in the past 18 months, capturing the increased appetite of pan-regional and global private equity firms. Two of the three largest trade sales involved foreign buyers.

When domestic strategic investors are willing to engage, there tends to be a compelling rationale. “For a very strategic acquisition, strategic buyers will pay a lot of money,” said Tetsuo Tsujimoto, a partner in Baker McKenzie’s M&A practice group.

Two industry participants cite Nippon Life Insurance’s USD 1.4bn acquisition of Nichii Holdings from Bain Capital in 2023 as an example: the company already had partnerships with Nichii and saw the commercial logic of expansion into nursing care in a rapidly ageing economy. However, plenty of others tap well before reaching that mark.

“A USD 1bn deal isn’t easy for a strategic investor. Either it’s a once-in-a-couple-of-decades opportunity for them to really go in, or they’re big enough that it doesn’t move the balance sheet needle significantly,” said TJ Kono, a partner at Unison Capital. “Once valuations get to USD 600m and above, that’s more the sweet spot for pan-regional and global GPs that can write a USD 300m cheque.”

Hiroshi Hayakawa, a partner at Advantage Partners, agreed that valuations of USD 300m-USD 500m are viable for strategic investors, but it becomes harder past the USD 800m mark.

Scale proposition?

Japan typically sees no more than a handful of USD 500m-plus exits in any one year. The uptick in deal count – a record 144 transactions in 2023 were eclipsed by 177 in 2024 – is chiefly the work of the middle market. Trade sales invariably account for over half of these deals.

In some cases, private equity firms are reluctant to look beyond a known circle of likely strategic suitors. T Capital Partners announced the sale of Hikari Metal Industry, which produces decorative parts for automobiles and industrial equipment, to Dainippon Printing for an undisclosed sum. The private equity firm, which secured a 2.7x return, selected 10 potential candidates, all with manufacturing backgrounds.

“We doubled EBITDA during our holding period, but the company is perhaps still too small for most private equity investors,” said Koji Sasaki, a managing partner at T Capital. “In addition, we think there is limited future growth for private equity, whereas manufacturing companies that know this industry and purchase products from Hikari Metal are going to be more interested.”

Of T Capital’s 22 exits, two have been to financial sponsors. One of these, Bushu Pharmaceuticals, was scaled to the point where it appealed to larger managers. T Capital doubled production capacity and quadrupled EBITDA, thanks in part to a bolt-on acquisition, and sold to EQT (then Baring Private Equity Asia) for JPY 77.3bn (USD 541m). EQT sold to KKR in 2023, so Bushu remains in PE hands.

Unison rode the same pan-regional wave. It acquired Ayumi Pharmaceutical in 2012, becoming the third consecutive private equity owner, and engaged in M&A to create a more focused business likely to appeal to strategic players. Seven years later, Blackstone bought Ayumi for about USD 1bn. It was the firm’s first PE buyout in Japan and an early statement of intent from the large-cap crowd.

If sponsor-to-sponsor activity continued to be concentrated at the top of the market, Sunrise, which is currently deploying its fifth fund of JPY 78.5bn, having upsized from JPY 48bn in the prior vintage, likely wouldn’t feature. However, the opportunity set has been expanded by the emergence of tiers within Japan’s middle market: call them lower, upper, super, and foreign.

The counterparty in Sunrise’s two remaining sponsor-to-sponsor sales from the past 24 months was Advantage (most recent fund: JPY 130bn). Advantage has also bought from Longreach Group (JPY 78bn) and sold a different asset to Integral Corporation (JPY 250bn). Longreach has bought from J-Star (JPY 75bn) and sold to Polaris Capital Group (JPY 150bn).

“If we buy an asset at say a USD 200m enterprise value and get the value creation right, we can move it up to a size where it is just large enough for the big global funds and a good size for the larger local funds,” said Mark Chiba, group chairman of Longreach. “There is a lot of demand in the upper mid-market and lower big cap category now, especially as more larger investors are trying to get into Japan.”

Longreach has received enquiries from non-Japanese GPs about a 600-outlet café platform it built through three separate deals. Chiba believes financial sponsors are most interested in scalable consumer and healthcare businesses as well as asset-light companies in areas like digital transformation and outsourced business services that play into Japan’s labour and demographic challenges.

Moreover, they will bid aggressively for the right assets, destroying the notion that corporates can always pay a premium because of a lower cost of capital and potential post-deal synergies.

“Private equity buyers often have more flexibility with leverage, and proven value creation playbooks and growth strategies that can support winning bids,” added Paul Ford, a Japan-based partner at KPMG.

Situation specific

BDA’s Acton points to good cash flow generation, a consistent track record of margin expansion, and a clear growth pathway as the key characteristics for PE buyers. That said, BDA’s recent advisory mandates demonstrate that assets can end up with a particular owner for idiosyncratic reasons.

NSSK ended up exiting Japan Energy Components to local welding equipment player Obara Group because of “strategic considerations.” Meanwhile, Advantage’s sale of printed circuit board maker FICT to MBK Partners was intended to ensure harmony within the customer base. US-based semiconductor testing specialist FormFactor, one of several interested parties, was restricted to a minority stake.

