What Is J-KISS? How It Works, the Valuation Cap, and Its Advantages and Disadvantages

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

Seed-stage startups are sometimes offered financing through J-KISS by investors. Because the contract documents presented are short, only a few pages long, there are cases in which founders rush to sign without a detailed review. In the start-up phase of a business, securing development funds and working capital is urgent, and there also tends to be a desire to prioritize early receipt of funds and simplify the review of contract terms.

Where this article describes specific terms of the template, it uses J-KISS 2.01 as published by Coral Capital (Japanese) as the baseline. Earlier versions and individually modified contracts are checked against the actual document. I continually receive consultations on financings using J-KISS from the seed stage through pre-Series A.

J-KISS is a financing method in which, instead of issuing common shares or preferred shares on the spot, the company issues for value stock acquisition rights that convert into shares upon a trigger such as a future financing round. Legally, it is a transaction in which stock acquisition rights are issued, and shares are delivered in accordance with the exercise conditions, call provisions, and class and number of shares to be delivered set out in the terms and conditions of the stock acquisition rights.

J-KISS is a contract template for seed investment published by Coral Capital. It is widely known as a mechanism for raising funds quickly using convertible equity. The Ministry of Economy, Trade and Industry (METI) guidelines on the use of convertible investment instruments also position it as a representative method. In some situations, founders want to consult consistently not only on the issuance of J-KISS but on everything from incorporation and founders' agreements through Series A. In that case, you can check the scope of our services as outside counsel at Startup Legal and Fundraising Support.

Founders should be cautious about proceeding with the procedures merely on the understanding that this is a simple contract. In practice, the basic task is to make it possible, before issuance, to foresee how this financing will connect to the next Series A and to a possible future M&A transaction.

The Legal Nature of J-KISS and How It Differs from an Equity Financing

Legally, J-KISS is a transaction in which stock acquisition rights are issued. In practice, the word "conversion" is used for convenience, but it is a procedure in which shares are newly issued or delivered based on the exercise conditions and call provisions set out in the terms and conditions of the stock acquisition rights. To understand the reality of the process called conversion, it is necessary to check not only the contract documents but also the wording of the terms and conditions of the stock acquisition rights against each other.

In a financing through shares, the amount paid in, the number of shares and the shareholding ratio are fixed at the time of issuance. With J-KISS, on the other hand, it is not fixed at the time of issuance what class of shares, and how many of them, will be delivered in the future. Instead, the rules to be used for future calculations are agreed in advance. Representative examples are the valuation cap and discount, the qualified financing threshold and conversion deadline, the treatment of change of control transactions, etc., and various investor rights. Founders need to view these as terms that reserve the future shareholder composition.

In explanations of J-KISS, the phrase "you can raise funds without determining the current corporate value" is sometimes used. In early-stage companies, sales and user numbers fluctuate significantly, and there are cases in which it is difficult to agree directly on the issue price of shares. The idea of calculating the number of shares to be acquired once the corporate value becomes clear, such as in a future Series A, has practical advantages.

However, founders should be cautious about proceeding with the procedures on this understanding alone. In many cases, J-KISS sets a valuation cap. This is an arrangement that fixes in advance the upper limit of the valuation of the company at the time of future conversion. Even if the final issue price has not been fixed, the upper limit of the valuation used in the future calculation formula has been decided at the time of the financing. Even if the company receives a high valuation in its Series A, J-KISS investors may be able to acquire shares at a discounted share price based on the cap.

For founders, it is more accurate to see this as a transaction that fixes in advance the calculation formula used for future share delivery, rather than one that allows the determination of corporate value to be postponed. This understanding significantly affects the negotiating stance. Care is needed not to assume that J-KISS is easier than preferred shares simply because it is J-KISS. If founders sign without sufficiently examining the cap, the discount and the exit terms, they may face an unexpected reduction in their ownership at Series A. With J-KISS, part of the valuation negotiation is replaced by agreement on calculation rules. Negotiating those rules continues to be highly significant.

Because J-KISS is an issuance of stock acquisition rights for value, there is no maturity or repayment obligation if it remains unconverted. The differences from loan-type instruments are explained in Convertible Notes vs. J-KISS.

How Conversion Works and How the Valuation Cap Is Calculated

The valuation cap functions as the upper limit of the company's valuation when converting into shares in the future. The lower the cap, the more shares the investor can acquire in the future; the higher the cap, the relatively fewer shares are delivered upon conversion. J-KISS 2.0 adopts a post-money valuation cap. It is designed so that ownership calculations remain easy to project even when multiple financings are carried out. The advantage of the post-money type is that, simply by dividing the investment amount by the cap, a rough indication of the floor of the investor's ownership before new shares are issued in the next equity financing can be calculated immediately. For example, raising JPY 30 million with a post-money cap of JPY 300 million can be read as a term that gives that investor the equivalent of around 10% ownership.

However, the calculation of dividing the investment amount by the cap only indicates a rough floor of ownership for conversion calculation purposes. Dilution from the issuance of new shares in the next Series A and from the expansion of the option pool accompanying the financing occurs separately. Where multiple J-KISS instruments have been issued, it is also necessary to confirm individually the scope covered by the stock acquisition rights of the same type and the calculation terms of each round. Only by modeling a capitalization table before and after the Series A, rather than just looking at the cap figure, can the full picture of the impact be understood.

The discount is a term under which the investor can receive delivery at a price discounted by a certain percentage from the share price at which new investors subscribe in a future round. The METI guidelines on convertible investment instruments give 20% (a factor of 0.8) as an example of the default value in J-KISS. This is not a fixed rate mandated by law, and the actual percentage is subject to negotiation.

The point to note is not to look at the cap and the discount in isolation. On the same assumptions, the price obtained by applying the discount to the Series A issue price per share is calculated. In addition, the price obtained by dividing the post-money cap by the prescribed fully diluted share count is also calculated, and the lower of the two is adopted. The cap is a mechanism that gives investors a lower share price by setting an upper limit on the company's valuation, and it does not guarantee a floor for the share price. Because which of the two applies changes depending on the valuation assumptions, the outcomes are modeled and compared under multiple scenarios.

If the business grows rapidly and receives a high valuation in its Series A, a low cap has a powerful effect. The conversion price for J-KISS investors is kept low by the cap. This can be described as legitimate consideration for investors who took on the early-stage risk. From the founders' perspective, however, the percentage of ownership given up in the event of success is larger than if there were no cap and the price were linked to the share price. That said, where the calculation basis is fixed by a post-money cap, the investor's acquisition ratio does not continue to expand without limit merely because the valuation rises. By contrast, with a discount-only design, the conversion price is determined in line with the next valuation, so there is no effect of fixing an upper limit as with a cap.

A qualified financing, which triggers conversion, is generally designed so that the rights convert into Series A preferred shares or the like when an equity financing of at least a certain size is carried out. Coral Capital's published materials indicate a guideline of an equity financing of JPY 100 million or more. However, the terms and conditions of 2.01 determine this based on the amount raised excluding the total issue amount of the shares issued upon conversion. It is important to check the defined terms in the contract and the terms and conditions, not just the summary in the published materials. The next round may be a small financing through common shares or a bridge financing. In that case, care is taken not to overlook whether it qualifies as a qualified financing and how the rights are maintained if no conversion occurs.

The timing of the expansion of the stock option pool also significantly affects the founders' ownership. In discussions with Series A investors, whether the pool is created before or after the new financing becomes an issue, and this choice changes who bears the burden of dilution. In calculating the fully diluted share count under 2.01, the prescribed unissued pool is included, while any increase in the pool in connection with the next equity financing is not. Treasury shares and treasury stock acquisition rights are also excluded. In addition, if there are J-KISS instruments that convert at the discount, the provisions of the terms and conditions that recalculate the denominator by incorporating the number of shares after their conversion are followed. If J-KISS conversion and pool expansion coincide without these points being understood, the reduction in the founders' ownership will be larger than expected.