“FICT has customers all over the world. If the company were sold to a strategic buyer that was also a customer, there would be potential conflicts of interest,” said Advantage’s Hayakawa. “FormFactor is a customer of FICT and also collaborates with the company. I believe it knew it couldn’t buy the business alone, so taking a 20% stake alongside a financial sponsor was fair to all concerned.”

Advantage’s second exit of 2025, which has yet to close, will see metalworking machinery manufacturer Amada Group buy Via Mechanics. Asked why it went to a strategic investor – given Advantage acquired the business from Longreach – Hayakawa highlighted efforts made to narrow the product range and clearly define Via Mechanics as a laser machining technology specialist.

Conversely, J-Star’s debut sponsor-to-sponsor transaction came in 2023 when Longreach picked up HR services player J-CEP. Kenta Shima, a partner at J-Star, suggested that private equity prevailed because “they could calculate future growth through M&A in their underwriting.” This is harder for strategics.

J-Star is to date the only Japanese GP to generate liquidity through a single-asset continuation vehicle (CV). It would be selective in utilising this structure again, Shima said, flagging challenges around stakeholder management and conflicts of interest. Other investors are equally circumspect, questioning whether CVs are necessary when traditional exits are available and preferred by Japanese LPs.

Buybacks also play a niche but not unwelcome role in Japan’s exit narrative. Sunrise and J-Star have completed a handful between them, generating adequate to outsize returns. They typically emerge once private equity has demonstrated that businesses can operate sustainably on a standalone basis and management teams want to secure full autonomy, ultimately with a view to going public.

IPOs, while not exactly marginal, remain a road less travelled for mid-market GPs. Once again, scale is a decisive factor. Rise Consulting Group represented a windfall for Sunrise – a partial exit at IPO with a 7x return, a recent sell-down at a premium to the IPO price – but Kuwata is wary of listing on the growth board, which is populated by retail investors and heavily swayed by market rumour.

“A lot of the large sponsors like IPOs because their companies are above USD 500m in enterprise value and they go straight to the Prime Market, which is institutional investors,” he explained. “If it’s a mid-cap company and you grow it 3x to somewhere below USD 300m, you wouldn’t get traction on the Prime Market, so you are left with the Growth Market, where it’s harder for IPOs.”

The Growth Market’s weak performance – captured in an index that has lost value since its introduction in early 2023, while the equivalent prime index is up more than 40% – is a source of broader disquiet. Measures under consideration include increasing the minimum equity requirement to maintain a listing.

Unison has only done one IPO in its history, and according to Kono, the public markets would rarely be considered “the singular primary exit route.” Others remain more upbeat.

“While listing requirements have become more stringent due to the trend toward stronger corporate governance, IPOs remain a viable option,” said Jun Niki, a founding partner at D Capital. “In addition, many companies are actively pursuing M&A opportunities to enhance capital efficiency, making trade sales another promising exit route.”

Valuation arbitrage

The reliance on trade sales will continue – all sponsors that spoke to AVCJ attest to this, even as they field dozens of enquiries from non-Japanese peers keen on entering the market. The lingering question is whether returns can be maintained, which is less a function of the mode of exit as how private equity firms get into deals and what they do when there.

Providing succession solutions to ageing founders is the dominant middle market thesis. Investors buy at low valuation multiples, often single-digit, and then set about professionalising operations. Management teams are upgraded; reporting and governance protocols are implemented; performance-tracking systems are introduced. There might be selective add-on acquisitions.

For the likes of J-Star, Sunrise and T Capital, the succession playbook hasn’t changed much, maybe just become more nuanced. And LPs are not complaining, based on recent fundraising data.

Sam Robinson, a senior advisor at family office North-East Private Equity Asia, estimates that Japanese managers deliver more investments of 3x and above in yen terms than any other market in Asia. There is still some volatility within portfolios, but good outcomes are generally sufficient in number to deliver fund-level returns of more than 2x.

However, Longreach’s Chiba isn’t convinced the status quo can last. “Buying cheap and selling at relatively high multiples had become standard in the Japanese middle market,” he said. “But as the age of easy multiple expansion ends, more must be done to achieve international standard value creation.”

Other industry participants have expressed similar views. Common criticisms include a lack of decisiveness and a reluctance to benchmark against global best practice. For example, Jun Tsusaka, CEO and CIO of NSSK, has previously highlighted shortcomings that prevent Japanese GPs from replicating the transformative impact of bolt-on acquisitions in the US and Europe.

While he accepts Japan is several years behind these markets on value creation, Robinson doesn’t necessarily see it eating into returns. First, sourcing remains a differentiator in the middle market despite increasing intermediation. Second, there’s so much white space to address.

“You’ve got inefficiency, cheap debt, massive barriers to entry, a private equity market that still isn’t large compared to the overall economy, fairly stable teams, reasonable fund sizes, and more or less consistent strategies,” Robinson said.

Unison’s Kono adds exit optionality to this list. “Appetite plus plentiful capital means liquidity and Japan hasn’t lacked that in 20-plus years,” he said. “Is it any different today? No. Japan can hang its hat on the idea of liquidity for the foreseeable future, at least at the mid-market level.”