It is also necessary to consider cases in which an additional J-KISS financing or a bridge financing is carried out before the Series A. Decisions arise such as whether to set the second cap at the same amount as the first or to add the amount raised. Where it is difficult to differentiate the corporate value because the timing is close, there are examples of setting the same amount. However, if multiple caps coexist, multiple conversion prices also arise, so a conversion calculation reflecting each set of terms is required. When raising funds through J-KISS from multiple investors at different times, terms may differ from investor to investor. This in itself is not immediately unfair, but if the company is not prepared, before the Series A, to explain the reasons to subsequent investors, it will struggle with questions about the differences in terms. It is necessary to confirm each time whether the explanation holds up as reflecting differences in the timing of investment, the risks assumed, or the support provided.

The Content of the Main Clauses and the Treatment of Investor Rights

The advantage of J-KISS lies in the speed and transparency gained by using the published template as is. Unless you first check whether the contract in hand is the template as is or has been modified somewhere, this premise breaks down. In actual transactions as well, it is not uncommon for the parties to have modified the template. As a clue for identifying changes, the J-KISS template contains, at the beginning, a sentence to the effect that "this agreement has not been modified from the published template, except for blanks and bracketed portions." In actual transactions, this sentence itself is sometimes deleted when the template is modified. This is done to avoid inconsistency with the individual modifications, and the deletion of this sentence is a strong clue for confirming the existence of individual modifications. However, even if the sentence remains, other clauses may have been modified, so in either case the contract is compared with the published template of the relevant version to identify the differences.

A typical example of modifications made in past transactions is the structure of the conversion price itself. The basic form of the template is designed to select the lower of the price after applying the discount and the price based on the cap. In actual transactions, however, there are also rearrangements in which conversion in a qualified financing uses only the discount, and the cap is retained only as a reference price upon arrival of the conversion deadline or in an M&A transaction. Conversely, there are also irregular forms for angel investors in which the discount is set at 0% (a factor of 1.0) and the cap is set at a high level at which it effectively does not function. Even in this case, if the cap clause is deleted entirely, the conversion share price upon an M&A transaction or upon arrival of the deadline cannot be calculated unless a Series A takes place. Even when relaxing the terms, it is necessary to identify the framework that should be retained.

The amount threshold for Major Investors is also frequently changed. Under the template, an investor whose amount paid in, aggregated with that of its related parties, is JPY 5 million (the default value) or more qualifies as a Major Investor. The company is obliged to provide financial information and preemptive rights, and also to grant the rights given to major investors in subsequent investment-related documents. Changing this amount threshold changes which investors receive which rights. In a round in which multiple individual investors participate with small amounts, this design directly affects the burden of subsequent investor management. The preemptive right granted to Major Investors is not a right proportional to the shareholding ratio. It is a right to participate in an offering on the same terms within the remaining allowance, calculated by deducting amounts previously participated in from a cumulative cap of twice the amount paid in under the agreement. The issuance of stock options is excluded. Note that even if the investment amount is small, the contractual rights are not necessarily limited.

The majority investor clause is also a provision that should be checked in investor management. A framework is provided under which, if investors holding a majority of the total issue price and the company agree in writing, the terms of the J-KISS of the same series can be amended or waived. However, matters such as assignment of rights, expense bearing and indemnification, cooperation obligations, the amendment clause itself, and the rights under Section 5.2 (limited to cases where only the investor in question is a Major Investor) are excluded. Amendments to these exceptions set out in Section 5.13 require the individual written consent of the investor concerned. Procedures under the Companies Act are also carried out separately. While there is a path to amend terms with majority agreement, important clauses are subject to individual protection, so it is important to understand at the time of issuance who constitutes the majority.

The practical operation of the most-favored-nation (MFN) clause also needs to be anticipated in advance. The template provides for a notification obligation if the company issues subsequent stock acquisition rights or similar instruments covered by the clause between the completion of payment and conversion. The company is obliged to give written notice within 5 days from the execution date, attaching a copy of the agreement. Stock options are excluded, and not every issuance of common shares is subject to notification. However, the more investors there are, the heavier the burden of the notification procedures becomes.

Careful judgment is also important when entering into a side letter at the J-KISS stage. The METI guidelines also point out problems that arise when information rights or MFN clauses are established by a side letter. Even a short agreement can create substantive binding force close to that of a shareholders' agreement.

J-KISS is a separate contract from the investment agreement and shareholders' agreement entered into at Series A, but in practice they are closely linked. If the template is followed as is, at the time of a qualified financing, the investor acquires shares in accordance with the terms and conditions through the procedures for exercise or the company's call provision. The issue price per share of the preferred shares issued in the next round and the J-KISS conversion price may differ. In that case, the design is to deliver a separate series of preferred shares with adjusted terms such as the liquidation preference amount and the acquisition price used in calculating conversion into common shares. Section 5.9 provides that, if prescribed investment-related agreements are entered into in the next financing, the J-KISS investors also enter into those agreements upon exercise or conversion. This does not mean that the contractual rights automatically become the same, so the documents the investors join and the applicable clauses are checked.

To what extent J-KISS investors join the Series A agreements as parties is a point that tends to become an issue in practice. Even where they hold shares of the same class as the Series A investors, how far information rights and preemptive rights are made common affects the contract design. Founders confirm in advance the terms that will apply to each investor at Series A. In transactions with multiple J-KISS investors, the scope of each investor's participation is questioned again during the Series A negotiations. At that time, the discipline sought by the lead investor may conflict with existing arrangements. The situation in which preferred shares are issued at Series A can be checked in The Terms Founders Should Treat as Business Decisions in Preferred Share Investment Agreements.

Treatment When Unconverted and in Change of Control Transactions, etc.

When a change of control transaction, etc. is carried out, the design is for the company to acquire the stock acquisition rights not exercised by the day before the acquisition date set by the company, in exchange for cash equal to twice the issue price. Investors consider whether to exercise before the acquisition date in accordance with the conditions of the terms and conditions, acquire shares at a price based on the cap, and participate in the transaction. The company notifies the terms of the transaction in writing at least 2 weeks before the acquisition date (or, if none is set, the transaction execution date).

Change of control transactions, etc. include M&A transactions that satisfy prescribed conditions such as a shift of voting rights, as well as the disposition of all or substantially all assets, dissolution and liquidation, and an IPO. However, the exceptions in the definition, such as the establishment of a wholly owning parent company that substantially maintains the previous voting ratios and share issuances for purely financing purposes, are checked. In some cases, a clause requiring the investor's prior consent for share transfers by the founders has been added to the individual contract. The terms in the published template and the additional terms are distinguished.

As for the arrival of the conversion deadline, the METI guidelines introduce a framework under which the rights can be converted into common shares at the investor's request after 18 months or more have elapsed. The template's design includes a provision for the case where no qualified financing occurs even after 18 months have elapsed from the allotment date. In this case, the rights can be exercised with the approval of a majority of the total issue price of the stock acquisition rights of the same type as defined. The rights are not automatically converted into shares or redeemed for cash as a matter of course. If the company cannot raise funds by the deadline, it discusses with the investors matters such as whether to agree to extend the period. The deadline functions less as a date for automatic processing than as a milestone for beginning discussions with investors based on the progress at that point.

If the conversion deadline is too short, the company may be forced into a hasty financing contrary to its business plan. Conversely, if the deadline is ambiguous, investors cannot form expectations. Based on development progress, hiring plans and the time needed until the next financing, it is necessary to set the clause while anticipating with whom and on what terms discussions will take place when the deadline arrives. It is important to know who the investors holding the majority are.

The Issuance Procedure and the Relationship with Existing Shareholders

J-KISS is issued as stock acquisition rights offered for subscription under the Companies Act. In a non-public company, the subscription terms are in principle determined by a special resolution of the shareholders' meeting, but it is also possible to delegate the determination to the board of directors or similar body by a resolution of the shareholders' meeting. In a public company, the terms can be determined by a board resolution unless the issuance is on favorable terms. If the company has issued classes of shares, whether a class shareholders' meeting is required is also checked.

In practice, attention to contractual relationships with existing shareholders is indispensable, beyond the statutory procedures. This is because past investment agreements and shareholders' agreements often include matters requiring prior consent, preemptive rights, and restrictions on issuing stock acquisition rights.

Failing to notify or consult existing shareholders not only damages relationships but also carries the risk of leading directly to a breach of representations and warranties to the new investors. Section 3.1 of the J-KISS template contains a representations and warranties clause. The company warrants that, to its knowledge (KNOWLEDGE), the execution and performance of the agreement and the issuance do not violate existing contracts in any material respect (MATERIAL). Section 5.5 provides for indemnification for damages and the like arising from or relating to a breach of contract or inaccuracy of representations and warranties. Reasonable attorneys' fees are included, but damages and the like caused by the investor's willful misconduct or gross negligence are excluded. If an existing investment agreement provides for an obligation to give prior notice at least 2 weeks in advance or similar requirements, omitting the notice may constitute a breach of the existing agreement. On that basis, it is checked whether this would also constitute a breach of representations and warranties to the new J-KISS investors in light of the company's knowledge and the materiality of the breach. Even when there is pressure to receive funds quickly, reviewing existing contracts is the top priority.

There are also requests to consider the issuance of J-KISS from the standpoint of an existing shareholder. These include cases considering a design in which an existing loan receivable against the company is applied to the payment for stock acquisition rights. Under Article 246, Paragraph 2 of the Companies Act, the company's consent is required, and the payment method under the contract and the tax treatment are checked. Delivery in lieu of payment for stock acquisition rights is at a different stage from an ordinary DES in which shares are acquired directly. In this case, if the design converts into preferred shares, the existing common shareholders become subordinated in the distribution of residual assets, so there may be moves to request amendments to a clause under which the rights always convert into common shares.

When individual investors participate, the requirements of the Angel Tax System must also be checked. There is a tax special provision for stock acquisition rights issued for value acquired on or after April 1, 2024. If the requirements are met on the exercise date, the system is designed so that the acquisition cost may be included in the acquisition price of the target shares. However, tax benefits are not necessarily fixed automatically at the time of investment, so it is safe to be in a position to confirm with tax professionals the preparation of the advance confirmation application and the tax return materials.

The procedural burden at the time of future conversion also needs to be anticipated in advance. The procedures for exercise or acquisition by the company proceed in line with the execution of the Series A. Exercise notices from each investor, the company's acquisition procedures, obtaining consents to any necessary changes in terms, and registration of changes are carried out. Furthermore, work such as updating the stock acquisition right register and the shareholder register arises all at once, in parallel with the Series A payment procedures. In a company that has already issued preferred shares, a resolution of a class shareholders' meeting may be required. The procedures for actual conversion at Series A are explained in detail in J-KISS Conversion (Exercise) Procedures: A Practical Guide to Avoid Scrambling at Series A.

Comparing the Advantages and Disadvantages of J-KISS

In deciding whether to adopt J-KISS, it is necessary to make an overall assessment by contrasting the advantages and points of caution from the perspective of the issuing company and the founders. While using a standardized contract enables fast financing, consideration must be given to the impact on future capital policy and procedures.

Advantages	Points of Caution (Disadvantages)
Speed and transparency	The shareholding ratio is not visible at issuance
Agreement on valuation can wait until the next round	The ownership given up because of the cap becomes larger in the event of success
No maturity or repayment obligation if unconverted	Terms become layered with multiple issuances
Short contract documents and a light administrative burden at signing	Procedures such as exercise, acquisition and registration arise all at once upon conversion

As shown above, while J-KISS offers excellent flexibility at the time of contracting, it also has the aspect of deferring the burden of future share delivery and procedures. Please decide whether to adopt it with an eye not only to the immediate speed of receiving funds but also to the effects on subsequent financings and organizational management.

Modeling the Capital Policy and Preparing Documents Before Issuance

Founders undertaking a J-KISS financing need, before signing the contract, to check the matters that can be confirmed from the materials at hand and to prepare the necessary documents in one place. The items to check before entering final discussions with investors are as follows.

• Understanding the floor of ownership before the issuance of new shares in the next round, based on the figure obtained by dividing the investment amount by the post-money cap
• Formulating a policy for the cap design of each round if J-KISS is issued multiple times
• Anticipating the counterparties and negotiation terms for discussions if the Series A has not been achieved when the conversion deadline arrives
• Checking whether there are obligations to give prior notice or obtain prior consent under contracts with existing shareholders
• Anticipating the exercise and acquisition procedures, obtaining of consents and registration of changes that will arise upon conversion at Series A

The preparatory documents to have ready before issuance are as follows.

• Conversion simulations under multiple scenarios
• A list of changes that distinguishes items filled in from items modified in the published template
• A policy for connecting to the next round that sets out the content of the preferred shares at Series A and the timing of pool expansion
• Materials reviewing existing contracts that summarize restrictive clauses in past investment agreements and shareholders' agreements
• An investor rights memo that organizes Major Investor status, the scope of information provision and preemptive rights
• Procedural documents under the Companies Act, such as shareholders' meeting minutes, the terms and conditions of the stock acquisition rights and registration documents

In preparing conversion simulations, multiple assumed Series A valuations are set, and the shareholder composition is modeled both when the cap applies and when the discount applies. In the calculation, treasury shares and treasury stock acquisition rights are excluded in accordance with the definition of the fully diluted share count under 2.01. On that basis, the assumptions of including issued stock options and the prescribed unissued pool and excluding the increase in the pool accompanying the next financing are reflected accurately. If there are J-KISS instruments that convert at the discount, the figures are reconciled in accordance with the provisions of the terms and conditions that recalculate the denominator by incorporating the number of shares after their conversion. J-KISS instruments issued in multiple rounds are not necessarily treated as stock acquisition rights of the same type as a matter of course, so the terms and conditions of each round are checked.

In the list of changes, items filled in and items modified are organized separately even where the published template is used as the basis. If the caps and discounts that differ by investor are listed, the list can be used as is in the Series A due diligence procedures. As a policy for connecting to the next round, the content of the preferred shares to be delivered at Series A and the form of participation in the investment agreement are clarified. Whether consent from existing shareholders needs to be obtained and the timing of pool expansion are also briefly written down. Even a policy document of a few lines serves as a starting point that supports a smooth initial response toward the next financing.

In the materials reviewing existing contracts, restrictive clauses such as those in past investment agreements and matters requiring prior consent are identified, and notice deadlines and consent requirements are checked. In the investor rights memo, Major Investor status, the scope of information provision, whether preemptive rights exist, and the composition of the majority under the majority investor clause are ascertained. As procedural documents under the Companies Act, shareholders' meeting minutes and registration documents are prepared. If you will continue to consult the same counsel on day-to-day contracts and through the next round after issuing J-KISS, How Startups Should Choose Outside Counsel explains how to check fundraising experience, deliverable formats, response times and fee terms. When rushing to accept the terms presented, attention tends to focus on the amount raised and the date funds will be received. However, because this is a contract that determines the future shareholder composition, there is a risk of misjudgment unless it is considered together with the capitalization table.

Frequently asked questions

What kind of financing method is J-KISS?

It is a financing method in which, instead of issuing common shares or preferred shares on the spot, the company issues for value stock acquisition rights that convert into shares upon a trigger such as a future financing round. Its feature is that the share price and the number of shares to be delivered are not fixed at the time of issuance; instead, the rules for future calculation are agreed in advance so that the financing can proceed quickly.

What is the valuation cap in J-KISS?

It is a term that functions as the upper limit of the company's valuation upon future conversion into shares. By dividing the investment amount by the post-money cap, a rough indication of the floor of ownership before new shares are issued in the next equity financing can be obtained. Even if the company receives a high valuation in its Series A, investors may be able to acquire shares at a discounted share price.

What happens when the J-KISS conversion deadline arrives?

If no qualified financing occurs even after 18 months have elapsed from the allotment date, the stock acquisition rights can be exercised with the approval of a majority of the total issue price of the stock acquisition rights of the same type. The rights are not automatically converted into shares and no money is refunded as a matter of course, so when the deadline arrives, the company discusses matters such as extending the period with the investors.

What are the main disadvantages of J-KISS?

They include that the shareholding ratio is not visible at the time of issuance, making dilution hard to grasp, and that the percentage of ownership given up because of the cap becomes larger if the business grows rapidly. Attention is also needed to the layering of terms from multiple issuances and to the practical burden of exercise and acquisition procedures, registration and the like, which all arise at once in the next financing.